A surge in long-term U.S. Treasury yields is putting pressure on a widely used hedge fund strategy that bets on Treasuries outperforming interest rate swaps. Known as the “basis trade,” this strategy involves exploiting differences between Treasury bonds and SOFR-linked swaps. However, rising yields, driven by concerns over growing U.S. debt and fiscal sustainability, are compressing swap spreads and eroding profits.

The 30-year Treasury yield briefly crossed 5%, a level not seen in nearly two decades, while the 30-year swap spread narrowed to -94 basis points: its tightest in over a year. Similarly, the 10-year spread shrank to -59 basis points, triggering stop-losses for multiple banks. Societe Generale, among others, exited its position, reflecting the speed and severity of the squeeze.

The trade had gained popularity again this year amid speculation that U.S. regulators might ease supplementary leverage ratio (SLR) rules, allowing banks to hold more Treasuries without capital penalties. However, official guidance remains unclear.

With recent volatility echoing April’s tariff-driven selloff, many funds are reassessing their exposure. The combination of tighter swap spreads, uncertain regulation, and rising fiscal risks has turned this once-favored strategy into a minefield for traders.

End Notes

Source: https://www.hedgeweek.com/rising-yields-squeeze-swap-spread-bets/