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Treasury basis trading is a financial strategy that involves taking offsetting positions in a cash market instrument (typically a U.S. Treasury bond) and its related derivative, such as a Treasury
futures contract In finance, a futures contract (sometimes called futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The item tr ...
. The strategy seeks to exploit pricing discrepancies between the two instruments, which are expected to converge over time. It is a specialized form of
basis trading Basis trading is a financial strategy involving offsetting positions in a spot (cash) asset and a related derivative—most commonly a futures contract – aimed to profit from price convergence over time. The price difference is known as the bas ...
applied to U.S. government securities.


Mechanics of the trade

In a typical Treasury basis trade, a trader: * Buys a Treasury bond in the cash market (often financing the purchase via repurchase agreements, or repos), and * Sells short a corresponding Treasury futures contract. The expectation is that the price differential (or "basis") between the cash bond and the futures contract will narrow favorably before the futures contract expires. The trade becomes profitable if the bond price, plus coupon income and financing costs, is lower than the futures delivery price at expiration.


Definition of basis

"Basis" in this context refers to the difference between the price of a spot (cash) instrument and its corresponding futures contract. It is commonly calculated as: * Basis = Cash Price − Futures Price, though the reverse is also used in some contexts. Each futures delivery month may have a different basis, reflecting changes in interest rates, time to maturity, and liquidity conditions.


Leverage and risk

Treasury basis trading is typically executed with significant leverage. In the post-2008 regulatory environment – and especially beginning in the early 2020s – hedge funds have commonly executed basis trades with leverage levels of 10x to 20x (meaning the size of the position is 10 to 20 times the capital used to fund it). This level of leverage is often attractive when financing bond purchases through the repo market at relatively low cost. In practice, repo rates are typically quoted either as an annualized percentage (''e.g.'', 4.85%) or as a spread over a benchmark risk-free rate such as the Secured Overnight Financing Rate (
SOFR Secured Overnight Financing Rate (SOFR) is a secured overnight rate, overnight interest rate. SOFR is a reference rate (that is, a rate used by parties in commercial contracts that is outside their direct control) established as an alternative to L ...
) or the
Federal funds rate In the United States, the federal funds rate is the interest rate at which depository institutions (banks and credit unions) lend reserve balances to other depository institutions overnight on an collateral (finance), uncollateralized basis ...
. Pricing reflects collateral quality, duration, counterparty structure, and broader market liquidity conditions. Repo rates may tighten significantly when specific bonds are “on special” or during periods of elevated demand for secured financing. Leverage amplifies potential returns but also increases exposure to small price movements, margin calls, and liquidity shocks. If both the cash bond and the futures price move adversely, or if the basis widens unexpectedly (rather than converging), the trade can result in large losses. In times of market stress—such as sharp movements in Treasury yields or tightening repo conditions—forced unwinds of basis trades can exacerbate market volatility.


Market impact and current relevance

As of 2025, Treasury basis trades are estimated to account for $1 to $2 trillion in gross notional exposure, with a significant concentration among large hedge funds. This level of exposure has drawn increased scrutiny from regulators, including the
Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the Kingdom of England, English Government's banker and debt manager, and still one ...
, which in 2023 warned that hedge fund basis trades had reached a then-record high of $800 billion and posed systemic risks due to extreme leverage and liquidity strain during periods of market stress.


Academic and regulatory perspectives


Regulatory concerns

In December 2023, the
Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the Kingdom of England, English Government's banker and debt manager, and still one ...
's
Financial Policy Committee The Financial Policy Committee (FPC) is an official committee of the Bank of England, modelled on the already well established Monetary Policy Committee. It was announced in 2010 as a new body responsible for monitoring the economy of the United K ...
(FPC) raised concerns about the scale and risk of Treasury basis trades, noting that leveraged hedge funds had built up record short positions in Treasury futures—used as part of basis trading strategies. The FPC highlighted the potential for these positions to amplify market volatility during periods of stress, citing risks related to high leverage, low margin requirements, and the reliance on short-term repo financing. According to the FPC, while the basis trade can improve liquidity in normal conditions, it may act as a transmission channel for systemic instability in volatile markets. In 2023, global regulators — including the U.S.
Securities and Exchange Commission The United States Securities and Exchange Commission (SEC) is an independent agency of the United States federal government, created in the aftermath of the Wall Street crash of 1929. Its primary purpose is to enforce laws against market m ...
(SEC), the
European Union The European Union (EU) is a supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are Geography of the European Union, located primarily in Europe. The u ...
, and the UK
Financial Conduct Authority The Financial Conduct Authority (FCA) is a financial regulatory body in the United Kingdom. It operates independently of the UK Government and is financed by charging fees to members of the financial services industry. The FCA regulates financi ...
— intensified scrutiny of Treasury basis trades, citing concerns over
systemic risk In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to the risk associated with any one individual entity, group or component of a system, that can be contained therein without harming the ...
and hidden leverage in the shadow banking sector. New SEC rules were adopted to increase transparency in the Treasury market and limit certain forms of leveraged trading. In 2025, economists Anil Kashyap, Jeremy Stein, Jonathan Wallen, and Joshua Younger proposed the creation of a "basis purchase facility" to help the Federal Reserve manage risks arising from large-scale, leveraged Treasury basis trades. Rather than intervene through broad asset purchases — as it did in March 2020 — the Fed could instead buy Treasury securities while simultaneously selling futures to hedge interest rate risk. The authors argued that this approach would distinguish financial stability operations from
monetary policy Monetary policy is the policy adopted by the monetary authority of a nation to affect monetary and other financial conditions to accomplish broader objectives like high employment and price stability (normally interpreted as a low and stable rat ...
, limit
moral hazard In economics, a moral hazard is a situation where an economic actor has an incentive to increase its exposure to risk because it does not bear the full costs associated with that risk, should things go wrong. For example, when a corporation i ...
, and reduce pressure on bond dealers during disorderly unwinds. The proposed facility aims to prevent destabilizing forced unwinds by acting as a liquidity backstop while maintaining neutrality in interest rate policy.


Academic reflections

Finance professor Craig Pirrong has argued that Treasury basis trades may be viewed as a form of "leverage intermediation," allowing non-leveraged asset managers to indirectly access leverage through futures contracts, with hedge funds acting as intermediaries. Pirrong characterizes this process as "leverage laundering," where regulatory or institutional constraints on direct leverage lead asset managers to rely on structured exposure through futures. He asserts that this intermediation chain – spanning asset managers, hedge funds, dealer banks, and money markets – could introduce unnecessary systemic risk, especially during episodes of volatility or liquidity stress, such as the March 2020 "dash for cash."


Participants and market structure

Treasury basis trading typically involves a network of institutional participants that span the
asset management Asset management is a systematic approach to the governance and realization of all value for which a group or entity is responsible. It may apply both to tangible assets (physical objects such as complex process or manufacturing plants, infrastr ...
,
hedge fund A hedge fund is a Pooling (resource management), pooled investment fund that holds Market liquidity, liquid assets and that makes use of complex trader (finance), trading and risk management techniques to aim to improve investment performance and ...
, dealer banking, and short-term funding (''see
Money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As short-term securities became a commodity, the money market became a compo ...
and
Repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...
'') sectors.


Hedge funds and asset managers

Leveraged In finance, leverage, also known as gearing, is any technique involving borrowing funds to buy an investment. Financial leverage is named after a lever in physics, which amplifies a small input force into a greater output force. Financial leverag ...
hedge funds are the primary participants in Treasury basis trades. These funds use capital from institutional investors to take long positions in Treasury securities and short positions in Treasury futures, aiming to profit from price convergence. Some large asset managers may also engage indirectly in basis trading by allocating capital to hedge funds or structured investment vehicles.


Dealer banks and prime brokers

Dealer banks (''i.e.'', banks that make markets and provide repo/futures financing),
broker-dealer In financial services, a broker-dealer is a natural person, company or other organization that engages in the business of trading securities for its own account or on behalf of its customers. Broker-dealers are at the heart of the securities and ...
, and prime brokers provide financing for the long Treasury positions through the
repo market A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...
. They also facilitate short futures positions by providing margin accounts and clearing services. These institutions may act as intermediaries, earning fees and spreads, or as counterparties taking principal risk.


Repo and clearing infrastructure

The financing leg of the trade is often conducted in the triparty repo market or through bilateral repos. Key clearing entities, such as the Fixed Income Clearing Corporation (FICC), play a role in settlement and risk mitigation. The efficiency of this infrastructure affects the cost and stability of basis trades.


Central counterparties and futures exchanges

Short futures positions are typically cleared through central counterparties such as the
CME Group CME Group Inc. is an American financial services company based in Chicago that operates financial derivatives exchanges including the Chicago Mercantile Exchange, Chicago Board of Trade, New York Mercantile Exchange, and the Commodity Exchange. ...
.
Margin Margin may refer to: Physical or graphical edges *Margin (typography), the white space that surrounds the content of a page * Continental margin, the zone of the ocean floor that separates the thin oceanic crust from thick continental crust *Leaf ...
requirements, delivery options, and contract specifications influence which bonds are cheapest to deliver and therefore affect the basis calculation.


Regulatory and central bank oversight

Regulators and central banks monitor basis trading activity for systemic risk implications. In particular, the SEC, Federal Reserve, and Bank of England have raised concerns about the scale of hedge fund participation, reliance on short-term leverage, and the potential for disorderly unwind scenarios during periods of market stress.


History of basis trading

Treasury basis trading emerged in the early 1980s alongside the development of Treasury futures markets, particularly the introduction of the 10-year Treasury note futures contract on the Chicago Board of Trade. The strategy gained traction in the 1990s as hedge funds and proprietary trading desks began exploiting pricing differences between cash Treasury securities and their corresponding futures contracts. Use of the strategy expanded significantly after the 2008 financial crisis, as regulatory reforms pushed banks to reduce trading inventories, while hedge funds—often financing positions through the repo market—took on a growing role as intermediaries. Though legally permitted and long considered a form of market arbitrage, basis trading has drawn increased regulatory scrutiny in the 2020s due to concerns over systemic risk and hidden leverage.


See also

*
Arbitrage Arbitrage (, ) is the practice of taking advantage of a difference in prices in two or more marketsstriking a combination of matching deals to capitalize on the difference, the profit being the difference between the market prices at which th ...
*
Basis swap A basis swap is an interest rate swap which involves the exchange of two floating rate financial instruments. A basis swap functions as a floating-floating interest rate swap under which the floating rate payments are referenced to different bases ...
*
Futures contract In finance, a futures contract (sometimes called futures) is a standardized legal contract to buy or sell something at a predetermined price for delivery at a specified time in the future, between parties not yet known to each other. The item tr ...
*
Hedge fund A hedge fund is a Pooling (resource management), pooled investment fund that holds Market liquidity, liquid assets and that makes use of complex trader (finance), trading and risk management techniques to aim to improve investment performance and ...
*
Repurchase agreement A repurchase agreement, also known as a repo, RP, or sale and repurchase agreement, is a form of secured short-term borrowing, usually, though not always using government securities as collateral. A contracting party sells a security to a lend ...
* System Open Market Account – The Federal Reserve’s portfolio for Treasury and agency securities purchased via open market operations; used during crises to stabilize markets, including Treasury liquidity events relevant to basis trade dynamics.


Bibliography


Notes


References

* Retrieved April 10, 2025. ; .
    1. (ABI/Inform and Research Library database).
* * * * ; ; . * (ABI/Inform database). * Retrieved April 10, 2025. ; .
    1. (ABI/Inform and Research Library database).


General references

* {{DEFAULTSORT:Treasury basis trade Hedge funds Arbitrage Bond market Systemic risk