According to Financial Times News, Federal Reserve Governor Lisa Cook warned Thursday that hedge funds’ growing basis trades in the $30tn Treasury market could magnify instability during periods of stress. These trades exploit tiny price differences between cash Treasuries and futures, with hedge funds now holding 10.3% of Treasury cash securities in Q1 2024—above the pre-pandemic peak of 9.4%. Fed research showed Cayman Islands-based hedge funds absorbed more Treasury issuance between January 2022 and December 2024 than all other foreign private holders combined. The trade was central to both the March 2020 Covid market panic and the 2019 repo crisis, forcing Fed intervention both times. Cook noted that while these trades improve market efficiency normally, their unwinding during stress could impact overall market functioning.
Why this matters now
Here’s the thing: we’ve seen this movie before. Twice in the past five years, these exact same trades have blown up and required Fed bailouts. And yet the positions have only gotten bigger. Basically, hedge funds are borrowing massive amounts to amplify tiny price differences, which works great until it doesn’t. When everyone tries to exit at once? That’s when the music stops and we get another March 2020 scenario.
The repo market connection
This isn’t just about Treasury prices—it’s about the entire plumbing of the financial system. These trades depend heavily on the repo market for funding. Remember 2019? That repo crisis was directly tied to basis trades unwinding. The Fed had to step in then, and they’ve been trying to build better safeguards since, like their Standing Repo Facility. But here’s the worrying part: even with those tools, we saw repo rates spike above the SRF borrowing cost in October. That suggests the system is still fragile.
What comes next
So what’s the Fed actually doing about this? They’re clearly paying attention—Cook’s speech wasn’t accidental. The Fed just announced they’ll halt quantitative tightening starting December 1, and several officials have signaled they might start expanding Treasury holdings early next year. That should help with liquidity. But let’s be real: regulators have been warning about this for years, and the positions keep growing. I think we’re looking at another case of regulators being several steps behind the risk-takers. The question isn’t whether another crisis happens—it’s when, and how bad it will be this time.
