People say 'Treasuries have become a risk asset' because hedge funds hold a record amount of US Treasuries. Why can supposedly safe Treasuries become risky, and does this affect my stocks?

Why do hedge funds hold so many Treasuries?

Hedge funds' holdings of cash Treasuries reached $2 trillion at the end of 2025, about three times the level five years earlier. That is 7% of all marketable Treasuries, a record share (US Treasury Office of Financial Research, OFR, 2026-08-19). They buy Treasuries not because of a rate view. Most of it is an arbitrage called the 'basis trade.'

Here is how it works. They buy cash Treasuries and sell Treasury futures of the same maturity, capturing the small price gap between the two. Because the gap is so small, they borrow in the repo market (where money is borrowed overnight against Treasury collateral) and apply leverage of dozens of times. On the other side are pension funds and asset managers who want to buy Treasuries through futures. After capital rules following 2008 led bank dealers to shrink their Treasury inventories, hedge funds filled the gap.

How a safe asset becomes risky

The default risk of Treasuries themselves hasn't risen. The problem is the leverage of those holding them. The OFR warned:

"A disorderly unwinding of highly leveraged basis trades could amplify volatility in the cash and futures markets." — US Treasury Office of Financial Research, OFR (2026-08-19)

There are two triggers: a sudden spike in repo rates, or a sharp increase in futures margin. Hedge funds then dump cash Treasuries all at once to repay borrowed money. Treasury prices fall further and yields rise more, which triggers margin calls at other funds in turn. This chain of selling actually happened during the COVID shock in March 2020, freezing what is said to be the world's deepest market, and the Fed had to put out the fire with massive Treasury purchases.

This is where stocks come in. When Treasury yields spike, equity valuations are squeezed, and leveraged funds may also sell stocks to cover losses. That creates days when stocks and bonds fall together.

But the current rise in yields isn't following that path

There is also data to filter out exaggerated fears. Morgan Stanley estimated that leveraged basis trades shrank 20% this year to $1.2 trillion. Hedge funds' net short in 2-year futures has fallen by more than 40% from its March peak (Bloomberg via Kitco, 2026-09-24). The reason is shrinking profit opportunities. Easing of the banks' supplementary leverage ratio (SLR) rule let banks rebuild Treasury inventories, and Treasury buybacks supported prices of older Treasuries, narrowing the price gap.

"The basis position in the market has been declining because the opportunity set is lower." — Meghan Swiber, BofA (2026-09-24)

Morgan Stanley saw no evidence of broad market stress in this unwinding. In other words, the recent rise in long-term yields is driven mainly by a rising term premium and weaker foreign demand rather than forced hedge fund liquidation. The fact that some leverage has already come out reduces the risk of an abrupt collapse like March 2020. Still, positions remain above $1 trillion.

What should investors watch

• Repo rate spikes: If the secured overnight rate (SOFR) rises well above the top of the Fed's target range, it is a warning sign. Pay special attention at quarter-end and month-end
• Days when weak Treasury auctions coincide with yield spikes: Repeated weak auctions like the one on September 23 increase margin pressure on leveraged positions
• Stocks and long bonds falling together: If this lasts several days, forced liquidation may have started. At that point long bonds (TLT) fail to act as a hedge against falling stocks
• Positioning: If you want to use bonds to reduce equity risk, short-term and ultra-short bonds are better than long bonds. Short-term rates are tied to the Fed path and are less affected by these flow-driven accidents

In short, the claim that 'Treasuries have become a risk asset' is half right. The risk isn't that Treasuries will fail but that those holding them with leverage will wobble. That leverage is currently shrinking, so an immediate blowup is unlikely, but it is too early to rely on long bonds as a safety net.