Federal Reserve officials are concerned about leverage risks in the US bond market and emphasize the importance of the bond market's resilience development
Federal Reserve officials are paying attention to the leverage risks in the U.S. Treasury market. They discussed various potential risks in the financial system at their recent policy meeting, especially the impact of basis trading. Although basis trading remains popular in hedge funds and is seen as a potential issue, it has not increased market volatility at the moment. Meanwhile, the yields on 10-year and 30-year U.S. Treasury bonds have dropped to their lowest levels this year, indicating that the market is preparing for a possible rate cut by the Federal Reserve
According to the financial news app Zhitong Finance, at last month's policy meeting, senior officials of the Federal Reserve expressed concerns about several potential risks in the financial system, one of which is related to leverage in the U.S. Treasury market.
The minutes of the Federal Open Market Committee (FOMC) meeting held on July 30th and 31st were released on Wednesday. Many participants at the meeting viewed leverage in the U.S. bond market as a risk. When discussing financial stability, participants emphasized the importance of monitoring the resilience of the U.S. Treasury market.
Since last year, there has been increasing attention on the issue of leverage in the $27 trillion U.S. government bond market, especially in the so-called basis trading. Basis trading is a strategy that involves shorting in the U.S. Treasury futures market while going long in the cash market, and financing and leveraging the trade through the repo market.
A report released in August last year indicated that staff from the Federal Reserve and the U.S. Treasury Department highlighted the need for "continuous and rigorous monitoring" of hedge funds' use of basis trading.
Lawrence Gillum, Chief Fixed Income Strategist at LPL Financial in Charlotte, North Carolina, stated, "Basis trading remains very popular among hedge funds. It's an issue that the Federal Reserve has been watching for some time, but it hasn't increased market volatility. The bigger concern is that this type of trading has disrupted markets in the past and could disrupt them again in the future, but it's not an imminent risk at the moment."
In fact, the minutes of the July meeting of the Federal Reserve listed several other financial system risks that need attention. These risks include unrealized securities losses in the banking system, risks in commercial real estate exposure, and risks from cyber attacks.
Following the release of the Federal Reserve meeting minutes on Wednesday, the yields on 10-year and 30-year U.S. Treasury bonds fell to their lowest levels this year, as investors prepare for a possible rate cut by the Federal Reserve in September.
A report on Tuesday from foreign media indicated that leverage positions in the U.S. Treasury futures market had reached historic highs ahead of the Federal Reserve's annual symposium in Jackson Hole, Wyoming. Some of these leverage positions are related to basis trading