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Many Happy Returns
Treasury Doom Loop: The World's Most Dangerous Trade?
Nov 22, 2023
This podcast explores the risks of the Treasury 'basis trade' and the concerns raised by regulators. It discusses the use of leverage by hedge funds and the potential consequences of market dislocations. The resurgence of the basis trade in the bond market and the risks associated with it are also covered. In addition, the podcast explains the difference between duration and maturity in bonds and how bond duration is used to measure risk.
29:52
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Quick takeaways
- The treasury basis trade involves leveraging borrowed money to profit from price discrepancies in treasury bonds, but its use of leverage and potential market dislocations during crises pose significant risks that require regulatory oversight.
- Regulatory bodies are considering measures to address the risks associated with the treasury basis trade, such as requiring traders to register as dealers, increasing oversight and transparency, and implementing limitations on leverage, but these changes face opposition from hedge fund managers who argue for market liquidity and price discovery.
Deep dives
The Treasury Basis Trade and its Risks
The podcast discusses the treasury basis trade, an arbitrage trade that aims to bring two essentially identical bond prices into line. It involves buying a cash bond and simultaneously selling a fixed-date bond future. The trade leverages borrowing through the repo market, which allows hedge funds to amplify their profits. However, the leverage involved and potential dislocations in the treasury market during crises can create significant risks. The Federal Reserve has stepped in to provide liquidity and prevent market freefall in previous instances, highlighting the integral role of the basis trade in the treasury market and the need for regulatory oversight.
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Discover
highlights
Listen to the best highlights from the podcasts you love and dive into the full episode