Hedge funds' most popular trade in the US bond market is showing signs of maxing out. Known as the basis trade, the strategy involves wagering on the small price difference between Treasury bond futures and the underlying securities using borrowed cash, but those gaps are narrowing and the trade is losing steam. Morgan Stanley estimates the amount of money locked up in leveraged investors' basis trades has declined by more than $200 billion to $1 trillion in recent months. Factors include Wall Street banks increasing their Treasury holdings, cooling demand for Treasury futures by asset managers amid this year's selloff, a shift in US government borrowing toward short-term bills, and the Federal Reserve no longer shrinking its balance sheet. The strategy's major players have traditionally included large macro hedge funds and multi-strategy giants like Millennium Management, ExodusPoint Capital Management, Citadel and Capula Investment Management, though representatives for these firms declined to comment.
