Treasury Turmoil: The Market's New Nightmare

Ladies and gentlemen, buckle up! We're in the midst of a Treasury selloff that's got the market on edge, and it's not just any selloff—it's a doozy! The $29-trillion Treasury market, which had been surging as investors fled to the safety of government bonds, is now in freefall. Yields are soaring, and the volatility is off the charts. This is a market that's been through a lot, but this? This is something else!



Let's break it down. On Monday, even as equities stayed under pressure, Treasuries were hit by a wave of selling that sent benchmark yields soaring by 17 basis points on the day, while trading within a yield range of about 35 basis points, one of the wildest trading swings for 10-year yields in two decades. The selloff continued, though less sharply, on Tuesday, leaving benchmark 10-year yields back above 4%. This is a market that's been through a lot, but this? This is something else!

So, what's driving this madness? Margin calls, the unwinding of basis trades, and the tightening of swap spreads. Let's dive in!

1. Margin Calls: Margin calls have played a crucial role in exacerbating the bond selloff. As market volatility increased, hedge funds and other investors faced margin calls due to portfolio losses across various asset classes. This forced them to sell liquid assets, including U.S. government bonds, to meet their margin requirements. For instance, "Some market participants said they believed based on the dramatic Treasury market moves and sharp tightening of swap spreads that investors including hedge funds have been selling liquid assets such as U.S. government bonds to meet margin calls due to portfolio losses across asset classes" (Reuters, April 9, 2025). This selling pressure further drove down bond prices and increased yields.

2. Unwinding of Basis Trades: The unwinding of basis trades has also contributed to the market volatility. Basis trades involve hedge funds borrowing to bet on the narrow gaps between the prices of cash Treasuries and futures. When market conditions change rapidly, these trades can become unprofitable, forcing funds to liquidate their positions. This unwinding can create a cascading effect, leading to further selling pressure. For example, "The basis trade has been closely watched by regulators over the past few years because it could be a source of instability for markets if highly leveraged hedge fund positions are unwound rapidly" (Reuters, April 9, 2025). The unwinding of these trades can reduce banks' ability to provide liquidity in the Treasury market, exacerbating the selloff.

3. Tightening of Swap Spreads: The tightening of swap spreads has signaled significant selling pressure in the Treasury market. Swap spreads reflect the gap between the fixed rate on an interest-rate swap and the yield on a Treasury security of similar maturity. A sharp tightening of these spreads indicates that investors are selling Treasuries, which in turn drives up yields. For instance, "Several analysts also pointed to changes in the price differential between Treasuries and interest rate swaps as evidence of specific selling of Treasuries, as opposed to a broader move reflecting, for instance, changes in monetary policy expectations" (Reuters, April 9, 2025). This specific selling pressure has contributed to the volatility in the Treasury market.

This is a market that's been through a lot, but this? This is something else! The current Treasury selloff is reminiscent of the 2020 COVID-era "dash for cash," where the market seized up as fears about the coronavirus grew, prompting the U.S. central bank to buy $1.6 trillion of government bonds. The current selloff is characterized by a wave of selling that sent benchmark yields soaring by 17 basis points on the day, while trading within a yield range of about 35 basis points, one of the wildest trading swings for 10-year yields in two decades. This is a market that's been through a lot, but this? This is something else!

One key lesson from the 2020 crash is the importance of liquidity in the Treasury market. The unwinding of the basis trade, a popular hedge fund arbitrage trading strategy between cash and futures Treasury positions, exacerbated the 2020 crash. This strategy has been closely watched by regulators over the past few years because it could be a source of instability for markets if highly leveraged hedge fund positions are unwound rapidly. This scenario could reduce banks' ability to provide liquidity, or intermediation, in the Treasury market, the building block of global finance.

Another lesson is the importance of margin calls and the need for liquidity. Hedge funds typically borrow from the repo market to buy Treasuries and use the latter as collateral. Falling prices of Treasuries due to the selloff provided less collateral value for borrowing, prompting margin calls. This is similar to the current situation, where investors including hedge funds have been selling liquid assets such as U.S. government bonds to meet margin calls due to portfolio losses across asset classes.

In conclusion, the current Treasury selloff is similar to the 2020 COVID-era "dash for cash" in terms of volatility and liquidity issues. The lessons from the 2020 crash, such as the importance of liquidity and the need to manage margin calls, can be applied to navigate the present situation.