Hedge funds have become an increasingly important force in the US Treasury market as traditional long-term investors reduce their exposure to government bonds, prompting regulators to examine whether the shift could amplify volatility, according to a report by he Wall Street Journal.
Hedge funds held around $2tn of US Treasuries at the beginning of 2026, more than twice their holdings five years earlier and equivalent to a record 7% of the market, according to data from the Treasury Department’s Office of Financial Research.
More recent Federal Reserve data suggests those holdings remain elevated, according to Molly Brooks, a research strategist at TD Securities.
The growing presence of hedge funds comes as pension funds and other traditional buyers of government debt have reduced their allocations to fixed income in favour of assets including private credit, real estate and infrastructure.
US pension funds once allocated close to 40% of their portfolios to fixed income, but that proportion has fallen to between 10% and 15%, according to research from the Centre for Economic Policy Research. European pension funds have followed a similar trend, with bond allocations falling to about 20% from roughly 35% at the start of the century.
The shift reflects the difficulty pension funds face in generating sufficient returns from government bonds, particularly following the prolonged period of ultra-low interest rates.
As traditional investors have stepped back, hedge funds have moved in, often using leverage and short-term trading strategies to exploit pricing discrepancies between different parts of the government bond market.
One prominent example is the Treasury basis trade, in which funds seek to capture small differences between Treasury securities and related futures contracts while borrowing to increase the potential return. The strategy has stopped expanding at the pace seen previously but remains significant.
The increasing role of leveraged hedge funds is attracting particular attention from the Federal Reserve Bank of New York, whose markets staff have been speaking with investors and other market participants about the impact of hedge funds on Treasury trading.
Officials have reportedly been asking specifically about relative-value strategies, which involve taking offsetting positions across different government securities. Foreign central banks and the International Monetary Fund are also examining the expansion of hedge fund activity in Treasurys.
The concern is heightened by the size and importance of the market. Around $1.2tn of Treasury securities change hands each day, while yields have recently climbed sharply amid worries over inflation, geopolitical risks and the scale of US government borrowing.
The benchmark 10-year Treasury yield reached 5% on September 14, while the 30-year yield has been trading around its highest level in almost two decades. Higher government borrowing costs could also feed through into financing costs across the wider US economy.
Multi-manager hedge funds are an area of particular interest for policymakers. Firms such as Millennium, Point72 and Citadel employ large numbers of specialised trading teams across multiple strategies, including government bonds, and can use leverage to increase the size of their market positions.
Their short investment horizons can make hedge funds more sensitive to changes in prices and funding conditions than traditional buy-and-hold investors. That could become significant if funds are forced to unwind leveraged positions rapidly during a period of market stress.
At the same time, hedge funds can provide valuable liquidity to government bond markets by acting as counterparties to other investors and facilitating trading when traditional participants are less active.
European policymakers have similarly highlighted both sides of the equation. The European Central Bank has noted that hedge funds can support government bond auctions through their demand, while warning that leveraged positions held by more short-term investors could exacerbate market stress if rapidly unwound.
Hedge funds already account for a substantial share of activity in other major government bond markets. The ECB estimated in 2024 that hedge funds represented more than half of trading volumes in European bond markets, up from around a quarter in 2018. In Japan, overseas investors including hedge funds account for about 60% of daily bond-market transactions and roughly 90% of bond-futures trading, despite owning only around 10% of outstanding bonds.
For US policymakers, the growing dependence on hedge funds as a source of Treasury demand therefore presents a complex trade-off. Their participation can deepen liquidity and absorb supply, but their use of leverage and greater sensitivity to market prices could also increase the speed and severity of a sell-off.
The issue is becoming more pressing as the US government continues to issue large volumes of debt. The federal budget deficit is projected to reach around 6% of GDP this fiscal year, adding to concerns over the amount of Treasury supply that markets must absorb.
