Bond market participants are predicting that hedge funds are likely to become increasingly important buyers of US Treasuries, providing liquidity in the world's largest bond market at a time of rising investor concerns over supply-demand dynamics, according to a report by Reuters.

An increase in the so-called basis trade, which takes advantage of the premium of futures contracts over the price of the underlying bonds, has seen hedge funds short positions in some Treasuries futures hit record highs recently.

And while economists at the US Federal Reserve and the Bank for International Settlements have warned that large basis trade positions could disrupt the US Treasuries market, as happened in March 2020, some bond market participants believe hedge funds using the strategy provide crucial demand for Treasuries at a time when the government is issuing more debt. The Federal Reserve, meanwhile, which used to be a big buyer in the market, has been reducing its bond holdings since June last year.

The report quotes Jason Granet, Chief Investment Officer at BNY Mellon as saying during a panel session at the ISDA derivatives trading forum in New York on Thursday, that: "It's necessary for those participants to come in because of the funding demands of the issuers, the issuers here being (President) Joe Biden and (Treasury) Secretary (Janet) Yellen. These basis positions with these transformations are going to be a part of the equation because it's a necessary evil to get the capital to meet the demand."