Hedge funds have reduced their exposure to the US Treasury basis trade as shrinking price discrepancies between Treasury futures and the underlying cash bonds have made the strategy less attractive, according to a report by Bloomberg.

The report cites estimate from Morgan Stanley strategists as highlighting that notional value of leveraged investors’ Treasury basis positions has fallen to about $900bn, down from approximately $1.26tn at the start of 2026.

The decline marks the smallest estimated size of the trade in more than two years and reflects a reduction in relative-value opportunities rather than, according to bank strategists, signs of stress in the Treasury market.

The basis trade involves buying Treasury securities while simultaneously selling related futures contracts, seeking to capture small differences between the prices of the two instruments. Hedge funds typically use substantial leverage to increase the potential return from these relatively small pricing gaps.

Morgan Stanley said the decline has been concentrated particularly in contracts linked to shorter-dated Treasuries, where the arbitrage opportunity has become less compelling. Basis positions involving longer-duration securities and futures, meanwhile, remain active.

The changing economics of the strategy are significant for the Treasury market because hedge funds have become an important source of liquidity and demand through basis trading. A sharp unwinding of leveraged positions has previously contributed to periods of severe market disruption, most notably during the March 2020 Treasury-market turmoil.

Morgan Stanley strategists said a major shock to Treasury markets or short-term funding markets could still prompt hedge funds to unwind positions. They nevertheless said the strategy had demonstrated resilience during more recent periods of market turbulence, while plentiful liquidity in the repo market has reduced immediate funding concerns.

The basis trade depends partly on Treasury futures trading at a premium to the corresponding cash securities. That premium can emerge as asset managers use futures to obtain interest-rate exposure rather than buying the underlying bonds, while uncertainty around the cheapest security to deliver into a futures contract can create additional pricing discrepancies.

Changes in institutional positioning have also affected the opportunity available to hedge funds. Commodity Futures Trading Commission data indicate that asset managers have reduced their net long positions in shorter-dated Treasury futures this year, following a significant shift in expectations for Federal Reserve policy.

Morgan Stanley said weaker demand from asset managers for Treasury futures had reduced the arbitrage opportunity available to leveraged investors.

The contraction has been concentrated in the two- and five-year parts of the Treasury curve, according to Morgan Stanley. Positions linked to the longest-dated futures, covering Treasuries with roughly 25 to 30 years remaining to maturity, have instead increased.

That pattern has led the bank's strategists to conclude there is currently no clear evidence of a broader deterioration in hedge-fund demand for Treasuries or systemic stress across the basis trade.