Hedge funds are increasingly shifting capital into swap spread arbitrage and other relative-value strategies as rising borrowing costs and regulatory changes reduce the appeal of the US Treasury basis trade, according to a report by Reuters.

The cash-futures basis trade, which involves purchasing US Treasuries using borrowed funds while selling Treasury futures to exploit pricing differences, has plateaued after several years of rapid expansion. Higher Treasury yields, increased financing costs and greater bank capacity to hold government bonds have reduced arbitrage opportunities, prompting leveraged investors to seek returns elsewhere in the rates market.

Swap spread arbitrage, which exploits differences between Treasury yields and interest rate swap rates, has emerged as a key alternative. However, analysts warn that the strategy carries greater market risk than traditional basis trades, with research from the Dallas Federal Reserve indicating significantly higher dollar risk relative to the notional value of positions.

Federal Reserve research estimates that hedge funds held approximately $830bn in cash-futures basis positions as of September 2025, representing around 35% of their total long Treasury exposure. Swap spread positions reached $305bn over the same period, accounting for 13% and making them the second-largest Treasury-related position among hedge funds.

Other strategies attracting interest include arbitrage between newly issued and older Treasury securities, alongside trades exploiting yield differences between inflation-protected and conventional government bonds.

Despite the shift, the basis trade remains a dominant strategy for fixed income relative-value hedge funds. Analysts expect continued US government borrowing to sustain demand for leveraged Treasury investors, potentially supporting a recovery in basis trading as market conditions evolve.