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ORLANDO, Florida, May 9 - Leverage in the U.S. Treasury market is picking up again, counterintuitively feeding off a"higher-for-longer" interest rate environment and building up potential trouble in the event of a price or rate shock.
But the longer interest rates are kept on hold, the more attractive it is for futures market participants - asset managers are drawn in by higher yields, and higher yields make the 'basis trade' more appealing for leveraged funds on the short side. The shift at the short end has been even greater. Asset managers' long position in two-year futures is now worth $458 billion - a new record, up 17% from last year's peak, and remarkably, up more than a third in the last month.
"In managing their dual objectives of generating returns for investors while matching a benchmark index duration, mutual funds' reach-for-duration incentive drives greater leverage in the Treasury market," the authors wrote. Christoph Schon, senior principal of applied research at Axioma, says the rise in mutual funds' long Treasury futures position should not be a surprise - yields are more attractive now and bonds are competing with equities for the first time in a long time.
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