World’s Safest Market Becomes a Magnet for Big Investors

Vineer Bhansali doesn’t sleep much nowadays. Nor is he getting in as many of the long-distance runs that he loves. But he’s having the time of his life.

Bhansali is the founder of LongTail Alpha LLC, a hedge fund in Newport Beach, California, and he’s newly obsessed with what was once among the sleepiest corners of finance: Treasury bonds. With volatility exploding in the long-placid market, he’s ordered his fund to shift away from other strategies and boost its focus on Treasuries. LongTail now buys and sells bonds constantly, he says, making four times as many trades as it did a year ago.

A self-confessed adrenaline junkie, Bhansali wakes up every two hours at night to check prices after being glued to his screens all day. “You have to be on it, because things are happening all the time,” he says. “This is probably one of the best times to get in the bond market in 20 years.”

or much of the past two decades, most US government debt was sequestered in the vaults of the Federal Reserve, foreign central banks and commercial lenders that used it as a kind of cash reserve. At the peak of the easy-money era, the Fed vacuumed up $100 billion a month in Treasuries and mortgage securities, blindly buying and holding to maturity whatever was offered, regardless of returns. Trading was quiet. Yields were pinned day after day at rock-bottom levels. Hedge funds, attracted by riskier investments that offered the promise of fatter profits, mostly stayed away.

Those days have been brought to an end by the post-pandemic surge in inflation. Now the Fed is letting the debt roll off its balance sheet and commercial lenders are outright selling their holdings. While that increases the fragility of the overall economy—risking even higher rates for consumer loans—it has made US government debt catnip for speculators such as Bhansali. These fast-money traders are much more price-sensitive and quicker to dump bonds at the slightest provocation: rising oil prices, an offhand remark by a Fed official, a change in the unemployment rate.

Hedge fund manager Bill Ackman made a very public bet against Treasuries over the past few months and moved the market when he closed it out on Oct. 23 over concerns about US growth prospects. And investor Stan Druckenmiller has taken what he calls a “massive” position in two-year notes to hedge against a souring economy—though he’s still bearish on longer-term bonds.

Unlike their less-active predecessors, the new buyers are likely to push yields ever higher to finance Washington’s swelling deficit, taking the market on a bumpier ride to get there. The result is a spike in Treasury yields—the benchmark used to set borrowing costs for consumers and companies—giving investors a chance to make (or lose) lots of money. “Bond volatility can and will provide tactical opportunities in the short run,” says Kathryn Kaminski, chief research strategist at Boston investment firm AlphaSimplex, who credits a bet against Treasuries for much of a gain of nearly 36% at one of the firm’s funds last year.

Price moves are dramatic and unpredictable, with the yield on 10-year US government debt on Oct. 23 surpassing 5% for the first time since 2007. Yields on 30-year Treasuries have been swinging by an average of about 13 basis points a day as, for instance, investors rush to buy to hedge the risk of escalating conflict in the Middle East or unexpectedly strong US economic data spurs a run for the exits. While 13 basis points—0.13%—may not sound like much, it’s more than triple the daily average of the past decade. Noting the increased activity of hedge funds in the market, the Treasury Department today tempered the pace of its planned increase in long-term borrowing.

The new buyers—whether you consider them a sign of healthy markets or call them vigilantes, as they were dubbed in the 1990s, the last time hedge funds got this charged about US government debt—are probably here to stay. Hedge funds have tripled their holdings of Treasuries to a record $2.3 trillion in the past year, Fed data show. New funds are being rolled out at the fastest level in more than a year, according to analytics firm Hedge Fund Research, and strategies designed to exploit price dislocations in bond markets are among the most plentiful. That’s leading to a hiring binge in the field, says Christian Hauff, chief executive officer at Quantitative Brokers, which sells trading programs to big-money investors. “They’re looking for more talent,” he says. “We have seen the movement of traders and portfolio managers from asset managers and banks to these hedge funds.”

Hedge funds have also been building positions in basis trades, a risky investment that’s attracting scrutiny from researchers at the Fed and regulators such as the Bank for International Settlements. The strategy typically involves borrowing large sums of money to exploit small price differences. It can be perilous, because investors are exposed to sudden market moves and sharp jumps in funding costs. Hedge funds have amassed some $600 billion of net short positions in Treasuries—bets that prices will go down—according to the BIS, increasing the danger to the economy. “The build-up of the basis trade now is too much for regulators to overlook,” says Stanford University finance professor Darrell Duffie.


The Fed, meanwhile, has been offloading as much as $60 billion in Treasuries a month. Also exiting are foreign banks that face prohibitively steep hedging costs and US commercial lenders compensating for flight by depositors. That’s brought the ownership of long-term holders, including foreign banks, below 55%—the lowest in more than two decades—versus 75% in 2014, according to JPMorgan Chase & Co. The Fed now has about $4.9 trillion in Treasuries, down from a 2022 peak of $5.8 trillion resulting from years of purchases following the 2008 financial crisis. “The infrastructure and the liquidity of the Treasury market is absolutely more fragile than it’s been in the past,” says Jay Barry, co-head of US rates strategy at JPMorgan.

That effort to revive the economy was great for struggling consumers, chief financial officers and politicians eager to borrow and spend ever-greater sums of money. But it helped trigger inflation unlike any the US has seen in decades. The new, more volatile era that the hedge fund crowd has ushered in stands to bring discipline to spendthrift ways in Washington and beyond—though that’s, of course, not the intent of the fast-money types. They’re just seeking big profits.

Source from: Bloomberg