As traditional long-term buyers gradually withdraw, hedge funds are filling the demand gap in the US Treasury market on an unprecedented scale 鈥?but this replacement force carries inherent high-leverage risks, presenting new challenges to market stability.

The scale of US Treasuries held by hedge funds has climbed to a historic peak. According to data from the US Treasury Department's Office of Financial Research, by the end of 2025, hedge funds held $2 trillion in cash Treasuries, accounting for 7% of the approximately $28.9 trillion in marketable Treasuries 鈥?a record high and nearly triple the level five years ago. More recent Federal Reserve data shows that hedge funds continued to be net buyers in the first half of 2026, with net purchases reaching $60.6 billion in the second quarter alone.

However, hidden concerns lurk behind this demand. In its May financial stability report, the Federal Reserve warned that hedge fund leverage remains near historic highs and is concentrated among large funds. The Bank for International Settlements stated bluntly that the rise of hedge funds as core intermediaries in the government bond market has created "new financial stability vulnerabilities." The Treasury market itself is also under pressure 鈥?the 10-year US Treasury yield rose to its highest level since 2007 on Monday, while the 30-year yield touched its peak since 2002 on Tuesday.

Traditional buyers retreat, hedge funds fill the gap

Pension funds have long been the primary buyers of long-duration Treasuries, as their ultra-long investment horizons naturally align with asset-liability matching needs. But this landscape is changing.

According to an OECD analysis, the structural shift from defined-benefit to defined-contribution pension plans is weakening pension institutions' willingness to allocate to long-term government bonds. Meanwhile, some pension funds are accelerating their shift toward higher-yield, less-liquid assets such as private credit 鈥?according to Mercer data, institutional investors poured nearly $300 billion into private credit instruments in 2025.

Noah Hamman, founder of AdvisorShares, pointed out the fundamental differences between the two types of investors: "Pension funds and insurance companies have extremely long investment horizons and focus on liability matching; hedge funds pursue performance, typically aiming to beat benchmarks and exceed high-water marks, with shorter holding periods."

This means that hedge funds stepping in to replace traditional buyers operate with behavioral patterns far removed from the "ballast" the market needs.

Basis trades: a double-edged sword of thin margins and high leverage

Hedge funds are not simply bullish on Treasury yields 鈥?their core driver for participating in the Treasury market is relative value strategies. The most representative is the "Treasury cash-futures basis trade": buying cash Treasuries while selling corresponding futures contracts to capture the tiny spread between the two markets.

Because the spread is extremely narrow, basis trades typically rely on substantial leverage to amplify returns. Funds finance through repos, borrowing against Treasuries as collateral, magnifying actual positions to several times or even dozens of times their own capital. Don Steinbrugge, founder and CEO of Agecroft Partners, said such trades have "razor-thin margins, with leverage multiples often reaching 20 times or even higher."

Stress signals have already emerged. According to Morgan Stanley estimates, hedge funds' leveraged Treasury basis trade positions have declined by about 20% from their peak this year, falling to approximately $1.2 trillion. However, Federal Reserve data shows hedge funds overall remain net buyers, with position contraction reflecting more of an active strategy adjustment rather than wholesale selling.

Forced liquidation: the trigger for a liquidity crisis

The vulnerability of high-leverage strategies during market turmoil has precedent. Steinbrugge stated bluntly: "As seen in March 2020, when Treasury market liquidity deteriorated sharply, leveraged funds were forced to quickly unwind positions. This triggers a vicious cycle 鈥?margin calls, forced selling, and further amplified market volatility."

Ricky Siao, a hedge fund specialist at Union Bancaire Priv茅e, noted that hedge funds "use leverage more aggressively relative to other types of investors, and therefore may amplify systemic risk." Once an extreme scenario triggers forced deleveraging, it could potentially spark a broader liquidity crisis or even a financial stability event.

A sharp spike in volatility can itself become the starting point of a downward spiral: falling prices force hedge funds to add margin or liquidate, selling pressure further depresses prices, dragging more funds into forced exits.

The dual nature of liquidity contribution and systemic risk

Despite the significant risks, experts also acknowledge that hedge funds have undeniable positive value for the Treasury market.

Ken Heinz, president of a hedge fund research firm, said hedge funds tend to actively trade rather than hold to maturity, providing two-way liquidity during both market upswings and downturns, which helps smooth interest rate fluctuations.

The core of the debate is not that hedge funds are inherently harmful, but rather their dual attribute as both stabilizer and amplifier 鈥?under normal market conditions, their trading activity improves liquidity and corrects pricing discrepancies; when markets come under stress, they can become a concentrated flashpoint for vulnerabilities.

Steinbrugge summarized this dilemma: "When formulating policy, regulators should weigh the positive role of hedge funds in providing market liquidity while paying attention to the potential risks of disorderly unwinding. The growing role of hedge funds in the Treasury market is both necessary for liquidity and a potential source of systemic risk."