Hedge Fund Swap Spread Trade Reaches Widest Level Since December 2022
The hedge fund swap spread widener trade has surged back to prominence, with 30-year spreads reaching 62 basis points inverted - the widest since December 2022. The strategy, which bets on Treasuries outperforming interest rate swaps, has seen its cash component value more than double from $281 billion in Q1 2024 to $631 billion according to BIS data. Growth is driven by expectations of Trump's deregulatory agenda and supportive Fed policies, though the trade carries risks from potential policy shifts and market volatility.
*this image is generated using AI for illustrative purposes only.
Traders are piling back into a popular hedge fund strategy that bets on US Treasuries outperforming interest rate swaps, with the trade reaching its widest level since December 2022. The so-called swap spread widener trade uses derivatives to wager that the gap between rates on interest-rate swaps and yields on Treasuries of the same maturity will grow.
Market Recovery After Initial Pressure
The trade came under pressure at the start of the week after a Japanese bond market rout and rising tensions between the US and Europe over Greenland sent bond yields higher. These moves threatened to derail a widening trend in the spread that had been in place since markets recovered after April's tariff-induced rout.
However, as tensions eased after US President Donald Trump announced a framework agreement on the Arctic island was reached, the trade regained momentum. By Friday, the 30-year swap spread reached as high as 62 basis points inverted, rising by about 8 basis points from a low reached on Tuesday.
Significant Growth in Trade Volume
The swap spread trade has experienced substantial growth in recent months, driven largely by expectations that Trump's deregulatory agenda will free up cash on banks' balance sheets, which in turn will favor Treasuries. A December BIS report highlighted the dramatic expansion of this strategy:
| Metric | Q1 2024 | December 2024 | Growth |
|---|---|---|---|
| Cash Component Value | $281 billion | $631 billion | More than doubled |
| Market Position | - | Widest since Dec 2022 | 62 basis points inverted |
This growth is largely driving the increase in hedge fund exposure to Treasuries, though it still trails the more popular basis trade strategy, which Morgan Stanley recently reported at close to $1.50 trillion.
Policy Drivers and Strategic Positioning
Several recent policies are adding fuel to the swap spread widener trade. Spreads widened recently in response to comments by Federal Reserve Governor Stephen Miran, who said that "sweeping deregulation" will support further monetary easing.
Trump's efforts to reduce home ownership costs, including ordering Fannie Mae and Freddie Mac to buy $200 billion worth of mortgage-backed securities, will support "hedging flows via paying in swaps from GSEs," according to Barclays strategists. Additionally, recent Federal Reserve steps to calm repo market conditions with Treasury bill purchases are favoring the long-cash side of the trade.
Wall Street Positioning and Outlook
Major financial institutions have taken strategic positions in the trade:
- Barclays: Hold long position in 5-year sector based on potential MBS hedging flows
- Morgan Stanley: Positioned in 2-year swap spread longs citing benign funding market conditions
- TD Securities: Expect swap spreads to widen as funding conditions ease and Treasury demand remains robust
Risk Factors and Market Considerations
The trade carries significant risks, as demonstrated in April when it violently unwound amid margin calls after Trump's tariff announcement roiled markets. Similar policy shifts or market shocks could again threaten to unravel these positions.
Additional risks include changing outlooks for Treasury supply and an influx of corporate issuance, including potential debt issuance for artificial intelligence projects hitting the market as early as next week. These factors could push Treasury yields higher and reduce the recent swap spread widening momentum.
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