U.S. Treasury Selloff Raises Alarm Bells Over Market Stability Amid Tariff Concerns

A significant selloff in U.S. Treasury bonds is reigniting fears reminiscent of the COVID-era “dash for cash,” raising concerns about the stability of the world’s largest bond market. After a period of relative calm, the $29 trillion Treasury market experienced a violent reaction on Monday, with benchmark yields surging by 17 basis points amid a backdrop of ongoing equity market pressures.

The recent selloff follows a flight to safety in government bonds as investors fled from stocks, spurred by tariff-related uncertainties. However, on Monday, even as equities remained under pressure, Treasuries faced a substantial wave of selling. This tumultuous trading session saw 10-year yields fluctuating within a range of approximately 35 basis points—one of the most volatile swings in two decades.

The pressure continued into Tuesday, pushing benchmark 10-year yields back above the critical 4% threshold. Market participants speculated that hedge funds and other investors were liquidating highly liquid assets, including U.S. government bonds, to meet margin calls resulting from portfolio losses across various asset classes. Some hedge funds were observed offloading stock positions to mitigate the impact of market declines that necessitated a reduction in borrowing.

“The significant moves across asset classes triggered the unwind,” stated Jan Nevruzi, U.S. rates strategist at TD Securities in New York. Analysts noted the selloff bears striking similarities to the liquidity crisis witnessed in March 2020, when the market seized up as the pandemic unfolded, prompting the Federal Reserve to purchase $1.6 trillion in government bonds to stabilize conditions.

Contributing to the turmoil was the unwinding of the basis trade, a popular hedge fund arbitrage strategy that pairs cash and futures Treasury positions. This unwinding likely exacerbated the sharp decline in bond prices, as noted by Nevruzi. “When you have significant market movements and rely on arbitrage relationships, tightening spreads can force you to trim your positions.”

Regulators have closely monitored the basis trade due to its potential to destabilize markets if leveraged hedge fund positions are unwound too quickly. This situation could constrain banks’ ability to provide liquidity in the Treasury market, which serves as the foundation of global finance. Torsten Slok, chief economist at Apollo Global Management, estimated the current value of the basis trade at approximately $800 billion.

Hedge funds typically utilize the repo market to finance Treasury purchases, using the bonds as collateral. As Treasury prices fell due to the selloff, the collateral value diminished, leading to margin calls. “There has certainly been an unwinding of many basis trades in recent days, resulting in margin calls for banks,” remarked David Rolley, global head of fixed income at Loomis Sayles.

Additional factors may also be influencing the bond market’s trajectory. Some analysts suggest that the bond market is adjusting to the view that President Trump’s tariffs on major trade partners could be inflationary, limiting the Federal Reserve’s capacity to reduce interest rates despite signs of slowing growth. “Can you realistically bid on bonds when inflation might hit a 4% rate in two months?” questioned Spencer Hakimian, CEO of Tolou Capital Management.

Concerns Over Demand Destruction

Market participants remain wary that vulnerabilities exposed during previous crises, such as March 2020, could resurface amid heightened volatility. “We’ve been warning for years that liquidity depth in the Treasury market is lacking,” stated Andrew Brenner, head of international fixed income at National Alliance Capital Markets. “These basis trades, which can be leveraged up to 100 times, overwhelmed the bond markets during Monday’s sharp selloff.”

Several analysts have pointed to the widening price differential between Treasuries and interest rate swaps as evidence of targeted selling in the Treasury market. An executive serving hedge fund clients at a major bank noted that investors are exploring alternatives to U.S. assets amid ongoing market volatility. Swap spreads, which represent the gap between fixed rates on interest rate swaps and comparable Treasury yields, have tightened significantly, particularly for longer-dated maturities.

The underperformance of Treasuries compared to swaps signals “substantial foreign selling,” according to Jonathan Cohn, head of U.S. rates desk strategy at Nomura Securities International. A consensus trade among hedge funds was positioned for a widening of swap spreads, driven by expectations of further bank deregulation. The recent tightening of 10-year and 30-year swap spreads has been noted since Trump’s announcement of sweeping tariffs on imports, with current spreads at minus 58 basis points and minus 94.5 basis points, respectively.

Analysts at Citi highlighted that Monday’s selloff culminated in a “light dash-for-cash,” indicating signs of potential demand destruction for U.S. Treasuries. They argued that the factors driving swap spreads lower typically reflect concerns over fiscal trajectories, with tariffs adding additional pressure. “Presumably, reduced trade will limit growth in global USD reserves, which tend to flow into U.S. Treasuries,” they concluded.