Hidden "time bomb" in US debt! Morgan Stanley: The basis trading has inflated to $1.5 trillion, beware of a market storm in 2020.

Morgan Stanley strategists pointed out that the current size of the US Treasury basis trading has expanded to approximately $1.5 trillion, highlighting the importance of closely monitoring the size of this trading to avoid a repeat of the severe market volatility in 2020. This trading strategy is dominated by hedge funds, with the core focus on exploiting small price differences between the US Treasury cash market and futures market. The bank's calculations show that the size of this strategy has increased by 75% compared to its peak in 2019, and the growth rate of its nominal trading size has exceeded the issuance growth rate of US Treasuries in recent years. Strategists including Eli Carter and Shaun Zhou stated in a research report released on Tuesday that the current trading activity is "not unprecedented" but still needs to be closely monitored, especially during times of tightening liquidity or market turmoil. From the nature of the trading, if hedge funds are forced to close out positions quickly, bond dealers may not be able to handle the sudden surge in trading volume. Morgan Stanley emphasized that the related risks are currently highly concentrated in the 5-year Treasury futures contract, followed by ultra-long-term and 10-year contracts; the risk exposure in the middle of the yield curve has been continuously expanding in recent years. It is understood that in 2020, the performance of US Treasury cash was weaker than futures, which was contrary to the market environment that basis trading relies on for profit, leading to hedge funds suffering huge losses and this trading becoming one of the drivers of market volatility that year. At that time, the Federal Reserve had to intervene by purchasing trillions of dollars in bonds to maintain market stability and injecting emergency liquidity into the repo and other short-term borrowing markets. It is worth noting that the total size of this trading in 2020 was only about $500 billion, only a third of the current size. Currently, global regulatory agencies have increased scrutiny on this trading. The Bank of England and the Bank for International Settlements in Basel have issued warnings that leverage operations by a few large hedge funds could pose a potential threat to financial stability.