The 10-year Treasury yield surged on Tuesday to close at 4.29% in a sign of the pressure building across the fixed income complex as investors seek cash.
Investors, facing significant volatility, are looking for a safe haven as global tariffs are implemented, margin calls are made, and aggressive investment strategies are unwound.
Overnight, it would appear that the $800 billion basis swap trade is disintegrating. A highly leveraged trade that is popular with hedge funds in which speculators exploit the gap between cash Treasuries and futures is unwinding, which sent yields as high as 4.45% on the 10-year Treasury and to 5% on the 30-year.
Should this continue, it will cause further liquidity issues in the market and could send yields spiking much higher.
Now there is the growing chance that an overleveraged hedge fund, private equity fund or private credit fund will seek a hasty liquidation as the shock intensifies.
While some have made the case that yields have spiked because foreign holders of Treasury notes have been dumping them, we would do not see this happening.
First, the dollar has appreciated as yields have increased, so that makes it unlikely that it is a foreign holder of U.S. Treasury securities dumping them on the open market.
Second, the offshore Chinese tradable currency hit an all-time low Tuesday, which cannot happen without the Chinese monetary authority purchasing Treasuries to force the value of the currency unit down.
In addition, the Chinese have reduced their Treasury holdings over the past three years to the point where they are now the second-largest holder of U.S. Treasury securities behind Japan, just in front of the United Kingdom. The Chinese hold 9% of total U.S. Treasury securities; the Japanese hold 13%.
The Federal Reserve is the largest single holder of U.S. Treasury notes.
Read more of RSM’s insights on the economy and the middle market.
Finally, inflation will most likely spike over the next 60 to 90 days as the new trade regime raises the price of imports. As that reality shows up in the hard data, there is a greater chance that yields will go even higher.
From our point of view, such a spike could force policymakers to seek an offramp from a current policy path of tariffs that if not stopped will tip the economy into recession this quarter.
