Hedge funds play a “significant and consistent role” in influencing the U.S. Treasury yield curve alongside other market players and forces, according to a new paper published Tuesday by the Treasury’s financial research arm.
The paper, published by the Treasury’s Office of Financial Research (OFR), was prepared by OFR economists Ram Yamarthy and Ron Alquist. The agency said the March 2020 stress on the U.S. Treasury market raised about the role of hedge funds in the financial system and whether their activities can increase systemic risk.
“In March 2020, a steep flight to the safest, most liquid assets led to Treasury market volatility that widened the Treasury cash-futures basis, the price difference between cash Treasury securities and futures contracts on similar securities,” the authors said. “While relative value hedge funds try to profit off of temporary differences on similarly yielding securities, the widening forced a number of these funds to unwind their positions, causing additional market instability.”
The paper uses a sample of regulatory hedge fund data that spanned eight years, the agency said. It is titled “Hedge Funds and Treasury Market Price Impact: Evidence from Direct Exposures.”
The agency said the authors found economically significant and consistent evidence that changes in hedge fund exposures are related to yield changes. “For example, a one standard deviation increase in net Treasury exposures (a $41 billion monthly movement) is significantly associated with a 6.2 basis point decline in bond yields,” the paper states. “The size of this estimate takes into account well-known macroeconomic drivers, such as inflation, and exists at various maturities. The results are also robust in controlling for the valuation effects of yields on exposures, changes in the Treasury demand of other financial intermediaries, and the effects of U.S. monetary policy.”