Major Wall Street dealers are returning to the U.S. Treasury market-making at the largest scale since the financial crisis, but underlying risks are brewing – hedge funds hold an 8% market share, backed by over $6 trillion in leverage. Economists at Apollo warn that a concentrated unwinding of highly leveraged positions could send shockwaves through global fixed-income markets; and with $10 trillion in debt rollover pressures expected next year, this vulnerability is becoming increasingly difficult to ignore.
Major Wall Street dealers are returning to the U.S. Treasury market at the largest scale since the financial crisis. However, this seemingly positive shift is overshadowed by the accumulating leverage risks on the other side—highly leveraged positions held by hedge funds have become the most significant vulnerability in the market structure.
According to calculations by the Financial Times based on data from the New York Federal Reserve, the average net position in Treasury bonds held by primary dealers this year has risen to approximately $550 billion, accounting for nearly 2% of the overall market—the highest level since 2007.
The core driver of this change is the revision of the enhanced supplementary leverage ratio (eSLR) rule—Trump's administration pushed for a relaxation of the non-risk-adjusted capital requirements for large banks, directly opening the door for banks to re-enter Treasury bond market-making.
On the other hand, Torsten Slok, Chief Economist at Apollo Global Management, warned that hedge funds’ share of the $31 trillion U.S. Treasury market has reached a historical peak of 8%, supported by over $6 trillion in repurchase agreements and prime brokerage financing that amplifies leverage. He pointed out that if these highly leveraged positions are forced into liquidation, "it could transmit shockwaves to global fixed-income markets," potentially impacting equities, corporate bonds, and mortgage markets alike.
The improvement in bank holdings coexists with the leverage risks posed by hedge funds, forming the core contradiction within the current U.S. Treasury market. Whether the market structure is being repaired or accumulating systemic risks in a new way remains a topic of debate.
Regulatory easing unlocks space for banks to hold bonds.
After the 2008 financial crisis, stringent capital regulations gradually led large banks to withdraw from their central role in U.S. Treasury market-making. Now, this trend is quietly reversing.
Michelle Bowman, Chair of the Federal Reserve’s Supervisory Board appointed by Trump, spearheaded the revision of the eSLR rule. Morgan Stanley confirmed this month that it has deployed more capital for Treasury trading by leveraging SLR revisions. Mark Cabana, Head of Interest Rate Strategy at Bank of America, stated, "The significant increase in dealer Treasury holdings over the past few months provides evidence that SLR is indeed having an impact."
Data from Coalition Greenwich shows that the six systemically important banks previously held capital exceeding regulatory requirements by an average of 2.4 percentage points. Minal Chotai, Global Head of Capital Analysis at the firm, noted that with adjustments to capital rules, "the rationale for maintaining these large excess buffers has disappeared," signaling that more capital could be released for trading activities.
Hedge funds have quietly become the largest foreign holders of U.S. government bonds.
During the decade when traditional market-makers withdrew, hedge funds quietly stepped in to fill the central role in the U.S. Treasury market.
According to data from the U.S. Office of Financial Research, as of the end of 2025, hedge funds held long positions in U.S. Treasuries worth $2.4 trillion and short positions worth $1.6 trillion, nearly tripling from three years ago. Economists at the Federal Reserve also noted that official TIC data underestimated the cross-border positions of hedge funds by as much as $1.4 trillion—after adjustment, hedge funds registered in the Cayman Islands have actually become the largest offshore holders of U.S. Treasuries, with holdings significantly exceeding those of China, Japan, and the United Kingdom. Between 2022 and 2024, hedge funds absorbed 37% of the net issuance of U.S. medium- to long-term Treasuries, "almost equivalent to the total of all other foreign investors."
This expansion has been primarily driven by 'basis trades'—arbitraging the price difference between Treasury spot and futures, while amplifying returns through high leverage. The strategy yields extremely thin profits and heavily relies on stable financing conditions. During the 2020 bond market turmoil, the Federal Reserve had to intervene directly to stabilize the market after rapid unwinding of hedge fund positions caused disorder.
Structural changes are difficult to reverse, and refinancing pressures remain ever-present.
There is a clear divergence among market participants regarding this structure.
Jay Barry, head of global interest rate strategy at JPMorgan, stated outright: "Primary dealers will not return to their pre-2008 roles; the dominance of hedge funds and high-frequency traders cannot be reversed."
Molly Brooks, an interest rate strategist at TD Securities, pointed out that if volatility declines or the Federal Reserve significantly cuts rates, hedge funds may proactively reduce their positions—leaving the question of who will take over their holdings still unresolved. Yesha Yadav, a professor at Vanderbilt Law School, warned that since banks are not legally obligated to act as market makers, "reversing these balance sheet rules does not guarantee effectiveness." Ajay Rajadhyaksha, chairman of Barclays Global Research, also noted that while increased bank holdings are related to regulatory changes, structural constraints have not fundamentally disappeared.
Against this backdrop, the refinancing pressure on the U.S. Treasury is a definitive constraint: next year, debt equivalent to 33% of the total U.S. Treasury bonds will mature, requiring the issuance of approximately 10 trillion dollars in new bonds, while non-U.S. central banks have already sold over 82 billion dollars' worth of U.S. Treasury bonds, reducing their holdings to the lowest level since 2012. Former Treasury Secretary Henry Paulson has recently made a public appeal for policymakers to prepare contingency plans in advance to prevent an extreme scenario of demand collapse.
Editor/Joe