House of cards
Hedge funds have built up complex trades worth more than $1 trillion based on US debt, funded by borrowing short-term from banks and selling to pension funds.
The trades are not bets on price. Rather, hedge funds are exploiting small gaps in market pricing to make money. The margins are small, but when the trades are so large it all adds up.
It is this sheer scale that has central bankers worried. The Bank of England noted last month that the trade had reached a new high, growing to $1 trillion from a previous record of $875bn. Officials warned that the trades could trigger a market meltdown in a worst case scenario.
Raphael Gallardo, chief economist at French asset manager Carmignac, says: “This is a risk that deserves watching. It represents something like 3pc of the total US debt.”
The so-called basis trade sparking concern will sound like jargon to most people. Effectively, it…
