Bank of England warns hedge fund leverage raises bond market shock risk

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BOE warns on hedge fund bond risk

Highlights

Bank of England Deputy Governor Sarah Breeden warns hedge funds’ increased participation and leverage heighten the risk of cross-market contagion in government bonds.
Hedge funds now hold a record 7% of the $30 trillion U.S. Treasury market and manage approximately $13 trillion in gross assets, according to IMF and U.S. Office of Financial Research data.
Yields on 10-year and 30-year U.S. Treasurys reached their highest since 2002, and European sovereign yields surged, intensifying worries about spillovers and sovereign debt stability.

Warning from Bangkok meetings

As reported by CNBC, Bank of England Deputy Governor for Financial Stability Sarah Breeden says hedge funds' rising presence in core government bond markets is making cross-market contagion more likely. Speaking on the sidelines of the International Monetary Fund-World Bank annual meetings in Bangkok, Thailand, she says the investor base has shifted away from traditional long-term holders such as insurers and pension funds toward hedge funds that are more price-sensitive, leveraged and international.

Breeden says that change increases the chances that a shock in one bond market transmits quickly to another. She adds that the source of potential stress is bond markets and that the likelihood of spillovers is higher than before.

The IMF says hedge funds now account for about $13 trillion in gross assets, underlining their growing role in global markets. In its latest Global Financial Stability Report published Tuesday, the fund says hedge funds support market liquidity and efficiency, but warns that leverage and crowded trades can intensify stress during periods of turmoil and spill into wider financial markets, including banks' prime brokerage activities.

Pressure points across sovereign debt markets

Scrutiny of hedge funds' role in government bonds, especially through basis trades, is increasing this year after a sharp sell-off in sovereign debt. U.S. Office of Financial Research data published on Aug. 19 shows hedge funds held a record 7% of the $30 trillion Treasury market at the end of 2025.

Basis trades involve buying cash Treasurys while shorting corresponding futures contracts to capture small pricing gaps, a strategy that often relies on heavy leverage to amplify returns. That structure has drawn attention because forced unwinding during market stress can amplify volatility.

Earlier this month, yields on 10-year and 30-year U.S. Treasurys reached their highest levels since 2002. In Europe, yields on 10-year UK gilts also touched multi-decade highs, while French OAT yields have risen sharply in recent weeks amid concern over the country's fiscal outlook, adding to fears of a renewed sovereign debt crisis affecting the euro zone.

Our earlier coverage on sovereign resilience in a higher-rate environment highlighted that prolonged geopolitical strain and elevated public spending are increasing sovereign borrowing and refinancing risks as funding costs stay high. We noted that persistent inflationary shocks can erode fiscal headroom and pressure credit outlooks, with emerging and frontier markets especially exposed due to heavier interest-service burdens and narrower revenue bases.

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