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US government debt fell sharply for the second straight day after a $58bn short-term Treasury auction drew weak demand and hedge funds continued to rapidly unwind popular trades.
The benchmark 10-year Treasury yield, which underpins trillions of dollars in assets worldwide, jumped 0.11 percentage points to 4.3 per cent on Tuesday. It has risen almost 0.3 percentage points over the past two days — a large jump for an asset that typically moves in small increments.
Tuesday’s sell-off is the latest sign of how some investors are ditching even very low-risk assets in a dash for cash, as President Donald Trump’s tariffs on major trading partners spark intense volatility in markets. Hedge funds have been critical players in the decline as they have sought to reduce risk in their portfolios and cut back on widespread trades in the Treasury market.
The sense of gloom worsened on Tuesday after a US Treasury department auction for three-year notes attracted the weakest demand since 2023.
The auction drew a higher than expected yield, and dealers — banks that are obliged to buy up any supply not absorbed by other investors — sopped up 20.7 per cent of the offering, the highest percentage since December 2023, according to Vail Hartman at BMO Capital Markets.
That disappointing deal will cast a shadow over upcoming auctions this week, including the $39bn of 10-year notes on offer on Wednesday and the $22bn of 30-year bonds on Thursday.
The weak auction will also add to fears that foreign investors are shifting away from US government debt at a time of rising concern over America’s high debt levels and the Trump administration’s targeting of government institutions such as independent regulators.
“The poor three-year auction today will definitely feed the rumours about foreign investors pulling back from the Treasury market,” said Matthew Scott, head of core fixed income and multi-asset trading at AllianceBernstein.
“People don’t want Treasuries right now, they’re in ‘get me out’ mode,” said one hedge fund manager who asked not to be named. The person added that the auction had been so “ill-received” that it might have weighed on equity markets. The S&P 500 had been up as much as 4.1 per cent on Tuesday but closed down 1.6 per cent in volatile trading.
“Post-auction, the [equity] market tanked,” the person said, though others attributed the afternoon sell-off to broader tariff concerns.
Hedge funds also continued scaling back risk in their portfolios on Tuesday. Traders and analysts homed in on several strategies that were being unwound, including the “basis trade” in which funds use huge amounts of borrowing to take advantage of differences in prices for Treasuries and associated futures.
Hedge funds this year also placed big bets on the likelihood that the Trump administration would cut banking regulation. One rule in particular — the standard leverage ratio — makes it more expensive for banks to hold debt such as Treasuries.
Hedge funds were expecting Treasuries to outperform interest rate swaps — derivatives that allow traders to speculate on moves in the debt market — because without these regulations in place, banks would buy more bonds.
But as tariffs roiled markets, bond yields have risen with investors, including banks, selling their Treasuries. As a result, interest rate swaps have outperformed Treasuries, upending the popular trade and forcing investors to exit their positions.
“It’s a proper, full-on hedge fund deleveraging,” said one trader at a Wall Street bank.
