ANALYSIS — Hedge funds sour on basis trade as Treasury selloff continues

Morgan Stanley estimates leveraged basis-trade holdings fall 20% this year to $1.2 trillion Pullback is mostly concentrated in 2-year and 5-year Treasury futures CFTC data shows net shorts in 2-year Treasury futures down more than 40% from March By Anirban Sen and Gertrude Chavez-Dreyfuss NEW YORK, Sept 24 (Reuters) — Like Treasuries themselves, the Treasury basis trade has fallen out of favor lately. Funds locked up in leveraged basis trades are down 20% this year to $1.2 trillion, Morgan Stanley estimates. The decline reflects a mostly uneventful rise in US interest-rate expectations and improved trading conditions, both of which tend to limit the trade’s profitability. The Treasury basis trade — in which hedge funds borrow overnight to profit on the narrow price difference between Treasury securities and futures — has been blamed for accentuating past market declines through margin calls and fire sales, mostly through the heavy borrowing funds use to boost returns. But this year’s Treasury selloff has reflected in part softer demand for both Treasury securities and futures. Meanwhile, Treasury inventories at large securities-dealing banks are higher, thanks to a rule change, and