UST Bonds and Interest-Rate Swaps
What’s the Hedge Fund Bet?
30y UST yield rose above 5% earlier last week and remained at this level at the start of the new week.
Bloomberg reports that:
“A surge in long-term bond yields is once again threatening to upend a crowded Hedge Fund bet that USTs will perform better than interest-rate swaps.”
To speak plain English:
A lot of hedge funds have placed a popular bet that UST bonds (USTs) will give better returns than interest-rate swaps. But now, long-term bond yields are rising quickly, which puts that bet in danger of failing.
And Bloomberg goes on to outline that
“The trade is at risk of falling apart as borrowing costs for the world’s biggest economies soar, diminishing the returns in US Govt debt against the swaps.”
In simplified words:
This investment strategy may no longer work because interest rates (or borrowing costs) are rising sharply around the world. As a result, the returns from US Govt bonds are becoming less attractive compared to the returns from interest-rate swaps.
It is now necessary to provide a brief background explanation:
Hedge funds often bet on the "spread" between UST yields and interest-rate swap rates.
Normally, USTs are considered safer and have slightly lower yields, but when that relationship gets disrupted (e.g., if UST yields rise too quickly), the trade can become unprofitable.
This Bloomberg note is saying that the recent sharp increase in long-term yields - driven by rising global interest rates - is damaging that trade.
If the yield on Treasuries increases too much, they may underperform relative to swaps, and hedge funds that expected the opposite could face losses.
But what exactly is the hedge fund bet?
Hedge funds often try to profit from small pricing differences between USTs and interest-rate swaps.
This is a type of relative value trade, where the investor bets on the spread (difference) between two rates narrowing or widening.
In this case, many hedge funds are betting that:
UST bonds will perform better than interest-rate swaps.
That means they expect Treasury yields to fall more — or rise less — than swap rates.
If that happens, they make money.
What are interest-rate swaps?
An interest-rate swap is a financial contract where two parties exchange interest rate payments:
One pays a fixed rate
The other pays a floating rate (based on something like SOFR)
Swaps are used by institutions to hedge or speculate on interest rate movements.
The swap rate reflects expectations for future short-term rates and credit conditions.
Why is this trade popular ("crowded")?
It's a relatively common hedge fund strategy because:
USTs are highly liquid and safe.
Swaps can behave differently under stress, making the spread trade potentially profitable.
But when too many funds do the same thing, the trade gets "crowded", meaning:
It’s vulnerable to market reversals.
If it goes wrong, everyone tries to exit at once, causing big losses.
What’s happening now?
Long-term UST yields are rising sharply - meaning bond prices are falling.
This is likely due to:
Higher inflation expectations
Stronger economic data
Central banks keeping rates higher for longer
Increased government borrowing (more supply of bonds)
Why is this a problem for the bet?
If Treasury yields rise more than swap rates:
The value of the Treasuries in the trade drops.
The hedge fund’s position underperforms.
The spread moves in the wrong direction, causing losses.
That’s why Bloomberg says:
“The trade is at risk of falling apart…”
Rising yields reduce the relative return on Treasuries versus swaps, making the trade go against the hedge funds.
A summary in plain terms
Many hedge funds are betting that US Govt bonds will do better than a certain kind of financial instrument (interest-rate swaps). But now, global interest rates are rising sharply, especially long-term ones. This is hurting the value of the US bonds and making them less profitable compared to the swaps — so the bet may not work out, and those funds could lose money.
Here's a simple example to help make it all concrete:
Let’s say a hedge fund does this trade:
Buys a 10y UST bond that pays 4% annual interest.
Sells (or receives fixed on) a 10y interest-rate swap where the fixed rate is 4.2%.
So at the start:
The Treasury bond yields 4%
The swap pays 4.2%
The hedge fund expects the spread (swap rate minus Treasury yield = 0.2%) to narrow over time (i.e., they think the Treasury bond will become more valuable relative to the swap).
If that happens, they make money.
What They Hope Will Happen:
Treasury yields fall to 3.5% (bond prices go up).
Swap rates fall to 3.8%.
The new spread is 0.3%, but since Treasuries gained more value, the hedge fund's bond outperformed the swap.
→ Profit!
What’s Actually Happening Now:
Instead, the opposite is happening:
UST yields rise to 4.8% (bond prices fall).
Swap rates rise only to 4.5%.
So:
The Treasury bond loses more value than the swap gained.
The spread narrows in the wrong way.
The hedge fund loses money.
This is risky because a lot of hedge funds made this same bet (it's "crowded"), when things go wrong, everyone tries to unwind the trade at once. That causes bigger market swings and even more losses.
Bottom Line:
Hedge funds bet that US Treasuries (UST) would outperform swaps.
Rising interest rates - especially long-term ones - are wrecking that bet.
They are now at risk of losing money, fast.