France’s 10-year government borrowing cost reached its highest level since 2002 amid volatile bond trading, Reuters reported in “French bond turmoil shines spotlight on hedge funds,” published Nov. 10.
Large investors linked the speed of recent moves partly to hedge funds’ growing presence in government debt markets. Their selling when prices fall can deepen declines and push borrowing costs higher.
Bond yields, which move in the opposite direction to prices, rose sharply around the world in recent months. Daily increases of about 10 basis points, or 0.1 percentage point, occurred regularly despite ordinarily being unusual moves.
Hedge funds tend to respond quickly to price changes. When bond prices fall, they can sell, adding to the pressure that drove prices lower in the first place.
European Central Bank calculations put hedge funds’ share of European government bond trading at about 50% across trading platforms. Their growing role extends beyond the euro zone to government debt markets elsewhere.
International Monetary Fund data showed that hedge funds’ holdings of government bonds worldwide had more than doubled since 2022. Much of that activity was in the United States.
The IMF put hedge funds’ total assets at around 13 trillion at the start of this year, rising to about 40 trillion including exposure through derivatives such as options and futures. The currency was unspecified.
Hedge funds often borrow money to finance their trades and use derivatives, contracts whose value depends on an underlying asset, to take large positions. That increases their exposure beyond the assets they hold directly.
Their expansion coincided with other buyers pulling back. Central banks held less debt, while regulatory requirements limited how much banks could keep on their books.
Large pension funds also held less long-dated government debt. These included defined benefit schemes, which promise members a pension based on factors such as salary and years of service.
Hedge funds’ frequent trading usually makes bonds easier and cheaper to buy and sell. But that ease of trading can diminish sharply when prices move against funds and they sell quickly.
The risks had not yet materialised dramatically. The remarks left open how far hedge fund selling might worsen future disruptions or increase governments’ borrowing costs.
Difficulty trading government bonds can make investors less willing to hold them or lead them to demand a lower purchase price. Lower bond prices mean higher yields and greater borrowing costs for governments.
Governments rely on borrowing alongside taxes to fund spending. Government bond yields also help determine prices across financial markets, including mortgage rates, so higher government borrowing costs can eventually raise mortgage costs.
