Why Did US Treasury Yields Spike in April 2025? The Truth Behind the Basis Trade Unwind

This post is written with the help of ChatGPT, as I lacked the necessary in-depth finance knowledge.  There are some points here that are written and has been fact-checked with the relevant information from other sources.

In early April 2025 after the "Liberation Day", where Donald Trump started imposing reciprocal tariffs to almost every country, besides the sharp plunge in stock markets which caused my portfolio to drop below the SGD 600K market value "support level", a bewildering sudden and sharp spike in US 10-year and 30-year Treasury yields (more specifically between 9th to 11th April) occurred and this caught markets off guard.  Investors were rattled because usually when stock market crashes occur, investors tend to move funds into the US Treasuries as a form of flight to safety, which tend to lower bond yields.  Hence when the 10-year bond yields suddenly spike from around 4.0% to above 4.5% in a couple of days, media headlines screamed about a potential bond market crisis.  Investors were speculating was it because Japan and China were dumping US debt, or was something more complex, yet largely hidden, going on behind the scenes?

The answer lies in an obscure but powerful strategy called the "basis trade", and its violent unwinding.

What Are Treasury Yields and Why Do They Matter?

Before diving into the basis trade, let’s clarify what a "spike in yields" means.

1)     Treasury bonds are loans to the US government.  You buy a bond, they pay you back with interest.

2)     The yield is the return you get for holding that bond.  Yields move inversely to prices.

        a)     If everyone sells bonds, prices fall and yields rise.

        b)     If everyone buys bonds, prices go up and yields fall.

Therefore as mentioned above, when investors saw yields on 10-year and 30-year Treasuries suddenly surging to levels not seen in years, that meant people were dumping bonds real fast.

Some speculated that China or Japan, two of the largest foreign holders of US Treasuries, were selling en masse, but that was not the full story.

Yes, Japan’s yield control policy changes may lead some Japanese investors to reduce their US bond holdings, and China may have trimmed its US exposure, but their actions were more likely to be gradual, not sudden or massive enough to explain the spike seen.

The real culprit?

Possibly it is the basis trade and its violent unwind.

What Is the Basis Trade?

According to Intacapital Switzerland:

"Basis trading is a financial trading strategy regarding the purchase of a particular financial instrument or security (in this case Treasury Bonds) or commodity, and the sale of its related derivative.  In this example, it is the purchase of a Treasury Bond and the sale of its related futures contract.  In the treasury market, the trade is centered on the price differential between treasury bonds and their associated futures contracts.

From time to time, due to heavy purchasing of Treasury bond futures by insurance companies, institutional investors and pension funds*, the bond futures price rises above the price of the underlying bond.  Once this price differential is in place hedge funds take advantage of this price differential and will buy Treasury bonds and at the same time sell corresponding Treasury futures.  The upshot of this trade is that by selling the higher priced bonds in one market and buying the cheaper priced bonds in another market, the hedge funds can profit from the price differential. 

However, the profits from these trades are very small, therefore heavy borrowing is required in order to make them more lucrative.  Sometimes when there are unexpected episodes or events, this can quite often lead to market volatility leading to potential tragic consequences for the trade leaving the trader no option but to straight away unload all their holdings.  This form of arbitrage**, as mentioned previously, requires heavy borrowing, and hedge funds usually borrow from the Repo Market***.  It is normal for hedge funds to offer their Treasury bonds as collateral, as the normal practice is to roll-over these loans on a daily basis.  Experts advise that these trades can be quite risky due to the amount of leverage involved (on average USD50 for every USD1 invested so 50 times leverage), plus a big reliance on short-term borrowings. 

When the Treasuries market experiences volatility, it can increase the cost of the trade thereby negating profitability, so hedge funds must very quickly unwind their trades in order to repay their loans thereby increasing volatility in an already volatile market.  Such fluctuations can see liquidity drying up and a decrease in the availability of buyers.  In such instances the Treasuries market can literally seize up, and with Treasury bonds being so fundamental to the credit market (and they are risk-free), the US Federal Reserve has had to intervene when the normal functioning of the market has become impaired.

*Purchasing Treasury Bond Futures – Asset managers instead of buying actual Treasury bonds quite often prefer to buy futures because there is less upfront cash to pay. 

**Arbitrage – the simultaneous buying and selling of currencies, commodities or securities in different markets or in derivative forms in order to take advantage of the differing prices of the same asset.

***Repo (Repurchase Agreement) Market – In this market money market funds, banks and others lend short-term capital against government securities, in this case US Treasury Bonds. Basically, in this transaction a borrower temporarily lends a security to a lender for cash with an agreement to buy it back in the future at a predetermined price. Ownership of the security does not change hands in a repo transaction."

To help other layman understand the concepts better, let’s use a concert ticket analogy.

Imagine you're a savvy concertgoer.

• You know a popular artist is coming to town next month.

• Today, you find physical tickets for sale on a secondary site for $95.

• Meanwhile, on another platform, people are pre-ordering these same tickets for $100.

You see an opportunity:

1. You buy the ticket now for $95.

2. You agree to sell it next month for $100.

That’s a $5 profit, easy money!

But, you want to make more, so you borrow money to buy 100 tickets instead of just 1.  Now you are making $500, not $5.

And that is what hedge funds do in a basis trade:

• They buy something today (actual Treasury bonds),

• Sell it for slightly more in the future (via futures contracts),

• And borrow a ton of money to multiply small profits.

What If Things Go Wrong?  The Unwind Occurs.  Now imagine this:

• Suddenly, the artist gets bad press.

• Demand for the tickets plummets.

• The resale value falls to $85.

• The buyers who pre-ordered at $100 back out.

Now you’re stuck holding 100 tickets bought at $95, but worth only $85.  To make matters worse, you borrowed money to buy them.  The lender calls you and says: “Hey, your collateral dropped in value.  Pay up now.”

Panicked, you try to sell the tickets fast, but so is everyone else.  Prices fall further, and losses pile up.  That is the unwind of the basis trade.

In Finance Terms:

• The ticket = Treasury bond

• The pre-order contract = Treasury futures

• The small profit = Basis

• Borrowing to buy more = Leverage

• The sudden price drop = Market volatility

• The rush to sell everything = Unwinding the trade

And when thousands of hedge funds all do this at the same time, prices crash, yields spike, and it almost breaks the system.

Why Did It Go Wrong in April 2025?

The basis trade works well in calm markets, but it depends on:

• Bond prices being relatively stable,

• The difference between bond prices and futures being predictable,

• And most critically: liquidity - the ability to buy and sell easily without big price changes.

In April 2025, several things happened at once:

1)     Due to the announcement and implementation of world-wide reciprocal tariffs, stock markets world-wide experienced market crashes to varying degrees.  This caused margin calls to happen to varying degrees in the stock market.  Retail and institutional investors on margin are frantically finding monies to top up their accounts to prevent margin call.  This may cause many to obtain the funds from treasuries.

2)     When traders began dumping long-term treasuries in large quantities, bond prices plunged and yields spike.

3)     Liquidity dried up.  Suddenly, it became harder to sell bonds without taking losses and in turn, margin calls happened within the bond markets, and funds have to dump bonds fast to prevent problems from escalating due to the leveraging.

As everyone rushed to unwind the same trade at once, it became a stampede.  The result?  Bond prices collapsed, and yields shot up like a rocket.  This probably triggered US President Trump to reverse his world-wide reciprocal tariffs implementation, and gave a 90 day pause.  This helped to relief the stress in stock markets and hence brought about relief in the bond markets.

Who is to Blame?

1)     Hedge Funds

They piled into the trade because it looked “safe” and profitable in a low-volatility world.  However they ignored the risks of:

• Liquidity shocks,

• Rising interest rates,

• Crowded positioning.

2)     Wall Street Banks

They financed these trades through the repo market, indirectly encouraging the leverage buildup.

3)     Regulators

Some critics argue that the lack of transparency around hedge fund leverage and basis trades left markets exposed.  The SEC and Fed had warned about these trades before, but perhaps did not act fast enough.

4)     Trade War

The implementation of the trade war by US President Donald Trump seems quite senseless as time passes because what he implemented does not seem to benefit the average Americans in the longer term.  However that is just my personal opinion.

The April 2025 Treasury yield spike was not just a story about bonds.  It was a warning shot about how hidden risks, when combined with leverage and herd behavior, can create flash-crisis moments in even the safest corners of the market.  Let this be a reminder to all of us, no where is safe when a crisis occur.  Even if the asset class was once thought to be a safe haven, market manipulators will find a way/ loophole to profit from it, and inevitably, destabilize the asset's position as a safe haven.  We, as retail investors, just have to accept that wild volatility is part of the game, and just ride out the volatility.  My personal take, just avoid leverage and margins in investing.  This is a choice that I can make to protect my portfolio.  Barista FIRE, here I come...!