This may seem obvious, but hedge funds dominate a significant portion of Treasury trading. Their exposure exceeds that of mutual funds, and their behavior strongly affects market direction. These are not the same bond vigilantes of long ago, but a breed of arbitrageurs and directional traders ready to go long or short based on small market deviations. They are both liquidity takers and makers. Their turnover is significant, and they use substantial financing.
You have to ask: what happens if they change their strategies, or if losses elsewhere in their portfolio lead to deleveraging? Treasury prices are unlikely to rise, and liquidity will decline. Regulators have little to do. Do you want hedge funds to leave the market? Data from Decomposing Hedge Funds’ U.S. Treasury Exposures.
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