Hedge funds pose greater threat to US Treasuries than China ever did

For years, China has been the biggest concern for the U.S. government bond market. Many feared that the Asian superpower could destabilize the financial system with a politically motivated sell-off of U.S. Treasuries. However, as China has reduced its Treasury holdings, a more significant risk has emerged from domestic investors, particularly hedge funds.

Over the past few years, China and other central banks have gradually decreased their presence in the $29 trillion U.S. Treasury market, while private-sector buyers, including hedge funds and speculators, have expanded their participation. This shift has diminished stability in the world's largest and most liquid financial market.

In 2011, China held $1.3 trillion, or 14% of all outstanding Treasuries. The fear was that Beijing could weaponize its financial clout by dumping these bonds, triggering a domino effect of rising borrowing costs, a weakened dollar, and potential economic recession in the U.S. However, this scenario was unlikely due to Beijing's vested interest in maintaining its foreign exchange reserves and primary export market.

Today, China's Treasury holdings have shrunk to $633 billion, accounting for just 2% of all publicly held Treasuries. The rest of the Treasury market is now dominated by hedge funds, who own $2.6 trillion, or 8% of the total. These hedge funds, known for their leveraged and yield-sensitive strategies, have amplified the market's vulnerability to volatility, as small movements in bond yields could trigger margin calls and forced deleveraging.

The concentration of this activity is also notable, with the 50 largest funds accounting for approximately 90% of the total. Despite no signs of a collapse yet, experts warn that the combination of large scale, high concentration, and elevated leverage creates potential systemic stress if multiple strategies face simultaneous pressure or if severe shocks affect the largest participants.