ORLANDO, Florida, May 7 (Reuters) - Amid all the

uncertainty surrounding U.S. growth, Federal Reserve policy, and

the attractiveness of the dollar, the U.S. bond market is

remarkably tranquil, calling into question long-held fears about

the massive 'basis trade'.

While Treasuries experienced a brief bout of volatility

following the Trump administration's 'Liberation Day' tariffs

last month, including a spike in long-term yields and

dislocation in 30-year swap spreads, the $29 trillion market has

withstood everything thrown at it.

Indeed, positioning in Treasury futures has quietly risen in

recent weeks and is now close to a record aggregate peak across

two-, five- and 10-year contracts. In the five-year space, both

'long' and 'short' positions have never been higher.

The Treasury futures market is where hedge funds operate the

basis trade, an arbitrage that profits from making highly

levered bets on tiny differences between the price of cash bonds

and futures.

Global financial authorities have repeatedly warned that, if

suddenly unwound, these positions - levered up to 100 times -

could pose a threat to financial stability, as sharp price

swings could trigger a devastating dash for cash and scramble to

cover.

But that hasn't happened yet, despite all the market

volatility over the past month.

Instead asset managers and leveraged funds are steadily

building their 'long' and 'short' positions, respectively.

Aggregate holdings across two-, five- and 10-year futures

contracts are all comfortably above $1 trillion in notional

terms. Speculators seem happy to continue peeling off the pips

in the basis trade, and asset managers are happy to lock in

yields between 3.80% and 4.20%.

"It's maybe a little surprising how fast these positions are

being rebuilt, but it shows a generally salient view leveraged

investors have in the functioning of the repo and Treasury

markets," says Steven Zeng at Deutsche Bank.

SOLID FOUNDATIONS

Treasury market depth may be a bit thinner than normal but

it's nowhere near crisis levels, and there's no sign of the

funding stress of late 2018, or September 2019 when the Fed was

forced to inject liquidity into the market.

The 'MOVE' index of implied Treasury market volatility has

come down almost as quickly as it spiked in early April and is

now below its average of the last three years.

Overnight repo rates, which hedge funds can use to fund the

basis trades, spiked at the height of the tariff turmoil a month

ago, but that was an insignificant blip compared to the surges

in 2018 and 2019. Repo rates are now in the middle of the Fed's

4.25-4.50% policy target range.

Meanwhile, New York Fed data shows that the volumes of

overnight cash borrowed at the Secured Overnight Financing Rate

(SOFR) hit a record $2.8 trillion at the end of April. That

suggests liquidity is ample, demand is strong and investors have

confidence in this source of funding. These all appear to be

signs of a well-functioning market.

True, there is some sign of elevated anxiety in the Treasury

market. The 'term premium' - the risk premium investors demand

for buying longer-dated bonds rather than rolling over

short-dated loans - has risen to the highest in a decade.

And there is always the risk that a sharp spike in borrowing

costs - perhaps driven by another policy surprise or twist in

the ongoing trade war - could put the basis trade in peril. But

then what?

If things did start to unravel, the Federal Reserve or

Treasury Department would almost certainly come in with a

backstop to preserve financial stability and maintain bond

market functioning.

So despite the fearmongering, the $1 trillion 'basis trade'

remains the dog that has barely barked, let alone bitten.

Perhaps the deepest and most liquid market in the world is

simply more robust than some Cassandras would have you believe.

(The opinions expressed here are those of the author, a

columnist for Reuters)

(By Jamie McGeever

)