ORLANDO, Florida, May 7 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

Glass half full...probably

A late rally ensured Wall Street's three main indexes rose

on Wednesday, as investors digested Fed Chair Jerome Powell's

press conference after the central bank left interest rates on

hold, a raft of stimulus measures from China and news that

high-level U.S.-China trade talks will open on Saturday.

In my column today I shine a light on how the U.S. bond market's

resilience has spurred hedge funds to build up their 'basis

trade' bets, which are now comfortably back above the $1

trillion mark. More on that below, but first, a roundup of the

main market moves.

I'd love to hear from you, so please reach out to me with

comments at [email protected]. You can also

follow me at @ReutersJamie and @reutersjamie.bsky.social.

If you have more time to read, here are a few articles I

recommend to help you make sense of what happened in markets

today.

1. Fed leaves rates unchanged, cites rising risk of

higher

inflation and unemployment

2. China injects 'tactical' monetary stimulus ahead

of US

trade meeting

3. NEWSMAKER-China's trade tsar He Lifeng takes

centre

stage in U.S. tariff talks

4. Dollar confusion reigns amid 'strategic

uncertainty':

Mike Dolan

5. Investors look to soft data for direction amid

trade

policy chaos

Today's Key Market Moves

* The Nasdaq rises 0.3%, the S&P 500 ends up 0.4% and the

Dow

climbs 0.7%.

* Shares in Google parent company Alphabet sink 7.5% on

Apple's

plan to add AI-powered search options to its Safari web browser,

a blow to Google's search ad business. The technology index

slides 0.5%.

* Disney shares jump 10.8% on strong Q1 earnings and

outlook.

* The dollar index rises 0.5%, gaining most against

the

yen and Aussie and Kiwi dollars.

* European stocks fall 0.5%, dragged lower by the

retail

sector after euro zone retail sales fell more than expected in

March.

* China's two main stock indexes rise 0.6% and 0.8%, as

investors

cheer Beijing's latest stimulus measures and news that

high-level U.S.-China trade talks will open on Saturday.

* Oil resumes its recent decline, with Brent and WTI

crude

futures settling around 1.5% lower on the day.

* Gold falls more than 1%, pressured by a stronger

dollar

and cautious optimism around U.S.-China trade talks.

Taking the positives from trade, China, Fed

If ever a day in financial markets reflected the thick fog

of uncertainty surrounding the global trade, growth and policy

outlook, Wednesday was that day.

Investors initially welcomed the wave of policy easing measures

from China and confirmation that U.S.-China trade talks will

open this weekend. But skepticism soon set in that Washington

and Beijing would make much progress. It's a welcome first step,

but the road ahead could be long and difficult.

The Fed's decision was widely expected and Powell's press

conference offered little clarity, leaving investors struggling

for direction. If there was a thread running through markets, it

was difficult to spot.

Wall Street rallied in the last half hour of trading after

trading in the red most of the day, yet long-dated Treasuries

rose after Powell flagged risks to growth. Gold fell, in part on

easing U.S.-China trade tensions, yet oil fell on skepticism

these talks will yield much.

Either way, U.S. Treasury Scott Bessent, who along with

chief trade negotiator Jamieson Greer will meet China's economic

tsar He Lifeng in Switzerland, characterized the meeting as the

beginning of "negotiations". It's a start.

It will be interesting to see how markets in Asia, especially

China, open on Thursday in a follow-on reaction to the trade

developments and stimulus steps. Currency traders will note that

China's central bank leaned against mounting downward pressure

on the currency on Wednesday and set its daily fix at its

strongest yuan level in a month.

$1 trillion basis trade has barely barked, let alone bitten

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.

What could move markets tomorrow?

* Bank of Japan minutes from March 18-19 meeting

* Taiwan trade (April)

* Germany trade, industrial production (March)

* Bank of England policy decision

* U.S. weekly jobless claims

* $25 billion auction of U.S. 30-year bonds

* Bank of Canada Governor Tiff Macklem speaks

Opinions expressed are those of the author. They do not reflect

the views of Reuters News, which, under the Trust Principles, is

committed to integrity, independence, and freedom from bias.

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