BoE deputy warns hedge funds raise bond market shock risk

Bank of England deputy governor Sarah Breeden stated on Thursday that the likelihood of a broader bond market shock is greater than it was previously, attributing the increased risk to the growing presence of hedge funds in global debt markets. Breeden, who serves as the central bank's deputy governor for financial stability and sits on the Monetary Policy Committee, explained that the shifting investor base and their use of leverage create conditions where localized turbulence can spread into wider financial stress.

In an interview with CNBC's Sri Jegarajah, Breeden noted that core government bond markets globally no longer see the same level of participation from traditional "real money" investors, such as insurance companies and pension funds. Instead, hedge funds have become a dominant force. She described these funds as price-sensitive, leveraged, and international, characteristics that increase the probability of a shock in one market transmitting to another.

Breeden made these remarks on the sidelines of the International Monetary Fund and World Bank annual meetings in Bangkok, Thailand. Her comments align with findings released by the IMF on Tuesday. The fund reported that hedge funds now hold gross assets of approximately $13 trillion, making them a significant component of the global investor base. While the IMF's Global Financial Stability Report acknowledged that hedge funds support market liquidity and efficiency, it issued warnings regarding their operational risks. Specifically, the report highlighted that the industry's use of leverage to boost returns and its tendency to pursue crowded trades could amplify market stress during periods of turmoil. The IMF suggested this stress could spill over into broader financial markets, including banks' prime brokerage businesses.

The scrutiny on hedge fund activities has intensified this year following a sharp sell-off in sovereign debt. Data from the U.S. Office of Financial Research, published on Aug. 19, showed that hedge funds held a record 7% of the $30 trillion U.S. Treasury market at the end of 2025. A significant portion of this activity involves "basis trades," an arbitrage strategy where funds take long positions in cash Treasurys while shorting corresponding futures contracts. Investors seek to profit from the small price gap between these instruments, often employing large amounts of leverage to inflate returns.

Market conditions have reflected recent volatility. Earlier this month, 10-year and 30-year U.S. Treasury yields reached their highest levels since 2002. In the United Kingdom, yields on 10-year government bonds, known as gilts, also touched multi-decade highs. Meanwhile, yields on French government bonds, or OATs, have moved sharply higher in recent weeks due to rising concerns about the country's fiscal outlook, fueling fears of a fresh sovereign debt crisis within the euro zone.