Why Are US Long-Term Interest Rates Moving Higher?

The textbook would be saying that when the stock market is going down, long-term interest rates should also be going down.

But this is not what is happening at the moment, see chart below.

What could be the reasons why long-term interest rates are moving higher when the stock market is moving lower?

1) With the yen, euro, and Canadian dollar strengthening at the same time, this could be foreigners selling US Treasuries.

2) With the VIX at elevated levels around 50, there is a lot of hedging activity going on, and it could, therefore, be risk reduction among large asset managers managing rates, credit, and equities.

3) With almost $1 trillion in the basis trade, it could be an unwinding of the basis trade among levered hedge funds.

The answer is likely some combination of these three forces.

Very unusual moves in long rates at the moment — Note: Data starts from January 2020. Sources: Bloomberg, Apollo Chief Economist

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What Is the Basis Trade?

Something very unusual happened in financial markets yesterday. Long-term interest rates went up 20 basis points despite stocks going down. One potential reason for the move higher in rates is an unwind of the basis trade.

The basis is the difference in price between a Treasury security and a Treasury futures contract with similar characteristics.

The source of this price difference is demand and supply imbalances in Treasury markets, or arbitrage limitations for regulatory reasons.

In the basis trade, hedge funds put on leveraged bets, sometimes up to 100 times, with the goal of profiting from the convergence between the futures price and the bond price, as the futures contract approaches expiry.

How big is the basis trade? It is currently around $800 billion and an important part of the $2 trillion outstanding in prime brokerage balances. It will continue to expand as US government debt levels continue to grow, see charts below.

Why is this a problem? Because the cash-futures basis trade is a potential source of instability. In case of an exogenous shock, the highly leveraged long positions in cash Treasury securities by hedge funds are at risk of being rapidly unwound. Such an unwind would have to be absorbed, in the short run, by a broker-dealer that itself is capital-constrained. This could lead to a significant disruption in market functions of broker-dealer firms, such as providing liquidity to the secondary market for Treasuries and intermediating the market for repo borrowing and lending. For example, during Covid, the Fed was at the peak buying $100 billion in Treasuries every day.

In addition, if the supply of Treasuries grows further, for example, because of a growing budget deficit or the Fed doing quantitative tightening, it will potentially depress Treasury prices, hurting the long leg of the trade, and stress repo funding, as dealers have limited balance sheet capacity.

The bottom line is that the large and growing cash-futures basis trade, driven by leveraged hedge fund positions in Treasuries, poses a risk due to potential market disruptions and liquidity issues, especially in the event of an exogenous shock or increasing Treasury supply.

Net Treasury futures by investor type — Sources: Commodity Futures Trading Comm, Bloomberg, Apollo Chief Economist

$2 trillion in prime brokerage borrowing — Note: The data are aggregated responses to SEC Form PF question 43. Only responses from Qualifying Hedge Funds are included. Sources: Data for the US Office of Financial Research, Apollo Chief Economist

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A Careful Look at the Incoming Hard Data

Our daily and weekly indicators for the US economy are available here, and the conclusion is that the hard data is still doing okay, but there are signs of weakness emerging.

Specifically:

– Las Vegas visitor volumes and total room nights occupied have started to decline, see the first two charts.

– Weekly bankruptcy filings are moving higher, see the third chart.

– Weekly data for movie theatre visits is weak, see the fourth chart.

– Daily data for job postings has been weaker in recent weeks, see the fifth chart.

– Daily TSA travel data is slightly weaker than at this time last year, see the sixth chart.

– Continuing claims are moving higher, see the seventh chart.

Las Vegas tourism declining — Sources: Bloomberg, Macrobond, Apollo Chief Economist

Las Vegas room nights occupied — Sources: Bloomberg, Macrobond, Apollo Chief Economist

Weekly bankruptcy filings — Note: Filings are for companies with more than $50mn in liabilities. For week ending on April 4, 2025. Sources: Bloomberg, Apollo Chief Economist

Weekly movie theatre visits — Sources: Boxofficemojo.com, Apollo Chief Economist

Daily jobs postings — Sources: Indeed, Bloomberg, Macrobond, Apollo Chief Economist

Daily data for US air travel — Sources: US Department of Homeland Security, Macrobond, Apollo Chief Economist

Weekly continuing jobless claims — Sources: US Department of Labor, Macrobond, Apollo Chief Economist

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The Impact of Tariffs on the US Economy

The table below shows our estimates of the impact on US GDP and inflation of tariffs and the decline in consumer sentiment and corporate sentiment.

Whether we will have a recession or not depends on the duration of this shock. If these levels of tariffs stay in place for several months and other countries retaliate, it will cause a recession in the US and the rest of the world.

We will be discussing the outlook for the economy and markets on a conference call today at 9 am EDT, you can register here.