• In normal times, hedge funds help keep money markets humming by profiting handsomely from tiny price discrepancies between Treasuries and futures linked to those bonds. When the $800 billion trade unwinds, however, the Federal Reserve may need to step in—as it did during the pandemic—to prevent the type of disastrous credit crunch exemplified by the 2008 financial crisis. 

Investors are looking to pick up the pieces after President Donald Trump announced a 90-day pause to the sweeping “reciprocal tariffs” that sent stocks plunging, but many on Wall Street suspect chaos in the bond market truly forced the administration’s hand. A confounding spike in yields sparked fears of a liquidity crisis, and the collapse of the so-called “basis trade” may have been one of the main culprits.

In normal times, hedge funds borrow heavily to take advantage of tiny price discrepancies between Treasuries and futures linked to those bonds. They profit handsomely and, in turn, help keep money markets humming. The COVID-19 pandemic and recent trade policy upheaval have shown what can happen when the $800 billion trade unwinds, however, and some experts think the Federal Reserve needs to be better equipped to handle the next potential crisis in, say, three months or so.  

After all, fixed-income markets can be fickle. Investors initially piled into Treasuries last week as stocks plunged, but the tide soon shifted—even as the carnage in equity markets continued. Yields, which represent an investor’s annual return, rise as bond prices fall, and they spiked early this week as a sell-off in U.S. debt raised questions about its typical safe-haven status.

Treasury Secretary Scott Bessent has said the Trump administration wants to see a lower 10-year Treasury yield, the benchmark for mortgage rates, car loans, and other types of borrowing costs throughout the economy. It spiked above 4.5% on Wednesday morning, and while the stock market soared after Trump’s “pause,” the reaction in bonds was more muted. As of Thursday afternoon, the 10-year yield had again surged past the 4.4% mark, even though stocks shed part of their gains from Wednesday’s historic rebound.

Shortly after Trump announced import taxes on goods from most countries (excluding China) would be reduced to a baseline 10% charge, Bessent denied bond market volatility was behind the president’s flip-flop. But Kevin Hassett, Trump’s head of the U.S. National Economic Council, told CNBC Thursday movements in the Treasury market had added “perhaps a little more urgency” to the decision to temporarily scrap the reciprocal tariffs. The White House did not respond to Fortune’s request for comment. 

Whatever the case, the unusual increase in long-term interest rates amid an equity sell-off has been akin to a “murder mystery,” said Torsten Sløk, chief economist at private equity giant Apollo.

“That’s telling me that there [are] some distressed, forced sellers out there,” he told Fortune. “Someone who’s selling not because they think the economy is good or bad, or inflation is good or bad, or [that] the Fed is going to hike or not hike [interest rates].”

To be sure, many commentators have also cited foreign selling as a possible cause. Trump has announced a 145% tariff on goods from China, the second-largest foreign holder of Treasuries, leading to questions about whether Beijing might retaliate by dumping some of its roughly $770 billion of U.S. debt—or simply have less reason to buy American assets as bilateral trade decreases.  

However, if that had been a major factor this week, Sløk said, he would have expected to see a more significant weakening in the U.S. dollar (which did fall more noticeably on Thursday). Goldman Sachs researchers William Marshall and Bill Zu agreed.

“We would not rule out a diversification away from dollar assets over time,” they wrote in a note Wednesday, “but the near-term behavior appears more consistent with some anticipatory concern about that possibility in conjunction with unwinds of levered longs.”

In other words, this is what can happen when hedge funds are forced to dump Treasuries en masse. In extreme cases, liquidity can dry up—posing a threat to the broader economy if the Fed doesn’t step in.

How the “basis trade” works 

Hedge funds are presented with an arbitrage opportunity in the first place, experts say, because of a fundamental imbalance in credit markets. Many asset managers of mutual funds, pension funds, and insurance companies have long-term liabilities—like payouts to retirees decades down the road—and want to buy assets with similar exposure to interest rates, or duration, over that span.

The classic way of doing that often involves buying large amounts of Treasury futures contracts, but someone needs to take the other side of the trade. That’s where hedge funds and other broker-dealers step in, selling those derivatives while hedging that “short” position by buying cash Treasuries.

In return, hedge funds profit off the spread between the value of the bond and the slightly overpriced futures contract: As the latter approaches expiry, its price falls and the short bet pays off. The profit comes from the price difference—the “basis”—between the futures contract and the underlying Treasury. 

But, “this arrangement is inherently fragile,” according to a recent Brookings Institution paper by Harvard economist and former Fed governor Jeremy Stein along with the University of Chicago’s Anil Kashyap, Harvard’s Jonathan Wallen, and Columbia’s Joshua Younger. 

To make the trade worthwhile, hedge funds need to borrow heavily, sometimes using as much as 50- to 100-times leverage. When markets start going haywire, however, they can be vulnerable to margin calls or otherwise be pressured to liquidate their position when they sustain losses on other trades (especially as stock prices plummet) and investors pull their money.

A better solution for the Fed 

When the market struggles to absorb a massive increase in the supply of Treasuries, a broader credit crunch a la the 2008 financial crisis looms as a worst-case scenario. When yields spiked this week, many Wall Street analysts watched closely for signs the Fed would be forced to intervene. The central bank was quick to prevent such a situation at the onset of the COVID-19 pandemic, buying $1.6 trillion in Treasuries over several weeks.

Kashyap and his co-authors claim this solution is less than ideal, though. It may just be an effort to keep money markets stable, but it also looks a lot like quantitative easing—when the central bank buys financial assets to push down long-term interest rates.

“Without a clear upfront distinction between bond-buying for market-function purposes, versus for monetary-policy purposes, the initial round of Treasury purchases in the spring of 2020 morphed into a broader monetary policy effort that eventually saw the Fed add over $4 trillion to its combined holdings of Treasuries and agency mortgage-backed securities by mid-2022,” the authors noted.

Therefore, they call for a more “surgical” approach to such a crisis: help hedge funds unwind by purchasing Treasuries and selling futures. While the prospect of bailing out hedge funds might raise some eyebrows, the authors claim their solution might be more effective at preventing reckless behavior than blunt-force Treasury purchases.

There are complementary solutions, of course. It’s hard to find buyers during a Treasury sell-off, in part, because banks and broker-dealers are limited by capital requirements strengthened after the Global Financial Crisis and the subsequent Dodd-Frank reform legislation. They were temporarily loosened during the pandemic to help lenders buy more U.S. debt, however, and Bessent said Wednesday those changes should be made permanent as part of a broader deregulatory push.

Even if the Treasury secretary gets his wish, though, markets may eventually need the Fed to take much more drastic action.

This story was originally featured on Fortune.com

Barry Callebaut, the world’s biggest supplier of chocolate to the food industry, warned on Thursday that another surge in cocoa prices had pulled down profits, prompting investors to dump its shares.

The Swiss-based group also cut its annual sales forecast after net profit tumbled 60 percent to 30.5 million francs ($36.9 million) in the first half of its financial year to February.

The company’s shares plunged 21.5 percent on the Swiss stock exchange to 828 francs.

It said cocoa bean prices had jumped 95 percent on average during the period from the year earlier, citing “speculative buying” as well as “adverse weather” affecting some harvests, without further detail.

“The intense cocoa bean price volatility had a significant impact on the industry, customer behaviour and our financial performance,” Barry Callebaut said in a statement.

It said price increases passed on to food manufacturers had weighed on demand, noting that some clients had postponed orders, with overall sales volumes falling 4.7 percent to 1.08 million tonnes.

A plan to cut costs by 250 million francs was also delayed by a year.

“The cocoa bean price environment and tariff uncertainties have created a perfect storm,” said Jean-Philippe Bertschy, an analyst at Vontobel, referring to the US tariffs announced by President Donald Trump.

“However, the cocoa bean price has come down significantly in recent weeks from a high of over 9,000 pounds [$11,640 per tonne] at the end of January to the current level of 6,000 pounds,” he said.

This story was originally featured on Fortune.com

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The Trump administration has moved to classify more than 6,000 living immigrants as dead, canceling their Social Security numbers and effectively wiping out their ability to work or receive benefits in an effort to get them to leave the country, according to two people familiar with the situation.

The move will make it much harder for those affected to use banks or other basic services where Social Security numbers are required. It’s part of a broader effort by President Donald Trump to crack down on immigrants who were allowed to enter and remain temporarily in the United States under programs instituted by his predecessor, Joe Biden.

The Trump administration is moving the immigrants’ names and legally obtained Social Security numbers to a database that federal officials normally use to track the deceased, according to the two people familiar with the moves and their ramifications. They spoke on condition of anonymity Thursday night because the plans had not yet been publicly detailed.

The officials said stripping the immigrants of their Social Security numbers will cut them off from many financial services and encourage them to “self-deport” and abandon the U.S. for their birth countries.

It wasn’t immediately clear how the 6,000-plus immigrants were chosen. But the Trump White House has targeted people in the country temporarily under Biden-era programs, including more than 900,000 immigrants who entered the U.S. using that administration’s CBP One app.

On Monday, the Department of Homeland Security revoked the legal status of the immigrants who used that app. They had generally been allowed to remain in the U.S. for two years with work authorization under presidential parole authority during the Biden era, but are now expected to self-deport.

Meanwhile, a federal judge said Thursday that she was stopping the Trump administration from ordering hundreds of thousands of Cubans, Haitians, Nicaraguans and Venezuelans with temporary legal status to leave the country later this month.

A representative from the Social Security Administration did not respond to a request for comment on the news that living immigrants were being classified as dead. The agency maintains the most complete federal database of individuals who have died, and the file contains more than 142 million records, which go back to 1899.

The Privacy Act allows the Social Security Administration to disclose information to law enforcement in limited circumstances, which includes when a violent crime has been committed or other criminal activity.

DHS and the Treasury Deprartment signed a deal this week that would allow the IRS to share immigrants’ tax data with Immigration and Customs Enforcement for the purpose of identifying and deporting people illegally in the U.S. The agreement will allow ICE to submit names and addresses of immigrants inside the U.S. illegally to the IRS for cross-verification against tax records.

The acting IRS commissioner, Melanie Krause, who had served in that capacity since February, stepped down over that deal.

In March, meanwhile, a federal judge temporarily blocked a team charged with cutting federal jobs and shrinking the government led by billionaire Elon Musk from Social Security systems that hold personal data on millions of Americans, calling their work there a “fishing expedition.”

Skye Perryman, president and CEO of Democracy Forward, an advocacy group that has challenged various Trump administration efforts in court, said her organization would likely sue over the Social Security numbers as well, once more details become available.

“This President continues to engage in lawless behavior, violating the law and abusing our systems of checks and balances,” Perryman said.

This story was originally featured on Fortune.com

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