OFR Monitor Shows Rising FX and Sovereign Debt Exposure

Views and opinions expressed are those of the authors and do not necessarily represent official positions or policy of the OFR or Treasury.

The OFR’s Hedge Fund Monitor (HFM) was introduced in July 2024. This tool provides information about qualifying hedge fund¹ activities with nearly 500 downloadable data series sourced from SEC Form PF, CFTC Traders in Financial Futures, Federal Reserve Board SCOOS, and FICC sponsored repo. These data series are presented in 85 interactive charts organized into six categories: Size, Leverage, Counterparties, Liquidity, Complexity, and Risk Management.

This blog demonstrates how to navigate the HFM to extract insights about hedge funds’ exposures and concentration using the foreign currency (FX) and foreign sovereign debt markets as case studies.

FX gross exposures, which include foreign currency futures, swaps, forwards, and currency holdings, increased by almost $2 trillion (+60%) since the end of 2022 to a record $5.3 trillion as of Q3 2024 (see Figure 1). The increase was driven by derivatives investment (unhedged) exposures, as opposed to derivatives hedging exposures². An example of the former is the yen carry trade. Hedge funds employing this trade are long, higher-yielding assets, such as dollar-denominated assets, and short the yen. Synthetic versions of this trade use derivatives for the short leg, for example shorting yen futures or, more commonly, selling yen forwards.

The build-up in broad FX derivative exposures was evident before early August 2024, when yen carry trades were unwound and market volatility sharply increased. It is not possible to quantify the yen carry trade using HFM data because FX derivative exposures by currency are not reported in SEC Form PF filings. However, the popularity of yen carry trade coincided with the larger hedge fund FX exposures through mid-2024. In Q3 2024, multi-strategy funds sharply reduced their net short FX derivatives investment exposures.

Foreign sovereign debt gross exposures are also at an all-time high. These exposures consist mostly of G-10 debt and related derivatives. They totaled $2.6 trillion as of Q3 2024, up 58% since the end of 2022 (see Figure 1). Macro and multi-strategy hedge funds account for most of the increase. Long and short exposures comprise 52% and 48%, respectively, of gross sovereign debt exposures, across all hedge fund strategies.

What triggered this increased activity? G-10 central banks started raising short-term rates in late 2021 and after. These actions changed expectations for interest rates and yield curves and created new trading opportunities for hedge funds. Higher sovereign exposures in the HFM are consistent with the European Central Bank (ECB) Bond Market Contact Group’s assessment earlier this year, which stated that “hedge funds have substantially increased their presence in euro area government bond markets.”³

The HFM shows record concentration in sovereign debt (see Figure 2). The ten largest hedge funds with sovereign debt exposures have 61% of those exposures across all qualifying hedge funds. The same measure for FX exposures is 46%, modestly above the historical average. Increased trading activity by hedge funds in these markets supports liquidity and price discovery. However, this activity also presents risks, given the leverage embedded in certain trading strategies. If a handful of very large hedge funds simultaneously unwind positions, particularly leveraged positions, this action could increase volatility and depress prices if dealer banks are not able to absorb the selling.

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