In April 2025, the Trump administration's unexpected tariff announcements introduced significant volatility into financial markets, disrupting swap spread trades and leading to substantial losses for investors who had bet on narrowing spreads.

Swap spreads, the difference between the fixed rate of an interest rate swap and the yield of a corresponding maturity Treasury bond, have historically been positive, reflecting the higher credit risk associated with swaps compared to U.S. Treasuries. However, post-2008 financial crisis regulations, particularly the Supplementary Leverage Ratio (SLR), constrained banks' capacity to hold Treasuries, leading to negative swap spreads.

On April 2, 2025, President Donald Trump announced sweeping tariffs, referred to as "Liberation Day" tariffs, imposing a 10% baseline tariff on all imports and higher rates on specific countries. This announcement triggered immediate market reactions, with major indices experiencing significant declines. The S&P 500 dropped 6.65% on April 3 and 5.97% on April 4, while the Dow Jones Industrial Average fell 2,231 points, or 5.5%, on April 4. The Chicago Board Options Exchange's VIX benchmark, known as "Wall Street's fear gauge," spiked 15 points to close at 45.31 points, the highest close since the 2020 stock market crash.

This market turbulence disrupted swap spread trades, which had gained popularity based on anticipations of financial deregulation, especially potential reforms to the SLR. Contrary to expectations of narrowing spreads, swap spreads briefly widened, adversely affecting investors who had bet on their contraction. Barclays, initially optimistic but caught off guard by this movement, now advises revisiting these positions, particularly in 3-year swap spreads.

Their recommendation is grounded in potential SLR reforms, improved market stability, and renewed bank purchasing of U.S. Treasuries. They believe this could benefit the middle of the yield curve, as banks typically favor mid-term Treasuries. Although confidence in renewed stability and more predictable policy from the Trump administration underpins these strategies, there is skepticism about relying on such an assumption. Barclays also notes that recent Treasury market liquidity remains solid, with no signs of foreign-driven sell-offs. Overall, analysts are cautiously reentering swap spread trades, encouraged by regulatory expectations and more settled bond markets.

The recent market volatility was exacerbated by highly leveraged hedge fund strategies, particularly "relative-value" trades like Treasury basis and swap spread trades. These strategies rely on short-term funding and aim to capitalize on minor price discrepancies between Treasury securities and derivatives. While they offer liquidity and help reduce government borrowing costs, they also introduce fragility into the $29 trillion market.

In April 2025, concerns over inflation and erratic government policy under President Trump led to a sell-off in Treasuries, triggering unwinding of these leveraged trades. The scale of such trades—totaling roughly $800 billion—magnified market volatility, though more orderly than the 2020 Covid-induced crisis.

Regulatory efforts to mitigate risks, such as the SEC’s central clearing and dealer rules, have faced legal and political setbacks, allowing hedge fund influence to persist. With foreign investment waning and U.S. debt levels high, market stability increasingly depends on these risky strategies. Despite their role in supporting Treasury demand, experts warn they heighten susceptibility to shocks, highlighting the trade-off between leveraging hedging services and maintaining market resilience.

The volatility in swap spreads and the broader Treasury market has significant implications for financial stability and economic policy. Investors, particularly hedge funds employing leveraged strategies, have faced substantial losses due to unexpected market movements. This underscores the risks associated with high leverage and the potential for regulatory changes to impact market dynamics.

Moreover, the potential easing of the SLR could encourage banks to increase their holdings of Treasuries, potentially stabilizing the market but also raising questions about the balance between financial stability and regulatory flexibility.

The events of April 2025 serve as a stark reminder of the complex relationship between government policies, regulatory environments, and financial market stability. Investors and institutions must remain vigilant and adaptable in the face of policy-induced market disruptions. Ongoing monitoring of regulatory changes and market responses is essential for informed investment strategies.