Funds locked into the leveraged Treasury basis trade have declined 20% this year to $1.2 trillion, Morgan Stanley estimates, as steadier U.S. interest-rate expectations and improved trading conditions reduced potential returns. The strategy involves hedge funds borrowing overnight to buy Treasury securities while selling corresponding futures, profiting from a narrow price difference. Asset managers use Treasury futures to increase the duration, or interest-rate sensitivity, of their portfolios, making their demand an important source of the trade. The pullback has been concentrated mainly in futures linked to two-year and five-year maturities. Hedge funds' net short positions in two-year Treasury futures have fallen more than 40% from a 15-month high reached in March and more than half from the record level in December 2024, while asset managers' net long positions have dropped more than 30% from their March record. The trade remains large enough to draw systemic-risk scrutiny from the New York Federal Reserve, but Morgan Stanley said it has not found evidence of broad market stress in the current cycle. A loosening of supplementary leverage ratio requirements has allowed bank dealer desks to hold more Treasury inventory, improving liquidity and reducing the relative-value opportunities that basis traders seek.