Everyone is suddenly talking about a “basis trade.” It might be the wrong one.

Another hot “Trump trade” was being unwound as tariffs threatened to alienate major U.S. trade partners and owners of U.S. government debt.

Huge washouts hit the $29 trillion Treasury market in recent days, as investors looking to exploit small price differences in the bedrock of financial markets were overcome by volatility resulting from President Trump’s tariff fight.

The Treasury cash-futures “basis trade,” as it’s widely known, had been a growing source of concern in recent years. Federal Reserve officials who focus on banking supervision warned in February that any “rapid unwinding” could exacerbate market stress. The trade seeks to profit from tiny differences between Treasury futures and the underlying cash Treasury, using leverage to supersize potential gains.

But a different, more widespread basis trade among investors has been causing the real havoc in markets lately, according to traders and investors.

It hinges on moves in the swaps market, a cornerstone of global trading activity. Specifically, it relates to the swaps spread, or difference, between the 30-year floating Secured Overnight Financing Rate, or “SOFR,” and Treasury yields. SOFR is the new, more transparent benchmark rate that replaced the scandal-plagued London Interbank Offered Rate, or “LIBOR,” over the past few years.

Hedge funds and other investors started flocking to this lesser-known basis trade in earnest a few months ago in anticipation of “pro-growth” and market-friendly policies that would be a priority of the Trump administration after Inauguration Day.

The trade counted on the spread to widen, but that hasn’t been playing out. Instead, the world got the biggest global trade fight in a century in the form of tariffs, and extreme volatility in bonds that has forced a sudden washout of some leveraged players.

There’s a fear that tariff turmoil is upending both basis trades, rocking hedge funds and forcing positions to be indiscriminately liquidated. That raises the threat of a market breakdown as Treasury yields jumped this week, despite a sharp selloff in equities. Worries of a wider crisis were seen by analysts as a reason why Trump moved on Wednesday to pause certain tariff increases against most U.S. trading partners.

“Since the beginning of all this tariff talk, there’s been a massive tightening of the SOFR swaps spread,” said Matthew Scott, head of core fixed-income and multiasset trading at AllianceBernstein. “There’s been a trend of investors selling cash bonds to reduce risk, and fear of foreign buyers pausing purchases amid tariff uncertainty.”

Things came to a head earlier this week as conditions deteriorated dramatically. The chart below shows the 30-year SOFR swap spread collapsing overnight on Tuesday.

Investors have been caught off guard by violent moves in the 30-year SOFR swaps spread.

What had been called “the trade of the year” was suddenly hit by extreme volatility, said Brij Khurana, a fixed-income portfolio manager at Wellington Management.

The ‘other’ basis trade

On one hand, 30-year SOFR has been driven below the 30-year Treasury yield because of persistent, strong demand from insurance companies and pension funds needing access to longer-duration assets to match their liabilities.

Hedge funds and others looking for opportunities on the other side of the trade began recently buying Treasurys and shorting SOFR.

For a while, the trade was starting to work for hedge funds, Khurana said. But then came the tariff tumult and a selloff in longer Treasurys, stoked by fears of a potential strike by foreign buyers in U.S. debt.

Traders said liquidity in Treasurys had briefly slowed to a trickle on Wednesday morning as swaps basis trades were being unwound, and as fears mounted about a potential crisis that could require some level of intervention from the Fed.

“You can image imagine all of those traders getting a tap on the shoulder,” said Daniel Siluk, head of global short duration and liquidity at Janus Henderson Investors, talking of when a trader exceeds their exposure limits. “They are essentially told to decrease their leverage.”

Since basis trades hinge on borrowed money, a lender can ask for more collateral when risks in markets increase. Traders can then be forced to sell what they can in an illiquid market to raise cash, causing prices to fall and creating a potentially dangerous feedback loop, until the unwind clears. That dynamic played out in August with the sudden unwind of the Japanese yen carry trade roiled financial markets.

The “classic” hedge-fund basis trade aims to amplify small differences between cash bonds and Treasury futures contracts with leverage, which has gotten it a lot of attention in recent years as a potential source of instability. But traders say it has grown more mainstream in the past few years, and includes a broader swath of participants. In theory, that should help limit the magnitude of swings in markets if highly leveraged basis trades were forced to unwind.

The Fed pegged this cash-futures basis trade as exceeding $1 trillion on a notional basis in recent years, while noting it warranted close monitoring.

But the other basis trade, which is newer and tied to the SOFR swaps spread, has largely flown under the radar — until the past few days. There have been several reasons why it has gained a following.

Trump’s second term has focused first on tariffs, but there also has been a goal of lowering Treasury yields, keeping a lid on issuance of longer Treasurys and making potential changes at major banks around the so-called Supplementary Leverage Ratio, a rule designed to limit systemic risks.

Powell in February said the Treasury market could benefit from a proposal for changes to the rule. If Treasurys received more favorable treatment in how capital buffers were calculated at banks, it could increase the buyer baser for U.S. government debt, potentially lowering bond yields.

When the new administration took over, it was assumed there would be regulatory relief for banks, said Amar Reganti, fixed-income strategist at Hartford Funds.

Trump instead focused immediately on new tariffs, which came good on April 2 and were surprisingly more widespread and larger than anticipated. Then, they were abruptly paused on Wednesday — except for those against China — as markets convulsed.

Tariff shocks continued to rattle financial markets ahead of the weekend, given Trump’s lingering threat to punish foreign owners of U.S. debt and America’s trading partners in 90 days.

The S&P 500 index and Dow Jones Industrial Average remained volatilethrough the end of a wild week.The Nasdaq Composite index and Russell 2000 have already slumped into a bear market, defined as a drop of at least 20% from their recent high, adding to fears that the rest of the stock market could soon follow.

Even typical safe-haven assets, including 10-year and 30-year Treasurys, have sold off sharply, causing yields to spike.

The 30-year yield on Friday rose to 4.873%, gaining 48.2 basis points in a week, cementing it’s biggest weekly jump since 1987, according to Dow Jones Market Data.

While some battered swaps-related basis trades appear to have washed through markets without triggering a broader liquidity crisis, traders said volatility and the threat of more tumult still hasn’t vanished.