By Paul Vieira
OTTAWA--The Bank of Canada raised warning flags on Thursday about the increased presence of hedge funds in the Canadian government bond market, as it signals debt levels are climbing in the financial system.
The worry comes weeks after a selloff in the U.S. Treasury market, triggered by President Trump's planned tariff policy, which was more aggressive than markets had anticipated.
The central bank's annual Financial System Report indicates that hedge funds can account for nearly half the volume in some auctions for Government of Canada bonds, and nearly a third of the volume of trades between dealers and clients in the secondary government-bond market.
Government bond markets "need to function smoothly for other markets to work," said Carolyn Rogers, the central bank's senior deputy governor. She said hedge funds have helped absorb increased bond issuance and kept yields low. On the flip side, she said, funds have taken on increased debt to finance their fixed-income purchases.
"This makes them more likely to pull back from these crucial markets in periods of stress, introducing added volatility," Rogers said. She added that an escalation in the U.S.-Canada trade conflict could prompt hedge funds to quickly sell their Canada-government bond holdings, posing strains on liquidity.
"Given their importance in government bond markets, hedge funds need to make sure that they are prepared to respond to sudden liquidity needs without disrupting market functioning," Rogers said.
Write to Paul Vieira at paul.vieira@wsj.com
(END) Dow Jones Newswires
May 08, 2025 10:24 ET (14:24 GMT)
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