"Everyone has blown up"... A hundred traders, two liquidations on the same trade!

Crowded positions, financing pressure, and liquidity contraction amplify each other, impacting the Italian bond market and exposing the European sovereign debt market's dependence on leveraged funds.

Written by: Li Jia, Wall Street Journal

European government bond arbitrage trades have faced consecutive liquidations, with nearly a hundred traders in London exiting the market, marking a collective collapse of high-leverage trading that is impacting the European fixed income market.

"Everyone has blown up... They all exited."

This statement comes from a senior trader at a liquidity provider who witnessed the violent fluctuations in the European government bond market: nearly a hundred traders blew up on the same trade twice, leaving their positions that once earned them annual salaries of over one million dollars.

This is not an isolated investment mistake by individual funds, but a chain collapse triggered by crowded trades, high leverage, and liquidity contraction.

The Trade That Was Once Like a "Money Printing Machine"

For nearly three years, one of the hottest operations among multi-strategy hedge funds in London has been a seemingly simple and stable arbitrage trade:

Buying French government bonds (OAT) and then using those bonds as collateral to finance in the repo market, earning the spread between bond yields and repo financing costs (carry).

By continuously leveraging, the originally small spread of just a few basis points could be magnified into millions of dollars in annual returns. This trade gradually became one of the most crowded strategies in the European fixed income market, with top multi-strategy funds like Balyasny, Millennium, and ExodusPoint participating.

Marion Le Morhedec, Chief Investment Officer of Fixed Income at Fidelity International, estimates that hedge fund trading activities can explain about 50% of the recent movements in the French-German bond spread. This means that market prices are not only influenced by fundamental factors like France's fiscal outlook but are also largely driven by changes in leveraged fund positions.

A senior trader observing this trade in the banking sector was not polite. He believes these individuals are not true portfolio managers but are treating European government bonds as arbitrage tools, buying bonds and earning spreads for commissions. This model has indeed brought substantial returns in the past, but many portfolio managers have been long on both French and Italian government bonds. As inflation heats up and interest rates rise, maintaining such highly correlated positions has become increasingly difficult.

Another industry portfolio manager summed it all up in one sentence:

"Every bubble has its moment."

First Liquidation: March's Alarm Failed to Prevent Heavy Positions from Returning

In March of this year, conflicts in the Middle East and the Strait of Hormuz crisis triggered market turbulence, leading to the first round of large-scale deleveraging in the European interest rate market. The arbitrage trades that relied on stable spreads and low financing costs quickly came under pressure, with multi-strategy giants like Millennium, Balyasny, and ExodusPoint giving back all or even more of their gains since the beginning of the year during concentrated liquidations.

This shock exposed the most vulnerable aspect of the strategy: when market volatility suddenly increases and financing conditions change, trades that rely on leverage to amplify spread earnings can also amplify losses. Even if the underlying bonds may eventually stabilize, funds may not have enough capital and time to wait for the market to rebound.

The March sell-off should have served as an alarm, reminding traders to reassess position sizes, financing conditions, and market liquidity. However, some chose to remain in the trade, while others re-established similar positions after slight recovery in losses.

The problem is that this is not a trade that can be divorced from market conditions and simply rely on time to earn spreads. When more and more funds hold positions in the same direction, liquidity that seems ample during normal times can quickly vanish when faced with concentrated liquidations.

Therefore, the March shock did not completely end this trade; instead, it laid the groundwork for even more severe liquidations in October.

Second Liquidation: October, Financing Pressure Triggers Chain Liquidations

If March was just a warning, then the market turbulence in October dealt another heavy blow to this strategy.

On October 1, the French government submitted its budget proposal. The French fiscal oversight agency subsequently criticized the proposal as overly optimistic, further undermining market confidence. Investors sold off French government bonds, causing bond prices to drop, which in turn pressured the arbitrage trades reliant on government bond collateral financing.

As the value of collateral decreased and financing conditions worsened, funds faced margin call pressures and had to sell more bonds to reduce risk; concentrated selling further depressed bond prices, creating a vicious cycle:

Collateral value drops → Financing pressure rises → Margin calls → Forced bond sales → Bond prices drop further.

The French-German 10-year government bond spread (OAT-Bund spread) surged to 154 basis points in just a few days, reaching its widest level since the 2011 eurozone debt crisis, and then further expanded to 156 basis points and 158 basis points. Meanwhile, the yield on French 10-year government bonds surpassed 5% in 2026, the first time since July 2002.

Goldman Sachs' tracked "long French bonds, short German bonds" rolling futures basket also suffered a sharp decline: the combination fell from a peak of about 104.3 in February to about 99.2, erasing nearly five years of cumulative gains.

Kaspar Hense, a senior portfolio manager at RBC BlueBay, observed that stop-losses were first triggered in the steepening of the government bond yield curve trades, and then losses spread to other leveraged arbitrage positions on the books. Goldman Sachs' systematic trading strategy (STS) team also noted in client reports that stop-losses in steepening trades were triggered first, which then affected leveraged arbitrage positions in the same risk book.

This indicates that the October sell-off did not merely reflect investors' repricing of the French fiscal outlook. The transmission of risks between different strategies, financing pressures, and passive liquidations compounded to turn the market decline into a broader deleveraging shock.

The Most Deadly Detail: The Same Group of People Blowing Up Twice on the Same Trade

What is most shocking about this turmoil is that some traders are not experiencing their first major setback.

According to the observations of that senior trader at the liquidity provider, many portfolio managers cleared from the market in October had already experienced a liquidation in March. They bet on the same trade direction again, only to face a similar outcome seven months later.

"They blew up twice on the same trade."

Between the two liquidations, the market had given them an opportunity to reassess risks, but similar positions accumulated again, ultimately leading to liquidation under financing pressure and concentrated selling. This not only exposes individual traders' misjudgment of risk but also reflects the structural issues of crowded trading: when participants all believe that spread earnings can continue, any party may underestimate the cost of everyone exiting simultaneously.

What is even more concerning is that hedge funds have become important providers of marginal liquidity in the European sovereign debt market. After banks, pension funds, and central banks reduced market-making or lowered allocations, high-leverage traders from multi-strategy funds in London filled some of the demand gap. However, these funds provide liquidity when the market is stable, and once risk limits are triggered and financing conditions tighten, they can quickly turn into sellers.

Data from the French central bank shows that French government bonds account for about €100 billion of the total collateral for eurozone sovereign debt repos, while the related market size is about €250 billion. French government bonds occupy an important position in this financing system, and their dramatic price and financing condition changes can easily influence the broader market through collateral channels.

During the crisis, reports indicated that some banks even refused to quote prices for French government bonds at certain times. A report from Allianz Trade showed that market depth had once fallen more than 50% below normal levels. When market-making capacity shrinks and leveraged funds are forced to exit, the market can fall into a situation where liquidity exhaustion and price declines reinforce each other.

Nearly a Hundred Traders Exited: High-Paying Positions Are Hard to Find

The cost of market turbulence has already transmitted from trading books to the job market. According to headhunters and industry insiders, the number of portfolio managers and traders cleared from the European interest rate trading market has increased from over seventy to nearly 100 in just a few weeks.

For these traders, who once earned over one million dollars a year, leaving hedge funds does not mean they can easily find another job with the same income.

Returning to banks is a possible route, but positions and salaries are limited. Headhunters indicate that banks do need talent familiar with European Central Bank exposures and bond book management. However, to match hedge fund salary levels, these traders usually need to hold relatively senior positions at banks, and such positions are limited.

Non-compete agreements also restrict short-term mobility. Some leavers are bound by non-compete clauses in their contracts and cannot join competitors for a while, having to wait for the restriction period to end.

Others are still receiving guaranteed salaries promised in their original contracts, so they are not in a hurry to find new jobs. For them, waiting for the market and hiring environment to clarify in the short term may be more beneficial than hastily accepting new positions.

Another portion of traders has chosen to start their own businesses. It is estimated that about 10% of leavers actively left their original platforms, planning to raise funds and manage their own funds. An industry insider pointed out that it is currently difficult for fund allocators to find individuals who are both capable and willing to take risks, so some traders still have opportunities to use external funds to establish their own investment businesses.

But this also brings a practical problem: when a group of traders who have just experienced significant losses tries to raise funds again, will investors view them as talents who have been tested by the market or as high-risk managers who need to reassess their risk management abilities? For these traders, leaving their original platforms is just the first step; regaining the trust of funders is equally challenging.

The Next Domino: Italian Bonds Also Under Pressure

As the storm surrounding French government bonds has not completely subsided, the market's attention has turned to Italian government bonds (BTP).

French OATs and Italian BTPs are both part of the eurozone sovereign debt market and are also common holdings in some hedge fund arbitrage portfolios. Similar trading logic, financing structures, and leverage levels mean that deleveraging in the French market could further impact Italian bonds.

Seth Carpenter, Chief Global Economist at Morgan Stanley, explicitly pointed out that the widening OAT spread has already put pressure on BTPs. One of the biggest concerns in the market right now is that the Italian government bond spread may repeat the trajectory of the French government bonds.

If the plunge in the French market is seen as a "positioning flush" to clear crowded positions, then Italy may become the next market where risk is concentrated and released. Once investors begin to reduce their risk exposure to the entire eurozone peripheral sovereign debt, the sell-off may not be limited to France.

What complicates matters is that some leveraged traders who provided marginal demand for these markets over the past few years have now been forced to exit. Whether potential buyers can timely fill the gap will directly affect the depth and duration of market adjustments.

Meanwhile, some departing traders are still in a "gardening leave," temporarily unable to join new institutions. For the market, this not only means a gap in the personal careers of traders but also signifies that a portion of trading capacity and risk absorption capability that was originally active in the European government bond market has temporarily exited.

Epilogue: This Is Not Just a Career Crisis for Nearly a Hundred Traders

A trader made a brief and heavy judgment on this turmoil:

"This is systemic."

What this turmoil exposes is not just the professional setbacks of nearly a hundred traders, but the collective dependence of the European fixed income arbitrage system on low financing costs, stable spreads, and ample liquidity. When similar positions are concentrated in a few high-leverage participants, once the market reverses, the risks that were originally dispersed across different funds can quickly converge and create a chain reaction through collateral, financing costs, and passive liquidations.

Whether the adjustment of French government bonds will further transmit to Italy remains to be seen. But at the very least, this round of shocks has shown that the seemingly stable arbitrage returns of the past three years do not mean that risks have truly disappeared; they may just have been masked by leverage until market conditions change and expose them all at once.

When those who once earned substantial returns from such trades begin to warn that this asset class may never return to its former state, what is concerning is not just a trading loss but that the market structure supporting this trading model is changing.

After all, before every bubble bursts, there are always those who believe that this money can keep being made.