Top Federal Reserve Governor Lisa Cook has sounded the alarm on the potential systemic risks posed by hedge funds in US Treasury markets, highlighting how crowded trades could amplify market instability during periods of stress, according to a report by the Financial Times.
Cook, who is responsible for financial stability, warned that the growing prevalence of so-called basis trades – where hedge funds exploit tiny price differences between Treasury cash securities and futures – could make the $30tn market “more vulnerable to stress” and, in extreme cases, disrupt market functioning.
“Outside of episodes of stress, relative value trades substantially improve the efficiency and liquidity of Treasury securities and related markets,” Cook said. “Yet, during episodes of stress, the unwinding of crowded positions in such trades could magnify instability.”
Research published by the Fed in October found that Cayman Islands-based hedge funds have dramatically increased their exposure to US Treasuries, absorbing more issuance between January 2022 and December 2024 than all other foreign private holders combined. Hedge funds’ share of Treasury cash securities reached 10.3% in Q1 2025, surpassing the pre-pandemic peak of 9.4%.
The basis trade is highly leveraged, with hedge funds borrowing massive sums to amplify returns on small price differentials. Historical episodes illustrate the risk: during the March 2020 Covid-19 market turmoil and the 2019 repo market crisis, forced unwinds of basis trades caused sharp moves in Treasury prices and short-term funding stress, prompting Fed intervention.
