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our assessment of asset valuations is that they are on the whole elevated relative to historical benchmarks and a number of markets including equity markets, corporate bond markets, leverage loan markets and housing markets currently my impression is that there is an increased likelihood an outside asset price decline however, given the system's overall resilient i do not see the kinds of weaknesses that played out so painfully during the great recession and thus i do not see potential asset price declines as posing risks to the financial system another potential vulnerability worth watching is the growth of private credit fed staff estimate that over the past five years private credit has roughly doubled we have also seen more complex and immediation changes involving more leverage players such as banks and insurance companies emerge in recent years some private firms may also have multiple sources of funding the increased complexity and the interconnections with leveraged financial entities create more channels through which unexpected losses in private credit could spread to the broader financial system, i do not currently see the potential for private credit to contribute an unexpected credit crunch in the same way that the asset that commercial paper market did in 2008 another vulnerability i am following closely is a footprint of hedge funds in the us treasury market, this footprint has grown substantially over the past few years and recently just succeeded its previous pre pandemic peak staff analysis suggests that the vast majority of hedge fund treasury positions involve relative value trading relative value trading strategies typically share key features that create potential treasury market vulnerabilities for example, while the value trades are highly leveraged to amplify returns from small price differentials with these trades generally funded with repo that is shorter term than the maturity of the trade resulting in maturity mismatch relative value trades that involve derivative contracts such as the cash futures basis trade and the swap spread trade are further exposed to margin calls when additional liquidity is required to satisfy increased minimum margin requirements such adverse funding shocks can result from episodes of market volatility are from moves and relative prices that are unfavorable to the trade sudden funding shocks can then pop in unwinding of hedge fund positions resulting in significant treasury security sales and the potential for market liquidity strains increased volatility and losses due to changes in relative prices can also lead hedge funds to choose to exit trades for risk management reasons also resulting in large treasury security sales all of these features of relative value strategies can make treasury market liquidity conditions and in the extreme market functioning more vulnerable to stress。


