FOMC Flags Treasury Market Fragility Amid Hedge Fund Surge and Stablecoin Impact

The recent minutes from the Federal Open Market Committee (FOMC) meeting, which took place on July 29-30, reveal significant concerns among participants about vulnerabilities in the U.S. Treasury market. Attendees highlighted issues related to the capacity of market intermediaries and the increasing involvement of hedge funds, as well as a lack of market depth, all contributing to the fragility of the market.

While the regulatory capital levels of banks remain robust, some committee members pointed out that certain institutions might still face challenges due to rising long-term yields and unrealized losses on their assets. Additionally, discussions highlighted the critical role of foreign exchange swaps as a key source of dollar funding for foreign financial institutions when providing loans to clients both in the U.S. and abroad, though these instruments also carry vulnerabilities due to maturity mismatches and refinancing risks.

Moreover, the meeting shed light on the potential impacts of stablecoins in the financial ecosystem. Participants expressed that their use might surge following the enactment of the GENIUS Act, possibly enhancing the efficiency of payment systems and driving up demand for their backing assets, including U.S. Treasuries. However, they also shared concerns regarding the broad implications of stablecoins on the banking sector, the financial system, and the execution of monetary policy, warranting close monitoring of the assets that support these digital currencies.