(Bloomberg) -- Federal Reserve Governor Lisa Cook said she is closely monitoring weaknesses at nonbank financial institutions as the central bank’s policy cools the economy and leads to tighter financial conditions. 

“Vulnerabilities at certain NBFIs could play a key role in amplifying stress associated with tightening financial conditions and slowing economic activity,” Cook said in prepared remarks Monday for an event at Duke University in North Carolina.

In a broad speech about financial stability, Cook said risks have risen in financial markets in recent years and pointed to several areas that she is watching, including liquidity mismatches at nonbanks, such as money-market and hedge funds, as well as debt-delinquency rates and Treasury market functioning.

Cook specifically noted Treasury cash-futures basis trades, which may have gained in popularity recently.

“Because the basis trade is often highly leveraged, a funding shock or heightened volatility in Treasury markets could force hedge funds to abruptly unwind their positions at potentially distressed prices,” Cook said.

Heightened Volatility

Policymakers left interest rates unchanged in a range of 5.25% to 5.5% — a 22-year high — at their meeting last week. The sharp run-up in rates since March 2022 has led to episodes of stress in financial markets, including the collapse of three lenders this spring. 

“An unexpected sharp increase in rates could lead to heightened volatility in financial markets, stresses to market liquidity, and downward pressures for asset prices,” Cook said. “Losses among financial intermediaries could lead to strains and a consequent reduction in credit supply.”

Cook made no monetary policy remarks but noted that the rise in Treasury yields over the past few months likely isn’t due to an increase in near-term Fed policy rate expectations. 

She said that while households and businesses have generally remained resilient in the face of higher interest rates, some stress is emerging for lower income borrowers. She said she’s also watching developments in both the residential and commercial real estate markets. 

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