The Federal Reserve’s public line is still that the financial system is resilient. But Vice Chair for Supervision Bowman said last week that some Fed officials and staff are concerned about the state of financial markets, which is the more revealing part of the story.

That concern shows up in Governor Lisa Cook’s November 2025 speech as well. She said the financial system remains resilient, supported by strong balance sheets among households and businesses and high capital levels across the banking system, then spent most of her remarks laying out three vulnerabilities that she said warrant attention: asset valuations, private credit, and hedge fund activity in Treasurys.

The Fed is not talking about a banking panic. It is talking about pressure building in markets that sit partly outside the traditional banking perimeter, where use and opacity can turn calm conditions brittle very quickly.

Cook said earlier this year that the Fed’s most recent semiannual Financial Stability Report affirmed the system is resilient while noting risks and vulnerabilities that have shown up in recent reports. That is a familiar Fed refrain, but the list has a habit of sticking around.

The first concern is valuation. Cook said the Fed’s assessment is that asset prices are elevated relative to historical benchmarks in equity markets, corporate bond markets, used loan markets, and housing markets. The point is not that prices are simply high. It is that they are high by the Fed’s own comparison with fundamentals.

There is also a more immediate market backdrop. At the July 2025 FOMC meeting, officials noted that equity prices had increased and credit spreads had narrowed over the intermeeting period, while the June 2025 minutes said the same thing about the earlier period. Those are the kinds of moves that can look reassuring right up until they stop.

The clearest structural shift Cook identified is private credit, loans to privately held businesses from nonbank lenders. Fed staff estimate that market has roughly doubled over the past five years, which is not a rounding error. It is a reallocation of corporate lending risk to a part of the system the Fed does not supervise in the same way it supervises banks.

That matters because the market is hard to see in real time. Such investments are usually locked up or ineligible for redemption for five to seven years, or even longer, so stress can build without showing up quickly in the usual warning lights. Default rates have stayed low, but Cook said they are backward-looking and can also reflect the use of payment-in-kind arrangements, loan amendments, and distressed exchanges that delay the recognition of losses.

Put differently, the surface can stay calm while the plumbing starts to creak.

The other pressure point is the U.S. Treasury market, the largest and most liquid financial market in the world. Cook said it averages around $900 billion in transactions per day, with high-volume days reaching about $1.5 trillion. When a market that large hiccups, the effects are not local.

Hedge funds have taken a much bigger role there. Their holdings of Treasury cash securities rose from about 4.6% of total Treasury securities outstanding in the first quarter of 2021 to 10.3% in the first quarter of this year, just above the pre-pandemic peak of 9.4%.

The Fed’s concern is not just that hedge funds are in the market. It is how they are positioned. Staff analysis suggests the vast majority of hedge fund Treasury holdings involve relative-value trades, which are highly used and typically funded with repo that is shorter term than the trade itself. That creates a maturity mismatch. If volatility jumps or relative prices move against the trade, funding can vanish faster than the position can be unwound.

That structure is exactly why the Treasury market keeps coming back as a Fed concern. Relative-value trades involving derivatives, such as the cash-futures basis trade and the swap-spread trade, can also face margin calls when liquidity needs rise. In a squeeze, the problem is not theoretical. It is cash.

Cook said adverse funding shocks can come from market volatility or from moves in relative prices that hurt the trade. When that happens, hedge funds may need to unwind positions, which can mean significant Treasury sales and the potential for liquidity strains in the very market everyone else relies on for pricing and collateral.

The Fed has already started thinking about the plumbing response. In the October 2025 FOMC minutes, most participants discussed the potential for central clearing of standing repo facility transactions, and the manager recommended the Committee consider stopping the runoff of the System Open Market Account portfolio soon. That is not a small aside. It is a sign that officials are watching market mechanics, not just interest rates.

Cook also flagged a longer-horizon issue: generative AI in financial market trading. The research cuts both ways. She said a recent experimental study by Fed economists found that algorithmic strategies using generative AI may be less prone to herding than human traders, and that AI agents were less influenced by the cognitive biases that can shape investment decisions.

But the other side of the ledger is less comforting. Cook cited theoretical studies showing that some AI-driven trading algorithms can learn to collude without explicit coordination or intent, and another that found self-learning algorithms can discover spoofing strategies. The market does not need bad intent to get messy. Sometimes it only needs software that becomes too clever for its own good.

Cook closed by saying vulnerabilities from elevated asset values, growth and complexity in private credit markets, and the potential for hedge fund activity to contribute to Treasury market dislocation warrant attention. That is careful language, but it is also a fairly direct map of where the Fed is looking.

The broader point is simple enough. The Fed still says the financial system is resilient. At the same time, several of the most important parts of the market structure are carrying more use, more complexity, and more opacity than officials seem comfortable with. Those risks do not have to become a crisis to matter.