Federal Reserve: The market crash in August was due to "high-leverage hedge funds rapidly selling to meet internal volatility requirements."

At the beginning of August, the U.S. stock market experienced a sharp decline. In the financial stability report released on Friday, the Federal Reserve pointed out that high-leverage hedge funds rapidly sold off assets in an environment of insufficient liquidity, which was one of the main reasons for the severe fluctuations in the U.S. stock market in August.

The report indicated that as of the first quarter of 2024, the average leverage ratio of hedge funds had reached or was close to the highest level since 2013. The combination of high leverage and insufficient market liquidity amplified market shocks, leading to significant volatility in the stock market.

The Federal Reserve wrote in the report that institutions rapidly sold off their positions to meet internal volatility targets, rather than due to additional margin calls from banks. The Federal Reserve added:

“During this period, liquidity in the U.S. Treasury market and other markets deteriorated significantly, but market conditions improved rapidly after favorable data was released in the following week.

Nevertheless, this event once again demonstrates that high leverage can amplify adverse shocks.”

Despite warning about high-leverage hedge funds, the Federal Reserve maintained an optimistic view of the overall risks to the financial system, stating that overall, banks “remain robust and resilient.” Most domestic banks in the U.S. hold a large amount of liquid assets, and their reliance on uninsured deposits has also decreased.

In the report, the Federal Reserve also expressed concerns in other areas. For example, the Federal Reserve's Wall Street contacts are worried about the sustainability of the U.S. debt burden, especially as the Treasury has to continue issuing more government bonds to repay the debt. The Federal Reserve warned that

“(This could) put upward pressure on long-term interest rates, thereby further suppressing economic growth and putting pressure on sovereign and private sector borrowers.”

Additionally, concerns about inflation and rising long-term interest rates have been replaced by worries over escalating geopolitical tensions. The Federal Reserve wrote in the report that this could lead to “sudden risk aversion,” which in turn could trigger a decline in asset prices and cause losses for affected businesses and investors, including those in the U.S.