(Bloomberg) — Higher-than-expected interest rates amid continued inflation are seen by market participants and observers as the biggest threat to financial stability, according to the Federal Reserve. That's what it means.
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“The risk of sustained inflationary pressures leading to a tighter-than-expected monetary policy stance continues to be the most frequently cited risk,” the Fed said in its semiannual Financial Stability Report released Friday.
The report includes the results of a survey of financial market stakeholders and the central bank's risk assessment in four key areas, including asset valuation, borrowing by businesses and households, financial sector leverage, and funding risk. ing.
Since the last report in October, the banking sector has “remained generally healthy and resilient, with most banks continuing to report capital levels well above regulatory requirements.” wrote the Fed. But the central bank warned that “available data suggests that hedge fund leverage has increased to historically high levels, primarily due to borrowing by the largest hedge funds.”
U.S. government agencies are warning about leverage tied to hedge funds. Securities and Exchange Commission Chairman Gary Gensler said in February that he was concerned about “where the banking and non-banking sectors converge.”
Read more: For Gensler, financial risk exists where banks and nonbanks meet
Losses from commercial real estate loans, which have been squeezed by increased remote work over the past few years, are seen as less of a threat in 2024 than they were last year, according to an earlier survey of Fed officials.
In its report, the Fed said that corporate and household balance sheets remain strong, but urged caution for households with low credit scores.
“Homeowners have strong equity, and many households continue to benefit from lower interest payments associated with refinancing and home purchases several years ago,” the Fed said. “However, some borrowers continued to experience financial stress, and auto loan and credit card delinquencies among non-prime borrowers increased.”
The central bank said some small financial institutions were still facing pressure from losses on fixed-rate assets. The Federal Reserve and other financial regulators dealt with multiple local bank failures last year, including Silicon Valley Bank.
The Fed highlighted some vulnerabilities in the funding market, particularly in small banks and some mutual funds in the money market, and said liquidity in the Treasury market is at the lowest level in its historical range.
“Conditions in the U.S. Treasury spot market appear to be difficult and could amplify shocks,” the report said, noting that broker-dealer capacity is limited or that the U.S. Treasury market is in short supply during times of market stress. He added that the reluctance to mediate remains a structural weakness.
Policymakers say they will soon slow the pace of Fed balance sheet shrinkage. Such a move would help ensure sufficient liquidity in financial markets.
risk area
This report focuses on four risk areas:
Asset valuations: Valuations rose to near historic peaks and were high relative to fundamentals. Residential real estate prices also continued to rise and were higher than fundamentals. Commercial real estate prices fell due to weak office demand.
Borrowing by businesses and households: Corporate and household balance sheets remained strong. Business debt decreased last year, but remains at a high level. Household debt was small.
Leverage in the financial sector: The banking system remained healthy and resilient, and banks reported capital levels above regulatory requirements. Some banks experienced large losses on fixed-rate assets, and some banks with exposure to commercial real estate were hit by stress.
Funding Risk: Liquidity remains ample for most US banks. Some banks saw funding constraints and some structural vulnerabilities in short-term funding markets. Prime funds and tax-exempt money market funds remain susceptible to runs.
(Updates details starting in 5th paragraph.)
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