The Federal Reserve’s Financial Stability Report said that the financial system remains stable overall. This is the assessment despite the dangers presented by the ongoing COVID-19 pandemic.
However, there are future dangers on the rise. In particular, investors should heed signs if the current bull run in the stock market tails off.
Free-for-all In The Market Right Now
Investors remained voracious as they snapped up equities, corporate bonds, and cryptocurrencies. Billions are pouring into blank check Special Purpose Acquisition Companies (SPACs).
Meanwhile, the market remains brisk for traditional initial public offerings. In short, asset prices like stocks are rising to alarmingly high levels. These could set investors up for big losses from sudden declines.
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The Fed report released Thursday noted that stocks and other risky assets have risen in value since last November. In some cases, they reached record highs.
The outlook for the post-pandemic U.S. economy continued to rise as vaccinations increase and businesses reopen. Asked whether rising prices should remain a concern, Chairman Jerome Powell said yes. As long as interest rates stay low, valuations remain justified.
However, the Fed report reminds the public that dangers are present. This is especially true if the market suddenly changes its mood. “High asset prices in part reflect the continued low level of Treasury yields. However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields. In this setting, asset prices may be vulnerable to significant declines should risk appetite fall,” the report stated.
Banks Should Increase Capital Requirements
In an accompanying statement, Fed Governor Lael Brainard said the situation bears watching. Also, Brainard emphasized the need for the system to have proper safeguards.
Specifically, she mentioned that banks should increase their capital requirements during economic expansions as a buffer against downturns. In addition, the report also mentions risk at hedge funds and other nonbank financial institutions as potential threats to the system.
“Vulnerabilities associated with elevated risk appetite are rising. Valuations across a range of asset classes have continued to rise from levels that were already elevated late last year.
The combination of stretched valuations with very high levels of corporate indebtedness bears watching because of the potential to amplify the effects of a re-pricing event,” Brainard added.
The Fed report also notes the particular sectors with high vulnerabilities. These include energy, travel, and hospitality. These sectors are particularly at risk due to their sensitivity to the pandemic. In addition, the Fed also mentioned potential threats from the money market and open-end funds.
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Foremost among the Fed’s examples was Archegos Capital Management. Big banks who backed the investment firm took big losses once Archegos failed to meet margin calls. “While broader market spillovers appeared limited, the episode highlights the potential for material distress at [nonbank financial institutions] to affect the broader financial system,” the report said.
Student Loans Offer Limited Risks
Overall, the Fed assured the public the system remains sound. Household balance sheets remain in good shape. Meanwhile, corporations remain buoyed by a rising economy and low interest rate. In fact, even the $1.7 trillion in student loans pose “limited” risks to the economy. Most education debt is in the hands of 40% of the country’s top earners.
A survey conducted by the Fed reported that the biggest worry remains virus-related. In particular, vaccine-resistant variants pose the biggest threat to the market.
Next in the list of concerns is a potentially sharp increase in interest rates. The third is a surge in inflation, while tensions between the US and China round out the fourth.
Watch Arirang News as they report that the Federal Reserve warns over the risk of “significant declines” in asset prices as valuations climb:
Do you agree with the Fed Report that rising asset prices are stretching valuations and creating risks? Are stocks and other asset prices getting unsustainable?
Let us know what you think. Share your thoughts on the current market in the comment section below.