Fed: Systemic Risk Eases in Several Dimensions

While risky asset prices have been rising relative to historical norms—and thus vulnerable to significant declines—other measures of financial stability have remained stable over the past several months, according to the Federal Reserve’s latest financial stability report released today. Borrowing by households and businesses remained stable, banks remain well-capitalized and funding risks at domestic banks remain low, the Fed said.

Regarding asset valuations, the Fed cautioned that “asset prices may be vulnerable to significant declines should investor risk appetite fall, progress on containing the virus disappoint, or the recovery stall,” adding that “[s]ome segments of the economy—such as energy, travel, and hospitality—are particularly sensitive to pandemic-related developments.” Pandemic-related disruptions continue to make it hard to assess commercial real estate valuations, the Fed said.

Vulnerabilities from household and business debt have fallen, the Fed said, with consumers and small businesses receiving continued support from government programs. With credit quality holding up “better than many had expected,” bank capital ratios remained healthy. Bank liquidity remained high as well, although the Fed noted “structural vulnerabilities . . . associated with liquidity transformation” at money market funds.

The Fed also flagged several near-term risks to the financial system, including a worsening of the pandemic at home or abroad and a potential rapid rise in global interest rates that could create instability in emerging market economies.