The Federal Reserve makes a bold statement stating that rising prices in the stock market and other sectors threaten the financial system. The statement came out in the central bank’s semi-annual Financial Stability Report. The bank stated that the overall system has stabilized during the pandemic; however, the future holds several risks. The most prevalent one in the lot is the aggressive run of the stock market.
If the risk appetite falls from the current level, numerous assets will be subject to a sharp decrease in market price. The development will put a massive burden on the financial system. Such situations will turn into reality if the pandemic recovery phase stalls, leading to pressurizing businesses and households.
Investors worldwide are snapping up bonds, cryptocurrencies, and equities. They are depositing billions of dollars into blank-check organizations (SPACs), causing the market to stay brisk for standard IPOs (initial public offerings). Fed’s financial stability report back in November 2020 also flagged high asset valuations. The latest report states how risk-taking potential is rising in both bond and equity markets. It notes a bunch of high leverage and opaque risk, especially in hedge funds and related sectors.
Lael Brainard (Fed Governor) stated that the current situation specifies the importance of ensuring the system is properly guarded. She emphasized banks are increasing their capital needs during the economy’s expansion to cope with the downturns. Brainard continued that risks surrounding the risk appetite are surging. The valuation charts have continued to increase, and combined with high corporate indebtedness, can increase the effects caused by a re-pricing happening.
As per the report, multiple sectors like hospitality, travel, and energy possess the most issues due to their sensitivity. Open-end funds and the money market are not exempt from the risks either. The 1.7 trillion dollars findings in the student loans also pose restricted risks to the financial system. The reason being the majority of the debt is owned by 40% of the top earners.
A recent survey by Fed showcased how pandemic-related issues are the biggest threats, followed by the resistance towards vaccination. The next on the line was increasing interest rates, rising inflation, and the tension between China and the US.
While the financial industry is stabilizing right now, the Federal Reserve Bank highlights the dormant risks in the sector. As per Fed’s semi-annual financial stability report, the assets might experience severe price decreases if the valuations keep rising. If the risk appetite showcased by investors starts to decline, the results can be disastrous for the economy.