Fed: Policy uncertainty tops list of risk factors to financial system

Policy uncertainty surrounding the independence of the Federal Reserve and global trade are risk factors to the financial market, according to the central bank’s most recent Financial Stability Report..Released Nov. 7, the survey included nearly two-dozen professionals at banks and other financial sector companies. Sixty-one percent said policy uncertainty is posing a risk to the financial system, followed by 48 percent who listed geopolitical risks. Forty-three percent cited higher long-term interest rates and persistent inflation.The survey was released as the government shutdown — the longest in U.S. history — continues. President Donald Trump’s second term has included a heavier tariff policy than his first to ease the country’s trade deficit. From January to April, the average applied U.S. tariff rate increased to 27 percent from 2.5 percent. The rate dropped to 17.9 percent as of the end of September. Critics have said high tariffs cause price increases, and dispute Trump’s belief that a trade imbalance is bad for the country. On the Federal Reserve front, Trump has often called on Federal Reserve Chair Jerome Powell to cut interest rates, with the FOMC doing so at its last two meetings, both 25 point cuts. Trump has moved to oust Gov. Lisa Cook, citing allegations of mortgage fraud before her time on the board. The Supreme Court has allowed Cook to remain in her position for now, before it takes up the case challenging her dismissal early next year. Thirty percent of respondents listed artificial intelligence and asset price declines as stability risks. AI can both enable fraud and help detect fraud faster, according to the Federal Reserve. “Some policymakers and academics have noted that AI-driven algorithmic trading may generate financial stability risks such as correlated trading, collusion, market manipulation and market concentration,” according to the report. “While the adoption of AI could increase these risks, other factors often mitigate the potential impact of its use by market participants.” Funding risks were described as moderate. Growth in money market fund assets — particularly government funds — limited short-term funding vulnerabilities. Banks’ reliance on uninsured deposits has decreased significantly from 2022-23, according to the report.Asset valuations remain high across several markets. Equity prices have reportedly recovered from April’s volatility, with the price-to-earnings ratio near its record high and the equity risk premium well below average. Corporate bond spreads have narrowed to pre-April levels, while liquidity in Treasury markets has recovered, according to the Fed. Home price growth has slowed, but the price-to-rent ratio is near a record high. Commercial real estate prices were stabilizing after recent declines, despite persisting refinancing challenges.Business and household debt levels were described as moderate, with borrowing relative to GDP falling to its lowest level in 20 years. Most household debt is concentrated among borrowers with strong credit, according to the Federal Reserve, and mortgage delinquencies remain low, supported by home equity and underwriting standards. However, delinquencies on credit cards and auto loans are above pre-pandemic levels.“The banking sector remained sound and resilient, and most banks continued to report capital levels well above regulatory requirements,” according to the Fed. “Fair value losses on fixed-rate assets declined but were still sizable and continued to be sensitive to changes in long-term interest rates.”