Amid growing uncertainty about the direction of the US and global economy, the US Federal Reserve identified a series of risk factors in its semi-annual financial stability report released on Monday.

Federal Reserve Chairman Jerome Powell testifies before Congress on Tuesday, June 22, 2021 (Graeme Jennings / Pool via AP)

He began by noting that since the last report in May, the prices of risky assets had risen further, despite concerns about the spread of the Delta variant of the coronavirus. This is due to rising profits and low interest rates, as banks remain profitable and heavily capitalized.

However, structural vulnerabilities have persisted “in certain types of money market funds and other cash management vehicles as well as bond and bank mutual funds and could again amplify shocks to the financial system in times of stress.” .

One of the new risk factors was the financial turmoil in China which cast doubt on the future of real estate giant Evergrande and other real estate developers, who either defaulted on their debts or struggled to keep them. refund.

“Given the size of the Chinese economy and financial system, as well as its extensive trade links with the rest of the world, financial strains in China could strain global financial markets by worsening risk sentiment. , pose risks to global growth and affect the United States, ”the report said.

This assessment is somewhat at odds with that of Fed Chairman Jerome Powell, who said when the Evergrande crisis erupted two months ago that it was “very special” for China.

In addition, a sharp tightening in global financial conditions, particularly in heavily indebted emerging market economies, could also present “certain risks to the US financial system.” Rising bond yields and a “deterioration in global risk sentiment” could drive up EME debt servicing costs and strain their financial systems.

The regional head of research for the Americas of the financial company ING, Padhraic Garvey, told the Financial Time: “There was a notion of correlation [in the report]. The fear is that if one thing happens, the rest might go away. “

Domestically, the report says key vulnerability measures have returned to pre-pandemic levels, as company balance sheets have benefited from continued earnings growth, low interest rates and government support.

While this was intended to be reassuring, it should be remembered that the high level of indebtedness of the pre-pandemic financial system and the rise of increasingly risky transactions led it to a near free fall when the pandemic struck. . It had to be bailed out by the Fed to the tune of more than $ 4 trillion, in addition to the $ 4 trillion already injected as part of the quantitative easing program that followed the 2008 crisis.

The report highlighted the sensitivity of financial markets and equity valuations to interest rates. In most asset classes, valuations were high by historical standards and this was in part due to improved earnings expectations. But the ratio of stock prices to corporate earnings expectations was “at the upper end of its historical distribution.”

Treasury yields were low by historical standards, meaning that “an increase in Treasury yields, if not accompanied by a commensurate strengthening of the economic outlook, could put downward pressure on valuations in various markets “.

The report called corporate borrowing “strong” because of low interest rates. Bonds with the lowest ratings, those just above the high-risk junk bonds, have remained at “historically high levels” and “the composition of newly issued bonds has become riskier.”

Regarding the impact of the Delta variant, the report warned that a deteriorating public health situation would slow the recent economic recovery if business closures returned and supply chains were further disrupted.

“An economic downturn could weaken corporate and household balance sheets, leading to an increase in defaults, bankruptcies and other forms of financial distress. These growing losses on non-financial debt could put a strain on banks and other lenders. “

This assessment highlights the reason for the homicidal campaign by the American ruling class to suppress virtually all public health measures. The health and lives of the people must be sacrificed to ensure the health of the financial system and the profit of businesses.

The report also highlighted why the issue of interest rates has gained such prominence in financial evaluations. “A sharp rise in interest rates,” he said, “could lead to a sharp correction in the prices of risky assets” as the valuation of many assets would be susceptible to a surge in yields.

Powell was particularly aware of this relationship. He has continually reassured Wall Street that, despite the decision to reduce its purchases of Treasury bonds and mortgage-backed securities at the rate of $ 15 billion per month, this does not imply an immediate increase in the rate of basic interest of the Fed.

The report also drew attention to trading in so-called memes stocks, such as GameStop, which attracted young people to stock trading. He said the development of social media apps has made stock trading a game for younger and less experienced investors.

Social media applications could create an “echo chamber” effect in which retail investors find themselves communicating more often with those who have similar opinions, reinforcing their opinions, even if they are biased or speculative.

He said that to date the effects of such exchanges on the wider market had been limited, but noted that young investors had higher than average debt and this vulnerability was magnified by using options.

The Fed report also returned to the issue of the March 2020 freezing of the US Treasury market which, as noted, continues to haunt it and other financial regulators.

In somewhat innocuous language, he said the market, which forms the basis of the US and global financial system, had experienced “serious upheaval.” In fact, it was a historically unprecedented situation.

As the report acknowledged, the typical response to severe global financial stress is the purchase of US Treasuries. But on this occasion, there was massive selling pressure in what has been dubbed a “pulling for money”.

Foreign investors, who held $ 7.2 trillion in U.S. Treasuries in the second quarter of 2021, played a significant role in the events of March 2020. They sold $ 287 billion worth of U.S. Treasuries in the first quarter of 2020, with more than half of net foreign sales made by official investors, i.e. governments and central banks.

The Fed has since set up a pension system, whereby foreign monetary authorities can use their holdings of treasury bills as collateral for short-term borrowing of dollars and therefore do not have to sell their bonds to obtain liquidity. . The report says this has helped stabilize the market.

However, US financial authorities have yet to produce a full analysis of what happened or develop mechanisms to prevent it from happening again.


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