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Fed warns of asset price peril as investors reduce risk

(Bloomberg) – A growing appetite for risk in a variety of asset markets is stretching valuations and creating vulnerabilities in the U.S. financial system, the Federal Reserve said in its semi-annual Financial Stability Report. Fed Governor Lael Brainard, head of the Council’s financial stability committee, said in a statement accompanying the report released Thursday. “The combination of stretched valuations with very high levels of corporate leverage is worth watching because of the potential for amplifying the effects of a revaluation event.” In this environment, prices may be vulnerable to “big drops” if risk appetite wanes, the Brainard and the report cite losses in banks resulting from transactions with Archegos Capital Management, and the governor called for “More granular and frequent disclosures”. as a reminder that the available measures of hedge fund leverage may not capture significant risks, ”she said. The Managed Funds Association, which represents hedge funds, disputed Brainard’s remarks. entities such as individuals and family offices, ”Association president Bryan Corbett said in a statement. “Hedge funds are well regulated” by the Securities and Exchange Commission. Near-zero interest rates and massive bond purchases, with the Fed buying $ 40 billion in mortgage-backed securities and $ 80 billion in Treasuries each month, fueled the search for yield and helped support asset prices, including those of risky investments such as speculative stocks, cryptocurrencies and high yield debt. The Standard and Poor’s 500 stock index rose 12% this year. “The real story here is the tension – if not the blatant contradiction – of the Fed’s pursuit of quantitative easing, whose goal is to lower long-term rates. and to encourage the search for yield, and their concern that people are indeed looking for yield, ”said George Selgin, senior researcher at the Cato Institute in Washington, referring to buying bonds. “The Fed could certainly reduce its QE activities to counter this risk-taking as the recovery continues.” Spacs, Meme Stocks “Indicators indicating a high risk appetite in the equity markets in early 2021 include episodes of high trading volumes and price volatility. – called meme stocks – stocks that have increased in volume after going viral on social media, ”the report said. “The high share issuance through SPACs also suggests a higher risk appetite than usual among equity investors.” Low rates also have an impact on the real economy. Home prices are up 12% year-over-year amid strong property demand and supply scarcity, while a home improvement boom has helped push contracts out. run on lumber at record levels. The Bloomberg Commodity Index, which tracks everything from grains to natural gas and nickel, is up 19%. The report says house price increases have had a positive effect on borrowers by increasing equity. Nonetheless, he noted that borrowers participating in forbearance programs, who are likely to be employed in industries hard hit by the pandemic, could be vulnerable upon exit. “Even so, a large chunk of borrowers have already given up on forbearance – typically these borrowers have loans outstanding or paid off,” the report says. The report also notes that low interest rates have reduced default expectations and underwriting. standards have weakened. “The share of new loans granted to large, highly indebted companies – defined as those with a debt-to-earnings ratio before interest, taxes, depreciation and amortization above 6 – has exceeded all-time highs reached in recent years,” he said. The report said that “the available data suggests” that hedge funds are heavily leveraged, and said there is a need to increase transparency on opaque risk exposures, echoing Brainard’s call for more transparency. losses during the stock episode meme in January 2021, when intense social media activity contributed to the price fluctuations of some specific stocks, ”the report says, likely a reference to the short squeeze in GameStop Corp’s stock. ., which climbed to over $ 300 per share from around $ 20 per share in a matter of days. Jon Caplis, chief executive of hedge fund consultant PivotalPath, said after the report was released that it is being said closure in particular could mitigate the risk of a future situation similar to that of Archegos to reoccur. “Before you try to rewrite all the regulatory statutes, you can make a little change that would be effective,” he said. “If you just treat total return swaps the same way hedge funds already disclose their holdings, you would significantly mitigate the Archegos-like fallout.” (Updates with the hedge fund reaction in the sixth and seventh paragraphs.) To learn more from articles like this, please visit us at bloomberg.com Subscribe now to stay ahead with the source of most reliable business news. © 2021 Bloomberg LP

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