Federal Reserve Hints at Potential Declines in Asset Prices, Calls for Hedge Fund Transparency

Federal Reserve Talking Points:

• The Federal Reserve discussed the vulnerability of asset prices should appetite change
• Lael Brainard, FOMC Board of Governors, said that more transparency with hedge funds is necessary
• The Fed report indicated that large pools of assets remain vulnerable to large & sudden declines

The Federal Reserve released its semiannual financial stability report on Thursday, in which the central bank discussed the strengths and weaknesses present in the U.S. financial system. In the report, the Fed indicated that overall conditions and sentiment continue to improve, but weaknesses and threats remain following the pandemic.

The report did go into detail on asset valuations, stating that a “broad range of assets could be vulnerable to large and sudden declines,” and that these changes may come as a result of changing risk appetite. Fed data indicates that hedge fund margin debt and borrowing of securities remains at elevated levels, which may present significant risks should a higher-rate environment have a sudden impact on asset valuations.

Yields on Nominal Treasury Securities

Courtesy of the Federal Reserve

According to the Fed, higher asset valuations are a byproduct of the current low-rate environment, and recent increases in Treasury rates indicate improving economic sentiment. In its review of broader conditions, the Fed highlighted that small business loan delinquencies have decreased drastically, indicating improved balance sheets. Overall, the Federal Reserve is delighted with the progress being made in the recovery, but plenty of challenges remain for the country and market participants.

--- Written by Brendan Fagan, Intern for DailyFX

To contact Brendan, use the comments section below or @BrendanFaganFX on Twitter