(Bloomberg) -- The US government’s debt load is now seen as the biggest risk to financial stability, outweighing persistent inflation in a Federal Reserve survey.
“Concerns surrounding US fiscal debt sustainability were atop the list this survey, followed by escalating tensions in the Middle East and policy uncertainty,” the Fed said in its semi-annual financial stability report.
The report includes a survey of the Fed’s financial-market contacts conducted from late August to late October by New York Fed staff members. It also includes the central bank’s assessment of developing risks in four main areas, including asset valuations, borrowing by businesses and households, leverage in the financial sector and funding risks.
More than half the respondents — 54% — cited fiscal debt sustainability as a salient risk, up from 40% just a half year ago. More debt issuance by the Treasury could start to crowd out private investment or limit policy responses if there’s an economic slump, the survey found.
The banking sector remained “sound and resilient overall,” with capital ratios hovering around record levels and high liquidity, the Fed said. But in financial markets, the Fed found valuations remain elevated, liquidity “generally low” and leverage across hedge funds at or near the highest level observed since data became available in 2013. The central bank also singled out life insurers for a steady decline in the liquidity of their assets amid greater use of alternative investments.
Taking a look at households, the Fed said credit card and auto loan delinquencies were above average, especially among those with lower credit scores. Overall, they judged vulnerabilities related to household and business debt as “moderate.”
“These borrowers hold a relatively small share of aggregate debt, and their high delinquency rates reportedly reflect, in part, more borrowing by some households during and after the pandemic, rather than an abrupt broad-based weakening in households’ ability to repay,” the report said.
Stablecoin Status
The central bank said funding risks have eased but remain “notable.” The report flagged that stablecoin assets “grew substantially” since the prior report and had a total market capitalization of more than $170 billion by the beginning of November — a notch below a record high seen in April 2022.
“These digital assets are structurally vulnerable to runs and lack a comprehensive federal prudential regulatory framework,” the Fed said.
The new report arrives shortly after the US presidential election, which has already had a big impact on most corners of US financial markets as investors expect less regulation and possibly bigger deficits from the incoming administration.
Bitcoin, following an embrace by President-elect Donald Trump, skyrocketed to near $100,000 a token. The S&P 500 and the tech-heavy Nasdaq 100 have been hitting new records, while Treasuries have been selling off as a resilient economy prompted investors to pare expectations of aggressive interest-rate cuts by the Fed.
With an eye on last year’s bank failures, the Fed said that most lenders were relying less on uninsured deposits. Those tend to attract customers who might quickly yank their money away if there’s a hint of trouble at a lender, a vulnerability that contributed to bank failures in the weeks surrounding the March 2023 turmoil.
Some lenders have now increased deposits collected through brokers and from other short-term sources of cash, according to the report. “The stability of this type of funding during periods of stress may be lower than that of traditional core insured deposits,” the Fed said.
--With assistance from Vildana Hajric and Ye Xie.
(Updates with sector assessments starting in the third paragraph.)
