The U.S. Federal Reserve is sounding the alarm on elevated asset prices.
In its semi-annual financial stability report, the Fed says investors’ appetite for risk across a variety of asset markets, notably stocks, is stretching valuations and creating vulnerabilities in the U.S. financial system.
In the current environment, asset prices may be vulnerable to "significant declines" should risk appetite fall, the Fed report states.
Near-zero interest rates and massive bond purchases, with the Fed buying $40 billion U.S. in mortgage-backed securities and $80 billion U.S. in Treasuries each month, have helped buoy asset prices including those of risky investments such as speculative stocks, cryptocurrencies and high-yield debt.
The Standard and Poor’s 500 stock index has risen 12% so far this year.
Overall, the Fed said the current state of the U.S. financial system is sound, with household balance sheets in good shape, and corporations supported by an improving economy and low interest rates that have allowed default rates to fall.
However, the U.S. Federal Reserve did single out the investor mania seen this year in so called "meme stocks," as well as cryptocurrencies and special purpose acquisition company (SPAC) deals.
"Indicators pointing to elevated risk appetite in equity markets in early 2021 include the episodes of high trading volumes and price volatility for meme stocks -- stocks that increased in trading volume after going viral on social media," the report said. "Elevated equity issuance through SPACs also suggests a higher-than-typical appetite for risk among equity investors."
Low rates are also impacting the American economy. Home prices are up 12% year-over-year amid high demand for property and scarce supply, while a boom in home remodeling has helped push lumber prices to record highs.
A survey the Fed conducts across 24 market contacts showed that the biggest worry moving forward is virus-related, specifically vaccine-resistant variants of COVID-19. That’s followed by a sharp increase in interest rates, a surge in inflation, and tensions between the U.S. and China.
