The Federal Reserve’s latest semiannual report has highlighted concerns over persistent inflation, potential losses in the commercial real estate market, and the stability of banks following the failure of three large firms. Three-quarters of survey respondents cited these issues as prominent near-term risks. Economic weakness in China has also become a growing concern, cited by 44% of those surveyed compared to just 12% in May. However, the war between Russia and Ukraine has slipped down the list of concerns. The Fed also identified vulnerabilities within the financial system, including historically high asset valuations and high leverage levels that could strain businesses if the economy were to slow unexpectedly.
The central bank’s survey found that commercial real estate valuations remain elevated despite declining prices and high office vacancies. A correction in office property valuations alongside a mild recession could result in significant losses for financial institutions with sizable exposures. Some banks are still facing challenges due to declines in the fair value of assets as interest rates rapidly increased. The report also noted that while overall banking system soundness remained intact, some firms are experiencing funding pressures as deposit outflows have abated but depositors have left and banks have had to pay more to retain depositors or secure other funding.
The report further highlighted that home prices have increased since May, but credit conditions for borrowers are tighter compared to the period leading up to the subprime mortgage crisis. However, household and business debt burdens remained moderate, despite the rise in interest rates. Borrowers with low credit scores are showing signs of stress in consumer debts such as credit cards and auto loans. Overall, the report emphasizes the need to address the risks posed by inflation, real estate market conditions, bank stability, and economic weaknesses, in order to sustain the current financial stability in the US.
