By Andrew Ackerman 

WASHINGTON -- The Federal Reserve identified elevated asset prices and historically high debt owed by U.S. businesses as top vulnerabilities facing the U.S. financial system, according to the latest copy of the central bank's financial stability report.

The Fed cited potential risks tied to borrowing by companies not in the financial sector, particularly leveraged loans -- a $1.1 trillion market that the Fed warned is growing quickly despite consistently "weak" credit standards.

Fed Gov. Lael Brainard, in a statement, said low credit spreads -- measured as the gap between yields on U.S. Treasurys and assets such as corporate debt -- combined with high levels of indebtedness among "risky" nonfinancial corporates, including through leveraged loans, "merits heightened vigilance."

She added that the "low-for-long" interest rate environment and the associated incentives to reach for yield and take on additional debt "could increase financial vulnerabilities."

Still, Friday's report suggested overall risks were fairly moderate. "The core of the financial sector appears resilient, with leverage low and funding risk limited relative to the levels of recent decades," the report said.

The document is the latest evolution in the Fed's efforts to spotlight financial stability monitoring and follows years of more intense in-house research. It comes as investors' recent recession fears have waned on a series of economic reports that turned out better than investors had feared.

In congressional testimony Thursday, Fed Chairman Jerome Powell said the central bank is optimistic its interest-rate cuts this year would buoy the U.S. economy against lingering headwinds. The Fed has cut its benchmark interest rate three times since July to cushion the economy against risks of a sharp slowdown from weakening business investment and global growth.

In Friday's report, officials said deteriorating liquidity -- or the ability to easily buy or sell -- in the U.S. Treasury and equity-futures markets could lead to greater incidence of flash events in which prices move abruptly and sizably and then quickly revert.

"Flash events may undermine confidence in trading venues and financial markets even if the price dislocations are short-lived," the Fed said, adding that because trading is increasingly connected across markets, flash events in one market could affect trading and liquidity in others.

While the banking sector overall is well-capitalized, the Fed said several large banks have announced plans to distribute capital to their shareholders in excess of expected earnings, "implying that capital at those banks will decrease."

The stability report also identified potential economic shocks that could test the stability of the U.S. financial system, including slowing global economic growth and trade tensions.

Write to Andrew Ackerman at andrew.ackerman@wsj.com

 

(END) Dow Jones Newswires

November 15, 2019 14:44 ET (19:44 GMT)

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