May 6, 2019 / 7:05 PM / 13 days ago

Fed flags high U.S. business debt, asset prices in financial report

WASHINGTON (Reuters) - U.S. stock prices are “elevated” and business debt is at historic levels, but the financial system overall “appears resilient” with low levels of leverage and less of a destabilizing run in key markets, the Federal Reserve said in its latest report on financial stability.

Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., May 6, 2019. REUTERS/Brendan McDermid

“Investor appetite for risk appears elevated by several measures, and the debt loads of businesses are historically high,” the Fed said on Monday in a report that noted the 20 percent growth in leveraged loans between the start of last year and this year, and other aspects of corporate debt.

The ratio of debt to assets among publicly traded, nonfinancial firms is near a 20-year high, the Fed noted, and the share of new loans going to the most indebted companies is near peaks reached in 2014 and just before the 2007 to 2009 financial crisis.

While the Fed sees the system overall as healthy, the levels of corporate debt stand out, said Fed Governor Lael Brainard.

“With financial volatility easing since the end of last year, the Federal Reserve Board’s Financial Stability Report suggests stretched asset valuations and risky corporate debt merit continued vigilance against a backdrop of low-to- moderate vulnerabilities in the household and banking sectors,” Brainard said in an emailed statement.

The Fed report is the central bank’s latest take on a financial system that went full circle in a matter of months, along the way prompting President Donald Trump to take aim at Fed policy and demand lower interest rates. After stock markets hit record highs early last fall, they plummeted by nearly 20 percent by year’s end, and investors began demanding higher interest rates to hold the bonds of weaker corporations.

Now, stocks are back near their records and by some measures prices are high, the Fed said - the expected future price-to- earnings ratio for the S&P 500 is above its 30-year median, though well below the levels hit during the 1990s tech bubble.

Corporate credit spreads have narrowed, again focusing attention on whether investors, markets and households are taking too muted a view of economic risks.

REASON FOR CAUTION

While not one of the Fed’s explicit mandates, financial stability issues are weighed as part of its policy discussions, and can shape the outcome. In the current environment, those issues provide more reason for the Fed to discount calls from the White House or elsewhere to cut rates, a step that could make riskier assets even more attractive by reducing the returns offered by safer investments like U.S. Treasury bonds.

As in the last edition of its now twice-yearly report on the financial sector, the Fed cited the rapid growth of business debt and leveraged lending to corporations as a source of possible concern, noting that it could leave weaker companies stressed if the economy softens. Business debt has grown faster than the overall economy for a decade, the Fed noted, and “the elevated level of debt could leave the business sector vulnerable to a downturn in economic activity or a tightening in financial conditions.”

Overall debt however, including that of households, has remained in line with the size of the economy.

Among the more immediate risks cited in talks with outside contacts, the Fed noted, trade tensions and tariffs were the “preeminent” potential problem, along with slowing growth globally, political risks surrounding “Brexit,” and uncertainty around Fed policy as well.

Reporting by Howard Schneider; Editing by Andrea Ricci

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