Federal Reserve Financial Stability Report: Multiple asset valuations are at high levels, U.S. Treasury yields are high, and trade has risen to the number one risk

The Federal Reserve assesses that there are risks related to asset valuations in the past six months, mentioning the high yields of U.S. Treasury bonds. The Fed's survey also found that after last year's U.S. election, the risks facing global trade surpassed the sustainability of U.S. government debt, becoming the number one threat to financial stability.

Low Liquidity in U.S. Treasury and Stock Markets, April Situation Worsens, But Markets Operate in an Orderly Manner

On Friday, the 25th, Eastern Time, the Federal Reserve released its semi-annual Financial Stability Report, reflecting the market environment and data from the last report period in November of last year to April 11 of this year. The report summarizes the developments in four types of vulnerabilities in the financial system over the past six months: asset valuations, corporate and household borrowing, financial industry leverage, and financing risks.

The report mentions risks related to asset valuation pressures, pointing out that asset prices fall during significant market turmoil, yet valuations of various assets remain high, including the stock market and residential real estate. The liquidity of U.S. Treasury bonds and the stock market is low, and the situation worsened entering April; however, the market continues to operate in an orderly manner and fulfill its functions.

Regarding the stock market, the report states that before the market volatility in early April, the price-to-earnings ratio of stocks remained near historical highs, while stock premiums, or market risk compensation valuations, are still well below average levels. Even after recent declines in stock prices, they remain high compared to analysts' earnings forecasts, and the speed of adjustments in analysts' earnings expectations has not kept pace with changes in market stock prices.

In the bond market, the report states:

“Yields on U.S. Treasury bonds of all maturities remain at the high end of levels since 2008. The spread between corporate bonds and U.S. Treasury bonds of the same maturity has recently widened, but remains moderate compared to historical levels. Many financial markets' liquidity remains low and further deteriorated in April, but the overall market operation is orderly.”

The report notes that in the U.S. real estate market, home prices remain high, and the ratio of home prices to rents continues to approach historical highs. The inflation-adjusted commercial real estate (CRE) transaction price index shows some signs of stabilization, while upcoming refinancing demands still pose vulnerabilities.

The Federal Reserve points out that the U.S. banking system remains robust and resilient, with institutions maintaining adequate capital ratios. However, the report also finds that credit commitments from banks to less-regulated non-bank institutions continue to grow.

Additionally, the Federal Reserve warns that the leverage ratios of large hedge funds are at or near historical highs, although it believes that leverage ratios have decreased somewhat since early April as funds were liquidated.

Global Trade Risks Become the Primary Concern

This is also the first such report released by the Federal Reserve since President Trump returned to the White House, where the impact of his aggressive policy agenda, particularly tariff measures, is clearly visible.

According to the Federal Reserve's survey, 73% of respondents listed global trade risks as their primary concern, more than double the proportion from the November survey last year. Half of the respondents identified overall policy uncertainty as the primary risk, a proportion that has also increased compared to last fall.

The report states:

“In this cycle, changes in trade policy have become the most frequently mentioned risk. While many respondents believe tariffs are a key risk, some believe that the domestic economy can withstand the incremental tariffs on imported goods with minimal disruption

Respondents believe that if the trade war escalates further, it could lead to more serious consequences.

Changes in government spending priorities and uncertainty regarding the level of U.S. international involvement have intensified the overall sense of policy uncertainty.”

The survey also showed an increase in concern about recent market volatility, with 27% of respondents expressing worries about the functioning of the U.S. Treasury market, up from 17% last fall. Concerns about foreign investors reducing their holdings of U.S. assets and issues related to the U.S. dollar exchange rate also ranked higher.

The Federal Reserve stated that among the 22 respondents (including scholars, investors, and financial professionals), “the vast majority” submitted their responses before April 2. On April 2 local time, according to CCTV News, the White House issued a statement saying that Trump would impose a 10% “baseline tariff” on all countries. Although on April 9 local time, the White House announced a 90-day suspension of implementation, there remains a risk of triggering a comprehensive global trade conflict