Fed says stock market fall may be sign of healthy readjustment

Snow covers the grounds of the US Federal Reserve in Washington.
Snow covers the grounds of the US Federal Reserve in Washington. PHOTO: REUTERS

WASHINGTON (REUTERS) - The Federal Reserve said on Wednesday (Feb 10) that the US financial system is well-positioned to weather headwinds and the fall in stock prices may have put the nation's asset markets on a healthier path.

The S&P 500 stock index has lost about 10 per cent since the central bank raised rates in December. US financial stocks in particular have been hit amid fears over banks' profitability and capital strength.

The rout has upset investors, who are reminded of the financial crisis of 2007-2009 that erased billions of dollars in household assets and sent the economy into a tailspin.

In its semi-annual monetary policy report to Congress, the Fed said financial vulnerabilities in the United States have continued to moderate since mid-2015, in part due to regulations introduced since the financial crisis.

"Regulatory capital and liquidity ratios at large banking firms are at historically high levels, and the use of short-term wholesale funding remains low," the Fed said in the report, which was prepared to coincide with chair Janet Yellen's appearance before lawmakers.

The Fed said in its report that direct exposures of the largest US banking firms to the troubled oil sector and to emerging market economies were "limited," although it acknowledged that wider stresses could result due to the globalized nature of modern finance.

In Europe, the euro zones's banking index is facing its worst weekly losing streak since 1998.

The Fed also noted that the sharp decline in US asset prices and repricing of debt securities has put valuations on a healthier plane.

"Overall asset valuation pressures have eased," the Fed said and some areas of particular concern "have cooled recently,"noting that risk premiums for below-investment-grade debt have widened.

Policymakers at the central bank have previously worried about asset bubbles, even going so far as discussing whether they needed new tools to deflate them.

One of the upsides of the recent tightening in financial conditions is that it has pricked such potential bubbles.

Forward price-to-earnings ratios, for example, are now running closer to their averages of the past 30 years, the Fed said.

Several Fed policymakers in recent weeks have said they are waiting to see whether the latest bout of market volatility was sustained enough to cause them to delay the next interest rate increase.

Despite volatility, liquidity conditions in corporate bond markets have deteriorated only slightly, the Fed said in the report.