WASHINGTON- US Treasury Secretary Janet Yellen said on Monday the US financial system was functioning in an “orderly manner” despite the current stock market sell-off, and valuations of some assets remain high compared to historical values.
In prepared testimony for a US Senate Banking Committee hearing on Tuesday, Yellen said the Financial Stability Oversight Council (FSOC) will continue to monitor developments related to the war in Ukraine and continued struggles against the coronavirus pandemic.
“There is the potential for continued volatility and unevenness of global growth as countries continue to grapple with the pandemic,” Yellen said. “Russia’s unprovoked invasion of Ukraine has further increased economic uncertainty.”
US stocks were down sharply again on Monday as the broad S&P 500 index extended its longest losing streak since mid-2011 and touched a one-year low as higher Treasury yields stoked market fears of aggressive monetary policy tightening.
Yellen said the FSOC’s annual report to Congress – the subject of Tuesday’s hearing – discusses other potential emerging financial threats and vulnerabilities that the multi-regulator council continues to monitor. These include short-term wholesale funding markets, central counterparties, alternative reference rates, cyber security, corporate credit markets and real estate markets.
Yellen said the FSOC report discusses vulnerabilities in the non-bank financial sector and the steps the FSOC has taken to examine these risks, including re-establishing an interagency Hedge Fund Working Group.
“The market turmoil in March 2020 demonstrated that the liquidity mismatch and the use of leverage by some nonbank financial institutions can make them vulnerable to acute financial stresses, and these stresses can be transmitted and amplified to the broader financial system,” she said.
Yellen also said the report highlights FSOC’s work in assessing climate-related financial risks and ensuring that financial institutions better understand them. The council has recommended that regulators build their capacity and expand their efforts to address climate risks, improve the availability of data and create enhanced and standardized disclosure rules.
The council is also drafting a report to identify financial stability and regulatory gaps related to digital assets, new products and financial technologies related to President Joe Biden’s March 9 executive order calling for a comprehensive approach to digital asset policies, Yellen said.
High inflation, volatility in stock and commodity markets and the war in Ukraine have emerged as the chief risks to the US financial system, the Federal Reserve reported on Monday in a biannual update on financial stability that warned of a system poised for potentially “sudden” disruption.
The quick rise in US Treasury yields, the war-related trouble in oil markets and other factors have already strained some parts of the financial system, the report cautioned, and while the stress “has not been as extreme as in some past episodes, the risk of a sudden significant deterioration appears higher than normal.”
“It is noteworthy that households and businesses have decreased their borrowing as a percentage of gross domestic product, and currently appear to have resources to cover debt burdens, which is an important aspect of resilience in an environment of rising interest rates,” Fed Governor and vice chair-designate Lael Brainard said in a statement accompanying the report.
The report is the first to take stock of the rapid shifts in the financial landscape that have taken place since last fall, including a swifter tightening of monetary policy by the Fed and rising interest rates generally, inflation that has threatened to become more persistent, and Russia’s invasion of Ukraine.
The volatility has been apparent in US stock markets that have dropped sharply in recent weeks as well as in bond markets that have adjusted to higher US interest rates and tougher financial conditions as part of the Fed’s efforts to slow inflation.
“Inflation has been higher and more persistent than expected, even before the invasion of Ukraine, and uncertainty over the inflation outlook poses risks to financial conditions and economic activity,” the report noted.
“Financial markets experienced high volatility and some strains on market liquidity,” over the last six months, the report said. “On net, over the period, Treasury yields increased markedly, broad equity prices declined notably, and credit spreads widened considerably in corporate bond markets.”
Since closing at a record high on the first trading day of 2022, the benchmark Standard & Poor’s 500 Index has since slid 16.5% and the Nasdaq Composite has fared even worse, losing more than a quarter of its value in roughly six months. Yields on the 10-year Treasury note, influential to a range of consumer and business financing costs, has roughly doubled since the year began.
