WASHINGTON Certain indicators of financial risk appear to be getting worse, including term premiums for Treasury bonds and dealer inventories of fixed-income assets, according to the Office of Financial Research.
The independent data agency, which is attached to the U.S. Treasury and tasked with examining the financial system for threats, said in a supplement to its annual risk report Wednesday that overall threats to the financial system remain moderate, but a few key indicators are emerging as sources of concern. OFR Director Richard Berner said that many individual indicators outlined in the agency's Financial Stability Monitor suggest that regulators should remain vigilant about the potential for an economic calamity to occur even after the reforms following the 2008 financial crisis.
"The current moderate level of threats to financial stability should not be cause for complacency," Berner said. "Our analysis suggests the need to remain vigilant about emerging threats."
Overall market risk in particular remained elevated in the first quarter of 2015 as compared to the same time last year, the data shows, and specifically premiums on long-term Treasury notes appear to be especially low, suggesting that there is increasing financial incentive for market participants to hold riskier assets.
Interest rate risk also remains especially high, according to the report, owing to the historically low federal funds rate and the length of time that it has been held at near zero. The report said that market participants are positioned in such a way that they face a serious risk of distress if and when the Federal Reserve raises its federal funds rate.
The Basel Committee on Banking Supervision earlier this month issued a proposal to examine regulatory options to prevent institutions from getting hamstrung by mismatched interest rates in their portfolios, addressing similar concerns.
The OFR report also indicated that broker-dealers are retaining low inventories of fixed-income assets, meaning they may be less able to serve as liquidity providers in a stress event. Other measures of liquidity, like trading volume, dollar funding and excess liquidity appear to suggest a tightening bond market, according to the report.
Those observations echo many made by industry and government officials, who have grown increasingly concerned that liquidity in the fixed-income markets is drying up and that the Dodd-Frank regulatory apparatus is largely to blame. But Treasury Secretary Jack Lew said during a House Financial Services Committee hearing June 17 that while the department is analyzing data and is willing to accept the possibility that regulations are causing liquidity problems, he is not observing "a major impact in terms of broad liquidity" in markets.
Not all the news from the report was bad. Market volatility has been improving year on year, and funding flows into emerging markets have improved. Corporate bond spreads and household financial fundamentals appear to be stable and individuals are deleveraging their debt at a healthy clip. Broad indicators of market contagion also appear to suggest that risks are more isolated than they had been in the past.