WASHINGTON – Risks to financial stability have risen in the past year across several key areas, the Treasury Department’s Office of Financial Research said in a report to Congress issued Wednesday.

While the overall level of risk remains in the “medium” range, the OFR cited growing threats in all the areas it examines including macroeconomic, market, credit and liquidity and market contagion risks. Many of those risks are interconnected and relate broadly to the declining fortunes of the Chinese and other emerging market economies since the third quarter of 2014 and the ensuing decline in demand for commodities. Those causes, and the secondary effects, indicate a broader economic slowdown in those emerging market countries, the report said.

“Macroeconomic risks have risen since our last annual report, largely due to economic deterioration in China and other emerging market economies,” the OFR report said. “The U.S. economy has been resilient to these global problems so far, but continued or magnified problems overseas could harm future growth and financial stability in the United States”

The decline in demand for commodities – particularly in the oil and gas sector – has increased the potential for market and credit risks, the report said. Declines in asset prices have driven down yields from Treasuries, which has created downward pressure on riskier assets such as corporate bonds. And declining commodity prices and a stronger dollar have weakened nonfinancial companies, which have been taking on more debt despite a weaker ability to repay – particularly in the oil and gas sector.

“The drop in the price of oil and other commodities, coupled with the slowdown in global economic growth, has diminished the ability of multinational companies and firms in the energy and commodity industries to repay their debts,” the report said. “In the United States, regional banks with exposures to energy companies or to local economies reliant on the energy industry face the prospect of increases in troubled loans.”

The report also highlighted some uncertainties in the availability of funding and liquidity – a subject that has been of particular interest to regulators in recent months – but concluded that “wholesale funding markets appear stable” despite some uncertainty about the susceptibility of those markets to sudden and unexplained shocks. And to the extent that the data office was able to examine contagion risk – the risk of stress being transmitted throughout the financial system – that has risen because of indications that volatility in emerging markets may find its way to the U.S.

“Although the Financial Stability Monitor suggests that overall contagion risk is low, this risk is difficult to measure in the absence of financial stress,” the report said. “In our assessment, contagion risk is actually higher than the current measures indicate.”

The report’s findings are largely in line with those of a companion report the OFR released last month. That report similarly found elevated risk from volatility originating in emerging markets and concern about persistently weak nonfinancial performance.

But the December report was published the day before Federal Reserve’s Federal Open Market Committee decided to raise the federal funds rate above the zero lower bound for the first time in seven years – a highly anticipated move that some feared would spark market volatility. The FOMC is scheduled to announce the results of its most recent meeting Wednesday afternoon, but is not expected to raise rates further.

The OFR’s most recent report determined that the market’s reaction to the Fed’s decision to tighten monetary policy was “muted” and that “U.S. stock market ands and credit markets were relatively stable, the reaction from emerging markets was mixed but moderate, and the dollar appreciated slightly against currencies in other developed countries.”

 

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