Trade tensions between the U.S. and its allies constitute one of the major near-term risks to the U.S. financial system, and could lead to a “particularly large” drop in markets, according to the Federal Reserve.
“An escalation in trade tensions, geopolitical uncertainty, or other adverse shocks could lead to a decline in investor appetite for risks in general. The resulting drop in asset prices might be particularly large, given that valuations appear elevated relative to historical levels,” the Fed wrote in a report on financial stability released Wednesday.
{mosads}President Trump is involved in ongoing trade disputes with some of America’s largest trade partners, and has levied tariffs against Canada, Mexico, the EU and China. In an interview published Tuesday, Trump said that he was unlikely to delay addition tariffs on Chinese imports set to come into play in January.
The Fed report found that price-to-earning ratios, a measure of whether stocks are overvalued, were above their median values over the past 30 years, even when taking into account recent drops in the markets.
It also noted that the Fed and other central banks decisions to increase interest rates could send shudders through markets, even if they’re expected.
Trump has frequently criticized the Fed’s rising interest rate policy. The report noted that the increases represented a “normalization” following “the very low interest rate environment of the post-crisis period.”
The report also cited Brexit and a slowdown in China’s growth as potential near-term risks to the financial system. Business debt, however, was at historically high levels.
But the report also found brighter spots. Household debt has remained in line with incomes, banks are more liquid than before the financial crisis and the largest ones are strongly capitalized.