“Vulnerabilities associated with elevated risk appetite are rising,” Lael Brainard,a Fed governor,said in a statement accompanying the Fed’s release. Stock prices are high compared with earnings and “the appetite for risk has increased broadly,as the ‘meme stock’ episode demonstrated.”
The report painted a generally sunny picture in which banks,consumers and businesses have weathered the coronavirus shock in decent financial shape,and it said that by some measures,risk appetite looked typical.
But it noted that some asset prices “may be vulnerable to significant declines should risk appetite fall” and said “episodes of high trading volumes and price volatility for so-called meme stocks” are among signs pointing to “elevated risk appetite in equity markets.” Officials also singled out hedge funds,saying the opaque investment vehicles have slightly higher-than-normal leverage while warning that available data on funds “may not capture important risks.”
The report,which at times took on an ominous tone,contrasts with the picture that Fed officials,economists and investors have been painting of the US economy,which is expected to rebound rapidly now that vaccines have become widely available. In doing so,it underscored that increasing consumer and business confidence could fuel risky bets and create or expand financial market vulnerabilities.
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The Fed’s suggestion that more data was needed on hedge fund debt followed an episode in March in which problems at a large fund,Archegos Capital Management,spilled back to hurt banks. The fund had amassed big,leveraged stock bets that went bad and ended up costing banks it had done business with.
“While broader market spillovers appeared limited,the episode highlights the potential for material distress” at financial companies that aren’t banks “to affect the broader financial system,” the Fed said in its report. It said hedge fund opacity also raised questions during the meme stock episode:Some funds that were betting against the stocks in question took losses as chat board vigilantes poured into them.