Fed warns struggling Chinese real estate sector poses risks to US economy


The Federal Reserve warned Monday that tensions in China’s real estate sector “pose a risk to the US financial system”, pointing to heavily indebted real estate companies like Evergrande as a potential source of global contagion.

“Given the size of the Chinese economy and financial system as well as its extensive trade links with the rest of the world, financial strains in China could strain global financial markets through a deterioration in risk sentiment,” pose risks to global economic growth and affect the United States, ”the Fed warned in its semi-annual financial stability report.

Domestically, the Fed also warned that a “sharp hike” in interest rates could lead to a “big” correction in risky assets, in addition to a reduction in housing demand which could in turn result in a drop in housing prices. Jobs and investments could also be affected by rising borrowing costs for businesses.

The US central bank said it was worried about China because “the country’s corporate and local government debt remains high; the indebtedness of the financial sector is high, especially in small and medium-sized banks; and real estate valuations are strained ”.

“In this environment, the current regulatory focus on leveraged institutions has the potential to stress some heavily leveraged companies, particularly in the real estate sector, as evidenced by recent concerns about the China Evergrande group,” he said. -he declares.

The Fed said the Chinese financial system could come under pressure if there was “fallout for financial firms, a sudden correction in house prices or a reduction in investor risk appetite.”

The central bank’s warning came about two months after Fed Chairman Jay Powell called Evergrande’s situation “very peculiar” to China. Speaking at a press conference, Powell said he did not see much “direct exposure to the United States,” but feared the unrest would have a broader effect on global financial conditions and investor confidence.

In its report, the central bank warned that heavily indebted emerging market economies could also pose a risk to financial stability, especially in the event of a “sudden and sharp” tightening in financial conditions. These have eased to historic levels in the aftermath of the Covid-19 crises due to actions taken by central banks and other policymakers around the world.

“A sharp tightening in financial conditions, perhaps triggered by higher bond yields in advanced economies or worsening global risk sentiment, could drive up debt servicing costs for sovereigns and companies in EMEs,” trigger capital outflows and stress EME financial systems. The Fed wrote in its report.

“Widespread and persistent stress” could spill over into the US financial system, the Fed said, adding that companies with “strong ties” to the most vulnerable countries were particularly at risk.

“There was a notion of correlation [in the report]”said Padhraic Garvey, regional research manager for the Americas at ING.” The fear is that if one thing happens, the rest could go away. “

In a special section of the report, the Fed also analyzed “the recent volatility of so-called memes stocks”. So far, he said that “the general implications of these developments for financial stability have been limited” as trade volatility has eased, but deserves “continued monitoring”.

The Fed said that the reasons for concern included the relatively high debt ratios of young investors and the possibility that these make them “more vulnerable to large swings in stock prices”, especially when so many players market trades in stock options.

The central bank said it was also concerned that the interaction between social media and retail investors “may be difficult to predict” and that “the risk management systems of the financial institutions concerned may not be calibrated for volatility. increased “.


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