Valuations in commercial real estate
“appear increasingly vulnerable to negative shocks, as CRE prices have continued to outpace rental income,” the Fed said in its semiannual Monetary Policy Report to Congress. The Fed noted that prices exceed their pre-crisis peaks by some measures.
The Fed included a special section on financial stability risks in the report, which accompanies Chair Janet Yellen’s testimony. The report said that even given “moderate’’ financial vulnerabilities, risks of external shocks, such as the U.K.’s possible exit from the European Union, pose stability risks.
The report also highlighted issues related to credit exposures to the energy sector, money-market mutual funds and stock valuations.
The central bank said price-to-earnings ratios on a forward-looking basis for stocks have increased to a level “well above” their median for the past 30 years.
“Although equity valuations do not appear to be rich relative to Treasury yields, equity prices are vulnerable to rises in term premiums to more normal levels, especially if a reversion was not motivated by positive news about economic growth,” the Fed said.
The Fed said “some structural vulnerabilities are expected to persist” in money-market mutual funds even after Securities and Exchange Commission reforms go fully into effect in October.
“Leverage for the non-financial corporate sector has stayed elevated and indicators of corporate credit quality, though still solid overall, continued to show signs of deterioration for lower-rated firms, especially in the energy sector,” the Fed said in its report.
Strong U.S. bank capital positions contributed to the resilience of the financial system, the Fed said.
The Federal Reserve warned that prices in the commercial real-estate market may have run up too far too fast.