Jim Glassman, Head Economist at JP Morgan Commercial Bank, reviews four financial vulnerabilities from the Fed’s report:
1. Asset valuation. Stock markets are expensive according to traditional metrics but a stable earnings outlook currently justifies valuations. Commercial real estate performance is also in line with the historic averages.
2. Leverage. Household leverage has expanded to $10 trillion since the 1990s but income has increased more than debt (Debt to Income ratio down from 136% in 1990s to 98% today). Business sector debt has increased to 75% of GDP, but the profits of the firms have increased faster.
3. Financial Sector. The sector is stable with low delinquency and default rates.
4. Funding market. Finance players are less reliant on wholesale sources of funding and banks are more liquid due to regulatory changes following the 2008 crisis.
Why does this matter? JP Morgan and the Fed take a sanguine view of financial risks. They appear to be looking out for a repeat of the 2008 crisis, rather than a different type of crisis. Meanwhile, corporate earnings momentum has worsened, trade uncertainty clouds the outlook, and there is little mention of market liquidity issues. The world does feel low risk.
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