Federal Reserve: The sustainability of U.S. debt has risen to the number one financial stability risk, inflation threats have decreased, alongside trade wars

The Federal Reserve's survey found that in the months leading up to the U.S. election, financial professionals' concerns about U.S. inflation have significantly decreased, believing that the threat of inflation to financial stability is now less than that of the global trade war. Meanwhile, their worries about the U.S. federal government's massive debt have noticeably intensified, with debt sustainability viewed as the number one financial stability risk.

On Friday, November 22, the Federal Reserve released its semi-annual financial stability report. The report disclosed that from the end of August to the end of October, staff from the New York Fed surveyed individuals from institutions such as brokerage firms, funds, and consulting companies, as well as academia. They found that 54% of respondents, or more than half of the professionals, believe that the sustainability of U.S. government debt is a prominent financial stability risk over the next 12 to 18 months, the highest proportion among the main risks surveyed.

In contrast, in the financial stability report released by the Federal Reserve in April this year, a survey conducted from the end of January to the end of March showed that only 40% of respondents believed that debt sustainability was a prominent risk over the next year to year and a half. This means that over the past six months, the proportion of professionals most concerned about government debt issues threatening financial stability has increased by 14 percentage points.

The current report shows a decrease in the perceived threat level of policy uncertainty, with 46% of respondents considering it a prominent risk, down from 60% in the last survey, a decrease of 14 percentage points. The proportion of respondents who believe that tensions in the Middle East are a prominent risk has increased by 15 percentage points, rising from 32% to 46%.

Concerns about high inflation have significantly decreased, with the proportion of respondents who consider persistent inflation and monetary tightening as prominent risks dropping to 33%, more than halving from 72% in the last survey.

The report stated:

"Concerns about the sustainability of U.S. fiscal debt are the most frequently mentioned risks by respondents. The survey points out that increased issuance of government bonds may begin to crowd out private investment or limit policy measures in response during economic downturns."

Regarding the situation in the Middle East, the report noted that respondents pointed out that the most direct risk posed by tensions in the Middle East is the escalation of conflicts in the region. Some respondents emphasized that "tensions in the Middle East could evolve into a global conflict, which is a tail risk." The impact of the Middle East situation on financial stability mainly comes from disruptions in energy supply and potential effects on broader commodity markets.

The report stated that the impact of rising inflation and the Federal Reserve's tightening of monetary policy are the most frequently mentioned risks recently, but the number of mentions in this survey is less than in the last one. Respondents who continue to list inflation as a risk believe that despite data showing some improvement in inflation, it may still take longer than expected to return to levels consistent with the Federal Reserve's dual mandate.

Wall Street Insights noted that in the list of results from this year's two financial stability surveys presented in the report, the risk of global trade was mentioned multiple times by respondents, marking a difference from the last report, where this risk was not included in the list of major risks identified by respondents In this report's survey, less than 35% of respondents considered global trade risks to be prominent, which is on par with the number of people who prioritize inflation risks, ranking after the risk of a recession in the United States.

The report stated that respondents particularly mentioned the risks facing global trade, with some pointing out that tariff barriers could trigger retaliatory protectionist policies, negatively impacting global trade flows and bringing renewed upward pressure on inflation. Others believe that the deterioration of global trade could suppress economic activity and increase the risk of economic downturn.

Hedge Fund Leverage Levels Near Highest Since 2013, Stablecoin Assets Surge, Market Value Approaching Record Highs

The report indicated that data collected through the submission of the SEC PF form shows that the leverage used by various hedge funds has reached its highest level since 2013, or is close to such high levels.

Compared to the financial stability report in April, during this reporting period, both the on-balance-sheet leverage ratio and the average total leverage ratio of hedge funds have increased. In the first quarter of this year, the leverage ratio of large hedge funds ranked 15th to 50th significantly rose, reaching about 10 times, the highest level since 2013.

The report believes that the high leverage of hedge funds reflects an increase in U.S. Treasury spot-futures basis trading activities. Moreover, the volatility spike in early August does not seem to have led to a significant unwinding of basis trades. On the contrary, the spike appears to be related to some highly leveraged hedge funds having to quickly reduce the leverage of other positions.

The report also mentioned that since the last report was published in April, the asset scale of a cryptocurrency digital asset pegged to fiat currency—stablecoins—has significantly increased. As of early November, the total market value of stablecoins exceeded $170 billion, slightly below the record high set in April 2022 before the collapse of the stablecoin UST's sister token Terra.

The report believes that structurally, stablecoins remain vulnerable to runs and lack a comprehensive federal regulatory framework. The influence of stablecoins in the U.S. economy is still relatively small, although they have experienced strong growth in recent years and have the potential to scale rapidly.