The Fed Is Concerned About Small Cap Forward Multiples And Covenant Lite Loans?
While everyone is focused on any additional clues about the taper and the pace of Fed Flow reduction, perhaps this is the key standout section in today's Minutes, one that focuses directly on the risk bubble the Fed's policies have blown.
Participants also reviewed indicators of financial vulnerabilities that could pose risks to financial stability and the broader economy. These indicators generally suggested that such risks were moderate, in part because of the reduction in leverage and maturity transformation that has occurred in the financial sector since the onset of the financial crisis. In their discussion of potential risks, several participants commented on the rise in forward price-to-earnings ratios for some smallcap stocks, the increased level of equity repurchases, or the rise in margin credit. One pointed to the increase in issuance of leveraged loans this year and the apparent decline in the average quality of such loans. A couple of participants offered views on the role of financial stability in monetary policy decision-making more broadly. One proposed that the Committee analyze more explicitly the potential consequences of specific risks to the financial system for its dual-mandate objectives and take account of the possible effects of monetary policy on such risks in its assessment of appropriate policy. Another suggested that the importance of financial stability considerations in the Committee’s deliberations would likely increase over time as progress is made toward the Committee’s objectives, and that such considerations should be incorporated into forward guidance for the federal funds rate and asset purchases.
In other words, the Fed realizes the "importance" of its role in preserving financial stability in the future, specifically one the bubble bursts? Don't worry though, yesterday none other than SF Fed president John Williams said stocks are undervalued.
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