5. Near-Term Risks to the Financial System
The Federal Reserve routinely engages in discussions with domestic and international policymakers, academics, community groups, and others to gauge the set of risks of greatest concern to these groups. As noted in the box "Survey of Salient Risks to Financial Stability," in recent outreach, significantly fewer respondents noted risks associated with a resurgence in inflation and further monetary tightening than had done so in the spring survey. Instead, contacts focused on risks associated with U.S. fiscal debt sustainability, Middle East tensions, and generalized policy uncertainty.
The following discussion considers possible interactions of existing domestic vulnerabilities with several potential near-term risks, including international risks.
A worsening of global geopolitical tensions could lead to broad adverse spillovers
Conflict in the Middle East and Russia's ongoing war against Ukraine pose risks to global economic activity, including the possibility of sustained disruptions to energy and commodity markets and global value chains. Further escalation of geopolitical tensions could reduce economic activity, boost inflation, and heighten volatility in global financial markets. The current combination of relatively high asset valuation pressures and heightened geopolitical and policy uncertainty increases the risk of a sudden pullback from risk-taking. These developments could lead to declines in asset prices and losses for exposed businesses and investors, including those in the U.S.
A marked slowdown in economic growth, domestically or abroad, could pose risks for U.S. markets and financial institutions
In the U.S., unexpectedly weak economic activity could trigger sharp corrections in asset prices, especially in equities and real estate, where valuations are elevated. Financial stress could be amplified by high leverage within certain NBFIs, as the rapid unwinding of positions could create liquidity imbalances and increase market volatility. If CRE fundamentals deteriorated further, it could lead to significant losses for exposed financial intermediaries, reducing their ability tosupply credit to the economy and further weigh on economic activity.
In addition, a sharp economic downturn in advanced foreign economies or China could prompt a pullback of investors from riskier assets, leading to heightened volatility and broader stress across global financial markets. Elevated public debt levels in many advanced economies, including the U.S., may limit governments' ability to respond to weaker growth. Concerns about fiscal deterioration could, in turn, put upward pressure on long-term interest rates that could further damp growth and strain sovereign and private-sector borrowers. In China, residential real estate prices continue to fall, potentially putting further pressure on the highly indebted property sector. Fiscal stimulus measures have been announced there, but uncertainty remains about their effectiveness in meaningfully strengthening domestic demand.
Shocks caused by cyber events could impair the U.S. financial system
The risk of cyberattacks has grown amid increased geopolitical tensions and rapid advancements in artificial intelligence. In addition to malicious attacks, nonmalicious cyber events, such as software malfunctions at key third-party service providers, have demonstrated the potential to cause significant disruptions. Shocks caused by cyber events, especially cyberattacks, may propagate through the financial system through complex interdependencies among financial institutions, market infrastructure, and service providers. When these channels are sufficiently systemic, cyber shocks can disrupt payments or other operational components of the financial system. The propagation of more severe cyber shocks could also be amplified by existing vulnerabilities in the financial system—for example, by triggering funding runs or asset fire sales. Various U.S. government agencies, including financial regulators, are taking steps to further protect the financial system and financial infrastructures from cyber risks and their effects.
Box 5.1. Survey of Salient Risks to Financial Stability
As part of its market intelligence gathering, staff from the Federal Reserve Bank of New York solicited views from a wide range of contacts on risks to U.S. financial stability. From late August to late October, the staff surveyed 24 contacts, including professionals at broker-dealers, investment funds, research and advisory firms, and academics (figure A). This section is a summary of the views provided by survey respondents and should not be interpreted as representing the views of the Federal Reserve Bank of New York or the Federal Reserve Board.
Concerns surrounding U.S. fiscal debt sustainability were atop the list this survey, followed by escalating tensions in the Middle East and policy uncertainty, which was also frequently cited in the last survey (figure B). Contacts also flagged the risk of a U.S. recession near the top of the list. The risk of persistent inflationary pressures and the implications of a restrictive monetary policy stance, which had been the top-cited risk in five out of the previous six surveys, including the last cycle, was less frequently cited this round. Respondents noted risks surrounding global trade more frequently this cycle than in the previous survey. A correction in risky asset prices as well as renewed stress in the banking sector, which were noted in the spring survey, continued to be cited but not as prominently. While not as frequently cited as other risks, further weakness in the Chinese economy and the potential for a cyberattack on a financial institution were seen as carrying some of the most severe consequences should either of them materialize.
Figure A. Fall 2024: Most cited potential shocks over the next 12 to 18 months
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Note: Responses are to the following question: "Over the next 12–18 months, which shocks, if realized, do you think would have the greatest negative impact on the functioning of the U.S. financial system?"
Source: Federal Reserve Bank of New York survey of 24 market contacts from August to October.
Figure B. Spring 2024: Most cited potential shocks over the next 12 to 18 months
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Note: Responses are to the following question: "Over the next 12–18 months, which shocks, if realized, do you think would have the greatest negative impact on the functioning of the U.S. financial system?"
Source: Federal Reserve Bank of New York survey of 25 market contacts from January to March.
U.S. fiscal debt sustainability
Concerns over U.S. fiscal debt sustainability was the top-cited risk. It was noted that increased Treasury issuance could begin to crowd out private investment or constrain policy responses in an economic downturn.
Middle East tensions
Respondents noted the most immediate risk in Middle East tensions would be a widening of the conflict within the region, with some highlighting a tail risk that it could become a global conflict. Disruptions to energy supplies, and potentially broader commodity markets, are seen as the main channels impacting financial stability.
Policy uncertainty
Respondents continued to see policy uncertainty as a risk, though it was cited less often relative to the last survey. Contacts noted elevated policy uncertainty can depress sentiment. The need to raise the federal debt limit next year was specifically cited by respondents as a potential watchpoint.
U.S. recession
Contacts cited the potential for a U.S. economic downturn more often than in the previous survey. It was noted by some respondents that there may be more underlying weakness in the labor market than currently believed.
Persistent inflation and monetary tightening
Elevated inflation and the implications of tighter monetary policy, which had been the top-cited risk recently, was less cited this round. The respondents who continued to flag it as a risk noted that while the inflation data had improved, there continued to be some chance that it would take longer than expected to return to a dual-mandate-consistent level.
Risks to global trade
Risks to global trade were specifically cited in this survey, with some respondents noting the potential for tariff barriers to prompt retaliatory protectionist policies that would negatively affect global trade flows and put renewed upward pressure on inflation. Others noted that a deterioration in global trade could depress economic activity and raise the risk of a downturn. Respondents noted this risk was global in nature, highlighting that Chinese policy decisions could spur more protectionist measures elsewhere and that developments like the French elections earlier this year could increase isolationism.