Expressing concerns over debt- market investors' excessive risks, US Federal Reserve chief Janet L Yellen has said the US needs to be sensitive and watch for risk to financial stability.
Yellen, who defended a near zero interest rate, argued that this policy was necessary to help US economies move back to full employment and to achieve price stability objectives.
"But it is true that in a low-interest environment we need to be sensitive and watch for risk to financial stability. Low interest rates can certainly incent some investors to reach for yield, Yellen said in a conversation with IMF head Christine Lagarde.
"It can incent them to take on leverage positions that if they unwind can create financial stability risks," she said.
Yellen said the US Fed is monitoring very carefully to look to see if those risks are developing. And to the extent the Fed sees some risks developing, it tries to take action where it can.
In the market for leverage loans, the Fed is certainly seeing reach for yield and seeing deterioration in underwriting standards, she said.
"That's something we've been highlighting for a number of years. In our role as a supervisor of financial institutions that are underwriting these loans, we are trying to ensure that underwriting standards move up and are higher to diminish risks," Yellen said.
Equity market valuations at this point generally are quite high. They're not so high when you compare the returns on equities to the returns on safe assets, like bonds, which are also very low. But there are potential dangers there, Yellen warned.
We need to be attentive and are to the possibility that when the Fed decides it's time to begin raising rates, these term premiums could move up and one could see a sharp jump in long-term rates, she said.
"So we're trying to communicate as clearly about our monetary policy so we don't take markets by surprise," Yellen said.
She said low interest rates could create interest rate risk at financial institutions.
"Many banks are finding their net interest margins compressed. They have an incentive to take on additional duration or credit risk. If interest rates move up, that can create risks in our supervision and in the stress tests we're looking for that and analysing their ability to withstand that," she said.
"I think risks to financial stability are moderated, not elevated at this point. I say that because we're not seeing any broad-based pickup in leverage. We're not seeing rapid credit growth. We're not seeing an increase in maturity transformation," Yellen said.
Responding to a question, Yellen said the US is better equipped today than in the past.
