The Federal Reserve issued a cautionary note Wednesday about risks to financial stability, saying trade tensions, geopolitical uncertainty and a buildup in corporate debt among firms with weak balance sheets pose strong threats.
In a lengthy first-time report on the banking system and corporate and business debt, the Fed warned of "generally elevated" asset prices that "appear high relative to their historical ranges."
In addition, the central bank said ongoing trade tensions, which are running high between the U.S. and China, coupled with an uncertain geopolitical environment could combine with the high asset prices to provide a notable shock.
"An escalation in trade tensions, geopolitical uncertainty, or other adverse shocks could lead to a decline in investor appetite for risks in general," the report said. "The resulting drop in asset prices might be particularly large, given that valuations appear elevated relative to historical levels."
The drop in asset prices would make it more difficult for companies to get funding, "putting pressure on a sector where leverage is already high," the report said.
The report further noted that the Fed's own rate hikes could pose a threat. A market and economy used to low rates could face issues as the Fed continues to normalize policy through rate hikes and a reduction in its balance sheet, or portfolio of bonds it purchased to stimulate the economy.