Fed issues geopolitical risks warning

First Russia-Ukraine and now Israel-Gaza. Escalating geopolitical tensions pose a threat to the global financial system amid heightened risks of higher inflation and slower growth, the Federal Reserve has warned in its latest Financial Stability Report.

Economic weakness in China have also grown in the Fed’s bi-annual survey, cited by 44% of those surveyed as a top risk, compared to just 12% in May. However, the war between Russia and Ukraine slipped to the 11th-most cited concern by respondents, after it was cited as the top financial stability concern one year ago.

The US central bank flagged the potential for “broad adverse spill-overs to global markets” in the event that the Middle East conflict and the war in Ukraine intensify or stresses emerge elsewhere. 

“Escalation of these conflicts or a worsening in other geopolitical tensions could reduce economic activity and boost inflation worldwide, particularly in the event of prolonged disruptions to supply chains and interruptions in production,” the report said. 

It added: “The global financial system could be affected by a pullback from risk-taking, declines in asset prices, and losses for exposed businesses and investors, including those in the US.” 

The report comes as Tel Aviv prepares for an expected ground offensive into Gaza following the attack on Israel by Hamas militants earlier this month.

Overall, the Fed identified several vulnerabilities within the financial system, including historically high asset valuations, including in equities and real estate. Specifically, the Fed found that commercial real estate valuations remain elevated, even as prices have declined amid high office vacancies.

The Fed cautioned that if the economy were to slow unexpectedly, generally high leverage levels could strain or even sink some businesses. It specifically noted a correction in office property valuations alongside a mild recession could lead to “significant losses for a range of financial institutions with sizable exposures, including some regional and community banks and insurance companies.”