The latest Financial Stability Report from the Federal Reserve highlights a stark shift in the priorities of risk that should serve as a warning to financial market participants around the globe. Uncertainty over financial market policies has risen to the top of a list of risks to financial stability in the United States, as indicated by a resounding 61% of respondents to a survey identifying it as their top priority.
Policy uncertainty dominates the Fed’s financial stability risk assessment
A twice-yearly survey reveals that current top-rated issues faced by investors, in order of priority, include issues of policy uncertainty, which have surpassed more established issues such as risks in global trade, which, until this past April, dominated investor concerns. For the first time in the survey’s history, issues of central bank independence have been raised, which have been brought into question by recent instances of political meddling in central bank decisions.
A key finding of this survey is that issues about trade, central bank independence, as well as data, rank amongst those that threaten financial stability the most. The current partial shutdown of the U.S. government has denied market participants access to several important data sets, meaning they cannot get an accurate indication of what is happening to the economy.
Artificial intelligence is listed as an emerging financial stability threat
Roughly 30% of the Fed’s market contacts pointed to artificial intelligence as a possible source of disruptions in finance during the coming 12 to 18 months. Artificial intelligence is a completely new source of risk that, in previous analyses of financial stability, has never been taken into account. The Fed is troubled by investor excitement surrounding AI, which has contributed to equity market rises during the current year.
The report warned of possible heavy losses in tech-heavy indexes in the event of an about-face in AI sentiment. Though AI is increasingly finding applications in financial markets, opinion is sharply divided in financial regulating bodies, as it is regarded either as an ultimate tool for increasing productivity in the long run or as an incubator for bubbles, which tend to evolve at a pace faster than regulating systems.
“A shift in views regarding the speed of, or profitability in, AI deployment could provoke significant market realignments,” according to the report.
Concerns about AI are shared by global regulatory agencies
The Fed’s interest in AI is in line with warnings from other central banks, such as the Bank of England, which also warned of a need for more review of AIs in trading, credit risk, and compliance processes, as did the European Central Bank. The warning about central bank independence as a risk factor is in line with warnings from Fed Gov. Lisa Cook, dismissed by Trump, as well as criticism from Trump of Fed Head Jerome Powell for failing to cut interest rates as low as he wants them to be.
Geopolitical risk is probably the second most-often-mentioned source of fragility, as around half of the respondents listed it as a source of fragility. Geopolitics-based risks tend to bring in a source of unpredictability, which is linear in nature, as compared to more traditional risks such as inflation and interest rates, into financial markets as a result of possible trade wars, military actions, sanctions, supply chains, etc.
Although this report did not carry an urgency of potential harm to financial systems, it did stress that political instability, data gaps, as well as overvalued technological assets could be potential stress tests for financial markets in the United States in 2025. This is a marked shift from past assessments, which vary from this current state of financial stability in a complex international atmosphere.