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Suppressed rates ‘threaten market price shock’

Low interest rates pose one of the biggest threats to the US economy and expose investors to the potential for heavy loses from a price shock across a range of markets, according to an independent arm of the US Treasury.

The concerns are raised in the Office of Financial Research’s annual financial stability report to Congress, which concludes that threats to stability remain “in a medium range”.

Aggressive central bank policy has suppressed global interest rates since the financial crisis, the OFR report finds, spurring record levels of corporate debt sales while also helping elevate equity valuations as well as prices for commercial real estate.

The S&P 500 has extended the long bull run that began in March 2009, rising a further 9 per cent so far this year and nearly 6 per cent since Donald Trump’s election victory last month.

On Tuesday, US equity benchmarks rose further into record territory with the Dow Jones Industrial Average nearing the 20,000 point level for the first time.

Technology stocks led a 0.7 per cent gain for the S&P 500 index and the tech-heavy Nasdaq Composite rose 1.1 per cent.

Mr Trump is set to meet a host of senior tech company executives on Wednesday, including Elon Musk, founder of electric car company Tesla, and Tim Cook, chief executive of Apple.

Tech companies have suffered mixed fortunes since Mr Trump’s election. The OFR on Tuesday warned that a rising dollar and slow global growth could pose a risk for corporate earnings.

“A price shock in one of these markets could threaten US financial stability if the assets were widely held by entities that use high levels of leverage and short-term funding,” the report said. “A price shock that coincided with a sharp increase in US corporate defaults would amplify the risks.”

This year investors have survived bouts of turmoil that have disrupted otherwise sedate markets. In January, uncertainty over Chinese growth triggered a sharp decline in both equity and bond prices in the US. Then in June, the UK’s vote to leave the EU triggered another sharp slide in asset prices.

But markets recovered quickly from both incidents and the OFR is now warning that investor confidence that either markets will rebound or central banks will intervene may be “overdone”.

“While markets have been resilient to recent market shocks, investors’ willingness to take credit, duration and liquidity risks could expose them to large losses in the face of a bigger shock,” the report added.

The OFR suggests that bond managers should be subject to stress tests similar to those now enforced upon banks. The report notes that the Securities and Exchange Commission is looking into how to implement stress testing requirements for large investment advisers and funds.

The OFR also highlighted the uncertainty created by the UK’s Brexit vote — and recent instability among European banks — as a threat to the US. A material depreciation in the single currency would damp demand for US exports, slowing growth and hurting US companies, it said.

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