Board of Governors of the Federal Reserve System

1. Asset Valuations

Asset valuations were notable despite price declines in some markets in early April

In April, announcements about changes to U.S. trade policy sparked a wave of price declines and volatility across multiple markets as market participants reported heightened uncertainty about the breadth and duration of possible changes to global trade patterns, perceptions of an increased risk of a slowdown in economic activity, and concerns about higher inflation. Nonetheless, prices remained high relative to fundamentals across a range of markets.

Treasury market liquidity continued to be low by historical standards heading into April. In early April, yields on Treasury securities exhibited considerable volatility, which contributed to a deterioration in market liquidity. Nonetheless, amid this increase in volatility, trading remained orderly, and markets continued to function without serious disruption. Treasury yields have remained above their average levels since 2008.

Equity markets have been turbulent since the previous report. After significant gains in late 2024 and early 2025, equity market price indexes experienced notable swings beginning in early March, with the largest moves occurring after April 2. On net through April 11, equity prices fell more than 6 percent from the previous FSR. Despite this decline, equity prices remained high relative to forecasted earnings, which adjust more slowly than market prices. Corporate bond spreads have widened significantly but have stayed at or below their historical medians, while corporate bond issuance slowed considerably, consistent with periods of elevated volatility.

CRE markets showed some signs of stabilizing prices and fundamentals, although the potential for distressed commercial property sales remains if CRE borrowers who need to refinance their mortgages are unable to do so. In residential real estate markets, prices relative to fundamentals continued to be well above their historical averages.

Table 1.1 shows the sizes of the asset markets discussed in this section. The two largest asset markets are those for equities and residential real estate, which are substantially larger than the next two markets, Treasury securities and CRE. The table also shows recent and historical growth rates for each asset class, because assets experiencing strong growth can be a sign of high risk appetite in that sector.

Table 1.1. Size of selected asset markets

Treasury yields remained high amid heightened volatility

Treasury yields across maturities continued to be well above their average levels over the past 15 years (figure 1.1). Since the November report, the Treasury yield curve has steepened as yields on shorter-maturity securities fell. A model-based estimate of the nominal Treasury term premium—a measure of the compensation that investors require to hold longer-term Treasury securities rather than shorter-term ones—fell a bit and remained near the top of its rangesince 2010, though also near its longer-term historical median (figure 1.2). Moves in Treasury yields were sizable in early April. Unlike previous flight-to-safety episodes, Treasury prices fell alongside steep declines in equity prices amid heightened uncertainty. Interest rate volatility implied by interest rate swaps was elevated by historical standards and increased further in early April (figure 1.3).

Equity markets declined, on net, amid a large increase in volatility

Measures of equity valuations were stretched by historical standards through March. The P/E ratio, defined as the ratio of equity prices to expected 12-month earnings, remained well above its historical median (figure 1.4). The difference between the forward P/E ratio and the real 10-year Treasury yield—a measure of the additional return that investors require for holding stocks relative to risk-free bonds (the equity premium)—remained well below its historical median (figure 1.5).² Equity prices had experienced notable swings in March before declining substantially in early April, with various indexes concluding the week of April 7 somewhat below their values as of the November report. Option-implied equity market volatility rose dramatically and reached levels not seen since March 2020 (figure 1.6, black line). These developments suggest that investors demanded increased compensation for holding stocks. Despite the recent decline, prices remained high relative to analysts' earnings forecast, which update more slowly than market prices.

Spreads in corporate debt markets widened notably but remained at moderate levels

Yields on BBB-rated and high-yield corporate bonds were higher than the levels reported in the November report (figure 1.7). Spreads relative to comparable-maturity Treasury securities widened notably, from very compressed to moderate levels relative to their historical distributions (figure 1.8). The excess bond premium for all nonfinancial corporate bonds—a measure of the risk premium required by bond investors after controlling for bond characteristics and credit quality—continued to be near its long-run average (figure 1.9). Nonprice indicators pointed toward moderating risk appetite, particularly in April. Issuance in the corporate bond market slowed significantly, consistent with previous episodes of elevated market volatility. In the second half of 2024, the share of deep junk corporate bond issuance—the fraction of total non-investment-grade issuance accounted for by bonds rated B- or lower—declined from already low levels. Market-based forecasts of one-year-ahead default probabilities of nonfinancial firms (a forward-looking indicator of credit quality) rose somewhat to elevated levels by historical standards.

Since the last report, the average spread on leveraged loans in the secondary market increased to around the 40th percentile of its historical distribution since 2009 (figure 1.10). Leveraged loan issuance also slowed substantially. Though other measures generally reflect moderate vulnerabilities, the year-ahead expected default rate for leveraged loan borrowers rose sharply to the 90th percentile of its historical distribution since 2009, consistent with increased market volatility.

Market liquidity has been low by historical standards and was further strained in April, although markets continued to function

Market liquidity refers to the ease of buying and selling an asset. Low liquidity can amplify the volatility of asset prices and result in larger price moves in response to shocks. Similarly, increased volatility can dampen liquidity because liquidity providers may become more cautious in providing quotes. In extreme cases, low liquidity can threaten continued market functioning, leading to a situation in which participants are unable to trade without incurring a significant cost.

Treasury market liquidity is particularly important because of the key role these securities play in the financial system. Before April, various measures of Treasury market liquidity, including two different measures of market depth in the most liquid on-the-run segment, indicated that liquidity remained low by historical standards (figures 1.11 and 1.12). In April, measures of market liquidity declined further amid a notable rise in trading volumes and volatility, but Treasury markets continued to function without signs of the severe strains that have emerged in some past stress episodes.

Liquidity in equity markets stayed well below average, and worsened somewhat amid a large increase in volatility (figure 1.13). Through March, liquidity in corporate bond markets was in line with the average level observed in recent years but deteriorated with the higher volatility in early April.

Commercial real estate prices showed some signs of stabilizing

Aggregate CRE prices measured in inflation-adjusted terms were stable since the November report after falling significantly in 2022 and 2023 (figure 1.14). These transaction-based prices may not fully reflect conditions in the CRE market, as many owners wait for more favorable conditions to put properties on the market rather than realizing losses. However, transaction volumes also picked up notably in the fourth quarter of 2024, including in the office sector, which had experienced the largest price declines in 2022 and 2023. Moreover, vacancy rates and rent growth, fundamental determinants of prices, have also shown signs of stabilizing. Capitalization rates at the time of property purchase, which measure the annual income of commercial properties relative to their prices, rose—suggesting prices may be better supported by operating incomes—but remained near the low end of the historical distribution (figure 1.15). In theJanuary 2025 Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), banks reported some further tightening of lending standards for all CRE loan categories in the fourth quarter of 2024 (figure 1.16).³

Refinancing risk remained a potential vulnerability for CRE prices. Industry estimates suggest that about 20 percent of all outstanding CRE loans, just shy of $1 trillion, will mature in 2025.⁴ In addition, many borrowers have not yet secured refinancing to pay off their maturing debts amid tight lending standards, reduced property valuations, and interest rates above the levels that prevailed when much of the debt was originated. Forced sales in a thin market could cause significant price declines, including for properties that are not distressed. Servicers of loans that have been securitized in commercial mortgage-backed securities (CMBS) granted a large number of office loan modifications in January, and the rate at which office loans in CMBS became delinquent at maturity dropped markedly, though it remained elevated by historical standards.

Residential real estate prices remained high relative to fundamentals

Valuations in the residential real estate sector remained elevated. House prices continued to increase through February of this year (figure 1.17). A model of house price valuation based on prices relative to market rents and the real 10-year Treasury yield suggested that valuations in housing markets were at levels seen in the early to mid-2000s. An alternative measure of valuation pressures (which uses owners' equivalent rent instead of market rents and has a longer history) remained similarly elevated (figure 1.18). The median price-to-rent ratio measured across a wide distribution of geographic areas was little changed since the November report, hovering near its previous peak in the mid-2000s (figure 1.19). However, outstanding mortgage balances relative to both market- and model-implied house values remained far below levels seen in the mid-2000s (see Section 2), suggesting that house price declines are less likely to leave borrowers in the types of low- or negative equity positions that are associated with a higher likelihood of default. Moreover, credit conditions for borrowers remained tighter relative to the early 2000s, suggesting that weak credit standards are not driving house price growth.

Farmland valuations remained high relative to farm income

U.S. farmland prices continued to rise in 2024 from historically high levels (figure 1.20), as did price-to-rent ratios (figure 1.21). Prices continued to be sustained in the short run by limited farmland inventory, despite elevated interest rates and higher operating costs. These valuations have been, in part, supported by expected growth in farm income.

 

References

 

 2. This estimate is constructed based on expected corporate earnings for 12 months ahead. Return to text

 3. The SLOOS results reported are based on banks' responses weighted by each bank's outstanding loans in the respective loan category and might therefore differ from the results reported in the published SLOOS, which are based on banks' unweighted responses. Return to text

 4. The Mortgage Bankers Association estimates $957 billion will mature in 2025, and S&P Global estimates $998 billion. Return to text