The Federal Reserve warned that stresses in China’s property market have the potential spill over and impact the U.S. in its latest Financial Stability Report.

Continued credit pressure for China’s property sector has led the Fed to speak out about the potential contagion risks, two months after chair Jerome Powell downplayed the situation, noting a lack of direct U.S. exposure.

«In China, business and local government debt remain large; the financial sector’s leverage is high, especially at small and medium-sized banks; and real estate valuations are stretched,» according to the Federal Reserve in the semiannual report.

«In this environment, the ongoing regulatory focus on leveraged institutions has the potential to stress some highly indebted corporations, especially in the real estate sector, as exemplified by the recent concerns around China Evergrande Group.»

Spillover Risk

According to the Fed, spillover risk to the U.S. could occur via Chinese financial firms or other areas.

«Stresses could, in turn, propagate to the Chinese financial system through spillovers to financial firms, a sudden correction of real estate prices, or a reduction in investor risk appetite,» it explained. 

«Given the size of China’s economy and financial system as well as its extensive trade linkages with the rest of the world, financial stresses in China could strain global financial markets through a deterioration of risk sentiment, pose risks to global economic growth, and affect the United States.» 

Two Months Ago

The new comments in the report contrast with statements made by Fed chair Powell two months ago when he downplayed the risk of contagion. 

«In terms of the implications for us, there's not a lot of direct United States exposure,» Powell said after the Fed’s policy meeting in late September.

«The big Chinese banks are not tremendously exposed, but you would worry it would affect global financial conditions through global confidence channels and that kind of thing. But I wouldn't draw a parallel to the United States corporate sector.»