As inflation continues to hit 40-year highs in the United States, financial markets are worried about both rising prices and the Federal Reserve’s monetary response.
In the Fed’s latest Financial Stability Report, released on Friday afternoon, persistent inflation and monetary tightening were identified as top concerns by 62% of brokers, investment funds, research organizations and consulting firms and academics interviewed by the Federal Reserve Bank of New York.
Some respondents cited the cumulative effect of interest rates being raised simultaneously by central banks around the world and potential liquidity restrictions resulting from the shrinking of the Fed’s balance sheet as specific concerns. Others feared the Fed would scale back its tightening efforts too soon.
Russia’s invasion of Ukraine also remains a major concern for financial stability, the New York Fed found, with an equal number of market participants listing it among their top concerns for the proper functioning of financial markets.
In addition, tensions over market liquidity and volatility, which were not mentioned at all during the preliminary reportwere mentioned in more than half of the responses in this month’s report, with respondents highlighting the Fed’s decision balance sheet reduction as a possible pressure on liquidity.
Fed Vice Chairman Lael Brainard, who has previously raised concerns about the potential ripple effect monetary tightening, said the volatility seen in financial markets over the past six months has highlighted the need to monitor vulnerabilities.
“The current environment of rapid and synchronous tightening of global monetary policy, high inflation and high uncertainty associated with the pandemic and war increases the risk that a shock could lead to the amplification of vulnerabilities, for example due to tight liquidity in core financial markets or hidden leverage,” Brainard said in a statement. “It is important to remain alert to the risks raised in the report and to work with national and international regulators to support the resilience of the financial system.”
This month’s report comes on the Fed’s tail fourth interest rate hike of 75 basis points of the year, which was implemented after the meeting of the Federal Open Market Committee this week.
It also comes amid growing concerns from economists and lawmakers that the Fed has raised its benchmark interest rate. too high too fast, hitting the US housing market and destabilizing other global economies heavily dependent on the dollar. Ahead of this week’s FOMC meeting, more than a dozen members of Congress urged the Fed to slow down its pace of tightening or a full pause to allow the impact of the increases already implemented to be fully absorbed by the economy.
Some have been waving a warning flag about the Fed moving too quickly since its first 75 basis point hike in June.
This week, Fed Chairman Jerome Powell dismissed those concerns, noting that he would rather risk too much tightening than too little. If the Fed went too far, he explained, it could always ease monetary policy again to offset the negative effects.
“It’s premature to discuss a pause and it’s not something we’re thinking about,” Powell said Wednesday during his post-FOMC press conference. It’s really not a conversation to be had. We have a long way to go,”
Although this month’s Financial Stability Report highlighted potential vulnerabilities and several exogenous factors to watch, its overall assessment of financial stability over the past six months has been quite positive.
“During the period, household and corporate indebtedness remained generally stable and, overall, households and businesses maintained their ability to service debt, despite rising interest rates. interest,” Brainard said.
Areas of vulnerability include asset prices, where residential and commercial property values remain high. Additionally, the use of leverage by hedge funds and other non-banks is on the rise.
Short-term funding has been identified as another area to watch, as key markets – such as bond and bank mutual funds – remain prone to unexpected drawdowns.
Worries over the war in Ukraine appear to have subsided since the Fed’s last stability report, released in may, when 77% of respondents cited it as a concern for the next 12 to 18 months, a drop of 15 percentage points. Inflation and monetary policy concerns were also cited less in this month’s report, down 6 percentage points from the spring report.
Meanwhile, concerns about a Chinese invasion of Taiwan within the next year have risen dramatically, from 14% of respondents citing the invasion in May to 42% in November.