By Michael S. Derby and Dan Burns
(Reuters) – The Federal Reserve's report released on Friday highlighted a number of what it said were “notable” vulnerabilities in financial markets, adding that the stress that rocked the banking sector a year ago had eased significantly.
The Fed also used the recent release of its periodic monetary policy report to say that officials will not begin lowering their short-term interest rate target until they have greater confidence that inflation will indeed return to 2 percent. Target goes back.
In the report, the central bank pointed out several ways in which the level of debt or leverage increases risks in the financial sector. It also said stock prices are “close to historic highs.” The Fed said hedge fund leverage has stabilized at high levels, while life insurers face a situation where they are increasingly reliant on non-traditional sources of funding.
While banks' funding sources remain liquid and stable, funding costs have increased, the central bank said. But despite these growing challenges, the Fed report says, “The banking system remains sound and resilient” and “acute stress in the banking system has declined since last spring.”
A year ago, the Fed was struggling with banking problems on a scale that forced it to introduce a new liquidity facility amid rising demand for central bank credit. Much of that borrowing is no longer a major concern for markets and the central bank, and the Fed will complete the Bank Term Funding Program this month to address the problems.
The Fed report said credit remains available to most borrowers, although borrowing comes at a high cost: “Interest rates on both credit cards and auto loans remain higher than levels seen in 2018 peak of the previous monetary policy tightening cycle were observed.”
On the economy, the Fed reiterated that it is committed to bringing inflation pressures back to their target, saying that the Federal Open Market Committee, which sets interest rates, “does not believe it will be appropriate to do so.” To reduce the target range until he has gained greater confidence in inflation. “We are moving sustainably towards 2%.”
The story goes on
Fed forecasts from late last year, backed up by comments from officials, all point to rate cuts this year amid easing inflation pressures. But economic strength and an uneven path back to 2% have pushed back market expectations for when easing will begin, likely in the summer.
PRELUDE TO POWELL
The Fed's semi-annual report to Congress precedes Fed Chairman Jerome Powell's two-day hearing scheduled for Wednesday and Thursday next week. Powell will likely face a barrage of questions from lawmakers about the Fed's tight monetary policy stance and expectations of easing, a sensitive issue in a presidential election year.
The report generally summarizes economic developments and actions taken by the Fed in the period since the last update to lawmakers. The Fed's concerns about the vulnerability of financial markets were already mentioned in the release of the meeting minutes for the January FOMC meeting, which was released last week.
At the Fed's last monetary policy meeting in January, central bank staff briefed policymakers on their assessment of the stability of the U.S. financial system. The minutes said employees “described the financial vulnerabilities of the system as notable.”
A number of Democrats in Congress have already pressured Powell over high interest rates, complaining that they are worsening already poor housing affordability for low- and middle-income households. Republicans, meanwhile, were critical of the Fed's initial slow response to inflation and may rebuke Powell because there were signs he might cut rates before the November election.
Reductions in the election year interest rate
The Fed's next interest rate meeting is scheduled for March 19-20, and policymakers are widely expected to keep its key interest rate unchanged at 5.25% to 5.5%, where it has been since July.
The upcoming meeting will also bring updated forecasts on inflation, employment, growth and interest rates. In December, the Fed planned three interest rate cuts, and in comments to reporters on Wednesday, New York Fed chief John Williams said the outlook was a “reasonable” place for Fed officials to think about the monetary policy outlook.
However, the timing of the measures remains questionable. After a positive development in inflation data in the second half of 2023 led to the financial markets initially preparing for interest rate cuts at the March meeting, the first inflation data for 2024 have at least temporarily slowed down some of this dynamic in order to increase the pace to curb price increases.
Market prices now reflect the prevailing view that the first cut will occur in June, although a first cut at the April 30-May 1 meeting is not ruled out.
(Reporting by Michael S. Derby, Ann Saphir, Lindsay Dunsmuir and Pete Schroeder; Editing by Nick Zieminski)
Comments are closed.