Fed Staff Suggest More Worry Over Financial Risk Than Powell

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Federal Reserve staff members gave a potentially more worrisome assessment of the risks to financial stability in the central bank’s policy meeting last month than the one presented publicly by Chair Jerome Powell.

Speaking to reporters on Jan. 27 after the Fed’s last policy making meeting, Powell called financial stability vulnerabilities overall “moderate.” Central bank staff gave a less sanguine assessment in their presentation at the January meeting, telling policy makers that vulnerabilities on balance were “notable,” according to the minutes of the gathering released on Wednesday.

Powell agrees with the staff’s overall assessment but was just speaking more generally to reporters than the granular approach taken by Fed economists in their presentation to the Federal Open Market Committee, according to a Fed official familiar with the matter.

Fed Staff Suggest More Worry Over Financial Risk Than Powell

The Fed’s appraisal of financial stability risks is important because it can play a role in determining the central bank’s stance on monetary policy and its approach to financial regulation. If policy makers consider the weaknesses of the financial system to be elevated, they can tighten rules governing banks or even raise borrowing costs to try to rein in any excesses they see.

Fed officials showed no sign at last month’s meeting of wanting to pull back anytime soon on their support for the pandemic-stricken economy and financial markets. They expected it would be “some time” before conditions were met to scale back their massive bond buying, according to the meeting’s minutes.

The Fed is currently buying $120 billion of assets per month -- $80 billion of Treasuries and $40 billion of mortgage-backed securities -- and has pledged to maintain that pace until it makes “substantial further progress” toward its goals of maximum employment and 2% inflation.

The question about when to begin to taper those purchases could come to the fore later this year as the economy gathers steam with a more widespread distribution of vaccines to fight Covid-19 and even more spending by the federal government, Fed watchers said. That could particularly be the case if stock and asset markets continue their seemingly inexorable advance and already loose financial conditions ease further.

In their detailed presentation to the FOMC last month, Fed staff “assessed asset valuation pressures as elevated” -- their highest characterization of risk. Supported by the central bank’s easy money stance, the S&P 500 stock market index has surged 75% from the lows it struck in March when the pandemic began. Corporate bond spreads have also declined, with yields on the riskiest debt dropping below 4% for the first time ever earlier this month.

As for household and business balance sheets, the Fed economists judged vulnerabilities on that front to be notable, “reflecting increased leverage and decreased incomes and revenues in 2020.” Big banks were seen to be in good shape.

In a Feb. 17 note to clients, Goldman Sachs Group Inc. chief economist Jan Hatzius and his colleagues said the minutes suggested that there was increased discussion by policy makers of financial stability after the presentation of the staff report, with a wide variety of views expressed.

Powell in the past has flagged the dangers that excessively elevated asset prices and other financial vulnerabilities can pose to the economy. In 2007, it was the bursting of a housing market bubble that took the economy down. In 2001, it was a collapse in technology stock prices that helped lead to a recession.

The Fed chairman defended the central bank’s easy monetary policy in his Jan. 27 press conference, saying it was justified as payrolls are some 9 million workers short of what they were before the pandemic.

He also argued that the increase in stock prices in recent months had been driven more by fiscal policy and the development and dissemination of vaccines, than by the Fed’s monetary stance.

“I would say that financial stability vulnerabilities overall are moderate,” he said.

©2021 Bloomberg L.P.

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