Inflation and Ukraine overtake Covid as biggest threats to financial system, says Fed

The Fed said economic uncertainty had increased since the bank’s previous report, with the war in Ukraine being a big part of the deterioration. The bank also pointed to sharp swings in asset prices – from Treasuries to stocks – as investors reassess risk in an environment of high inflation.

“Inflation has been higher and more persistent than expected, even before the invasion of Ukraine, and uncertainty about the inflation outlook poses risks to financial conditions and economic activity,” he said. the Fed in its report.

The Fed said persistently high inflation could force central bankers to raise interest rates quickly, which could also pose a potential risk of financial instability in the form of lower economic output as well as higher borrowing costs for individuals and businesses. This could cause debt levels, which the Fed says are high but not yet a major concern, to become unsustainable for some companies.

“Further adverse inflation and interest rate surprises, particularly if accompanied by a decline in economic activity, could negatively affect the financial system,” the bank said.

For individuals, inflation could lead to job losses as the Fed raises interest rates, which could also impact the housing market via higher mortgage rates, the bank said.

Because the report reflects Fed thinking, its findings could form part of the backdrop when the central bank conducts its annual stress tests of the nation’s largest banks in the coming weeks. The Fed used previous reports to highlight the pandemic as well as last year’s interest in “meme” stocks such as GameStop and AMC Entertainment.

In a statement, Fed Governor Lael Brainard also cited recent volatility in commodity markets as a place of potential risk. While swings in the energy market have been in the headlines for several weeks now, other commodity markets – particularly those for industrial metals like nickel, zinc and lithium – have seen sharp swings.

“The Federal Reserve is working with domestic and international regulators to better understand the exposures of commodity market participants and their connections to the core financial system,” she said.

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Don F. Davis