WASHINGTON — Federal Reserve researchers and officials last week asked experts on Wall Street and around the world about pressing questions.
According to four people from another agency who participated in such conversations and spoke on condition of anonymity about the closed-door meetings, the answer they gave was that it’s probably possible. Other market participants conveyed the same message when conducting their own research into the possibilities. Central banks have raised interest rates dramatically, raising the risk of a financial crisis.
The Bank of England had to swoop in to buy government bonds and calm the market after the UK government announced a fiscal spending plan to stimulate an economy already struggling to keep inflation under control. Markets plunged, and pension funds using common investment strategies scrambled to adjust, prompting central bank intervention.
The shock was unique to the UK, but economists around the world are wondering if the situation is a canary in the coal mine as signs of financial stress surface around the world.
Officials at the Federal Reserve, Treasury Department and White House are among those trying to understand whether the United States could experience its own market-shaking meltdown.
Administration officials are confident that the U.S. financial system is unlikely to suffer such a shock and will be strong enough to withstand it should it occur. I keep a close eye on what is happening in those moments when I feel unusually vulnerable.
Markets have been volatile in the US and globally for months as central banks, including the Federal Reserve (Fed), rapidly raised interest rates to control inflation. This has caused unusually large fluctuations in the prices of currencies and other assets because their values depend in part on interest rate levels and international interest rate differentials. Stocks are rocking. The market hasn’t collapsed, but it may be difficult to find buyers for US Treasuries anytime soon. There are also concerns that volatility could set off dangerous chain reactions in areas of finance with more complex investment structures.
“There’s a lot of anxiety in the market and everybody says something is about to go bust,” said Roberto Perli, an economist at Piper Sandler who worked at the Fed. He added that it made sense for authorities to check the situation last week.
President Biden has repeatedly convened top business advisers in recent weeks to discuss the resurgence of markets that have rocked the UK.
Federal Reserve officials and staff have met with investors and economists during regular outreach and on the sidelines of the World Bank and International Monetary Fund annual meetings in Washington last week.
Inflation FAQ
What is inflation? Inflation is the loss of purchasing power over time. So your dollar won’t go as well tomorrow as it did today. It is usually expressed as annual changes in the prices of commodities and services such as food, furniture, apparel, transportation and toys.
Fed researchers asked three big possibilities during the conference. They wanted to know if there could be a class of transactions or investments in the US that could pose a significant and underappreciated threat similar to pension funds in the UK.
They also looked at whether problems abroad could spill over into the U.S. financial system. For example, Japan is one of the largest buyers of US Treasuries. However, unlike other central banks, Japan’s currency is depreciating rapidly because it keeps interest rates low. If this turmoil causes Japan to reverse course and stop buying or selling U.S. Treasuries (which Japan has shown little appetite for, but which some on Wall Street see as a risk), the U.S. bond market could can affect
The final threat they asked was whether the lack of easy trading in today’s Treasury market could turn into a more serious problem that would require the Fed to swoop in to restore normal functioning. What was the focus?
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Analysts told officials that none of these regions appeared to be in danger of collapsing anytime soon. The US pension system is different from the UK and the bond market may be volatile, but it still works. However, they also expressed reasons for concern. It’s impossible to know what will break until something breaks. The market is large, complex and intertwined, making it difficult to obtain comprehensive data. Given how much central bank policy has changed around the world in recent months, something could go wrong.
Officials have good reason to worry about that possibility. A meltdown in the current market would be particularly problematic.
A financial crisis could force the Fed to deviate from its plan to control the fastest inflation in 40 years. This includes allowing interest rates to rise rapidly and bond portfolios to shrink. In the past, officials have bought large amounts of government bonds to restore stability in turbulent markets.
Central banks will likely try to distinguish between bond purchases to keep markets functioning and monetary policy, but it may be difficult to tell.
The White House has reason to worry, too. Mr. Biden was scarred by his experience as Vice President during the Great Recession, which resulted in the worst economic recession since the 1930s. Meanwhile, millions of people have lost their jobs, spending years of painstaking and slow recovery on the Obama administration’s policy agenda.
Mr. Biden pressured his team to estimate the likelihood of the U.S. experiencing another 2008-style shock on Wall Street. Treasury Secretary Janet L. Yellen and her representatives are closely monitoring developments in the US government debt market, looking for signs of UK-style stress.
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Administration officials say trading in the bond market has become more difficult, but that it is otherwise working well. Multiple officials this week said they expected the Fed to intervene in an emergency, just as the Bank of England has done.
Other senior government officials walked away from a meeting in Washington last week in so-called emerging markets, including parts of Africa, Asia and South America, where food and energy prices are soaring and the Federal Reserve is making steady progress. Fears of a possible financial crisis have increased. Rising interest rates have forced governments to raise their own borrowing costs.such a crisis can spread all over the world Wealthy countries like the United States rebound.
Yet administration officials say the U.S. economy, still supported by rapid job growth and relatively low levels of household debt, remains strong enough to withstand such shocks.
“This is a challenging moment in the global economy where stability is hard to find,” said Michael Pyle, Biden’s deputy national security adviser for international economic affairs. The United States is well positioned to meet these global challenges. ”
And there is no guarantee that something will explode. A senior Treasury official said this week that financial risks were rising due to high inflation and rising interest rates, but a range of data tracked by the Treasury continues to show strength in U.S. businesses, households and financial institutions. said there is.
Barclays managing director Joseph Abeit said for now the market for short-term borrowing, which is crucial to the functioning of finance as a whole, looks healthy and fairly normal. Authorities are also working on safety measures to contain the fallout in the event of a disaster. The Financial Stability Oversight Council, chaired by Yellen, discussed the issue at its meeting. recent meeting Earlier this month, I listened to a staff presentation on U.S. financial vulnerabilities.
The Treasury Borrowing Advisory Committee, an advisory group of market participants, asked in the latest survey Regarding Treasury Department programs that may buy back government debt. Some investors are concerned about the potential for trouble and believe it signals a desire to improve the functioning of the market, especially in light of comments and outreach.
“I am concerned about the lack of sufficient liquidity in the market,” Yellen said last week in response to a question after a speech in Washington.
The Fed already has great tools to help stabilize markets.they include Swap lines into which dollars can be poured To banks that need it abroad and are being used by Switzerland and the European Central Bank in recent weeks.
Barclays’ Abate said the Securities and Exchange Commission, Treasury Department and Fed appeared to be “knowing” the situation.
“It is clear in the market that liquidity is a concern,” Abate said. “Regulators are working to address it.”