The Fed warns that a sharp rise in interest rates poses a risk to the US economy.

A sharp rise in interest rates to control further inflationary shocks would pose a risk to the US economy, the Federal Reserve said on Monday as it reported a “higher than normal” chance that business conditions in US financial markets would suddenly deteriorate.

“Further adverse surprises in inflation and interest rates, particularly if accompanied by a decline in economic activity, could negatively affect the financial system,” the authorities wrote in the Fed’s financial stability report, published today. twice a year in May and November.

Consumer finances could be hit by job losses, higher interest rates and lower home prices, the Fed warned, with businesses also facing “increased delinquencies, bankruptcies and other forms of financial hardship.”

“A sharp increase in interest rates could lead to increased volatility, market liquidity strains and a large correction in the prices of risky assets, which could cause losses in a variety of financial intermediaries,” the Fed reported. .

That would reduce “their ability to raise capital and retain the confidence of their counterparties,” the central bank added.

The US also issued a warning about liquidity, the ability to buy or sell an asset without influencing the price, after several frantic months in US markets. A sell-off has wiped trillions of dollars from the value of stocks and bonds while closing the door on new stock listings and raising borrowing costs for consumers and corporations.

The Fed said the ability to buy or sell assets at prices quoted by brokers had “impaired” and was worse than expected given levels of volatility. He added that the decline in liquidity could be exacerbated by brokers and high-frequency trading firms that “are particularly cautious” given market conditions.

“Decreasing depth at times of increasing uncertainty and volatility could give rise to a negative feedback loop, as lower liquidity in turn can make prices more volatile,” policymakers wrote in the report.

Conditions in the stock, commodity and Treasury markets have been notoriously bad this year, with traders reporting having trouble making even relatively small trades without influencing prices.

Fluctuations in the price of everything from Treasuries to corporate bonds to stocks have also been fueled in part by the Fed’s decision to tighten monetary policy, as well as Russia’s invasion of Ukraine and the economic slowdown in China.

The central bank last week delivered its first half-point rate hike since 2000 and is set to implement additional hikes of the same magnitude at its next two policy meetings. In June, it will also start whittling down its $9 trillion balance sheet, which soared after it soaked up bonds during the coronavirus pandemic, as it steps up efforts to rein in the highest inflation in about 40 years.

The prospect of higher interest rates has pushed the benchmark 10-year Treasury yield to its highest level since 2018. That surge has forced investors around the world to reassess the value of many of the stocks that rose record levels in the past. year, with the S&P 500 stock index down more than 16 percent this year and the tech-heavy Nasdaq Composite down more than 25 percent.

The Fed also pointed to potential risks associated with a “protracted” war between Russia and Ukraine, which has already put pressure on commodity markets.

“Russia’s unprovoked war in Ukraine has triggered large price movements and margin calls in commodity markets and has highlighted a potential channel through which large financial institutions could be exposed to contagion,” said Lael Brainard, vice president, in a statement along with the report on Monday. .

“The Federal Reserve is working with domestic and international regulators to better understand commodity market participants’ exposures and their links to the core financial system.”

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