Written by: Wu Yu, Jin Shi Data
Concerns about the stability of financial markets, including the risk of a sharp decline in asset prices, are becoming a new theme in discussions among Federal Reserve officials regarding the timing of interest rate cuts or even whether to cut rates at all.
In a speech at Georgetown University on Thursday, Federal Reserve Governor Lisa Cook did not specifically comment on recent interest rate policies.
However, she listed a series of risks to the financial system, including the rapidly growing private credit market, hedge fund trading in the Treasury market, and the application of generative artificial intelligence in algorithmic trading.
Cook also hinted that she would not be surprised by a collapse in asset prices that are at historically high levels—these overvalued assets support overall consumer spending and the broader U.S. economy—although such a decline in itself does not imply instability in financial markets. "At the moment, I feel that the likelihood of a significant drop in asset prices has increased."
Earlier, in another setting, Cleveland Fed President Beth Hammack reiterated her opposition to further rate cuts, citing that inflation remains too high, and stated that she believes loose financial conditions are another reason against cutting rates.
While rate cuts may be seen as "insurance" for the job market, she said, "We should remember that this insurance may come at the cost of exacerbating financial stability risks."
Like Cook, she stated that she believes the financial system is in good shape, banks are well-capitalized, and household balance sheets are robust. But like Cook, Hammack also indicated that she is monitoring the high leverage levels of hedge funds and believes private credit deserves attention.
The remarks from both officials echo broader concerns among Federal Reserve policymakers, as highlighted in the minutes from the Fed's October meeting released on Wednesday.
"Some participants commented on the issue of overvaluation of financial market assets, with several emphasizing the possibility of a disorderly decline in stock prices, particularly when the market suddenly reassesses the potential of AI-related technologies," the minutes stated.
The debate among policymakers primarily centers on whether another rate cut would further push inflation, which has been above the Fed's 2% target for years, in the wrong direction, or whether the more pressing concern is the need for further easing due to a weak labor market.
On Thursday, two Federal Reserve officials viewed as hawkish again expressed unease about inflation.
Federal Reserve Governor Michael Barr stated on Thursday that the Fed needs to be cautious when considering further rate cuts.
"I am concerned that the inflation rate we are seeing is still around 3%, while our target is 2%, and we are committed to achieving that 2% target," Barr said. "Therefore, we need to be cautious about monetary policy right now, as we want to ensure we achieve both aspects of our dual mandate."
Barr did not announce opposition to another rate cut, but his unease about stagnant inflation will complicate the work of Fed Chair Jerome Powell, who is trying to reach a consensus among policymakers with differing opinions ahead of the Washington meeting on December 9-10.
Barr supported the Fed's rate cuts in September and October but has not signaled anything for December so far. His vote could be crucial, as several of his colleagues have publicly stated their support or opposition to a third consecutive rate cut, leading to a highly uncertain outcome.
In another setting in Indianapolis, Chicago Fed President Austan Goolsbee expressed his continued concern about another rate cut in December.
"The progress on inflation 'seems to have stalled, and if anything, there are warnings of it moving in the wrong direction,'" Goolsbee said. "That makes me a bit uneasy."
After a prolonged government shutdown, the Fed finally received new official employment data, but so far, this data has not significantly resolved the differences among policymakers. The September employment report released by the Bureau of Labor Statistics on Thursday presented a mixed picture: employers added 119,000 jobs—the best figure since April—but the August data was revised downward, and the unemployment rate slightly rose to 4.4%.
After the data release, Barr stated that he believes the labor market is "softening to some extent," with job creation in the economy approaching what is known as the "breakeven" level, which is the level that keeps the unemployment rate stable.
Hammack described the September employment data as "stale" and reiterated her opposition to additional rate cuts. "Cutting rates to support the job market could potentially prolong the period of high inflation and may encourage risk-taking in financial markets. This means that when the next recession comes, it could be larger than it would otherwise be, with a greater impact on the economy," she said.
After the data release, traders maintained their previous expectations: unless there is decisive evidence of a collapse in the job market, the Fed is likely to skip a rate cut in December and then cut rates by 25 basis points in January. The Bureau of Labor Statistics will not release another comprehensive employment situation report until a week after the Fed's December meeting.
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