Fed chair says economy is in 'good health' despite risks

America's economy is still growing robustly, but a string of possible outside shocks including President Don...

Posted: Nov 28, 2018 5:56 PM
Updated: Nov 28, 2018 5:56 PM

America's economy is still growing robustly, but a string of possible outside shocks including President Donald Trump's protracted trade rift with China could trigger a downturn, according to a report released by the Federal Reserve on Wednesday.

The US central bank warned, in its first report on vulnerabilities in the financial system, that escalating trade tensions with Beijing and other sources of geopolitical uncertainty could spark a decline in investor appetite for risk — a problem given the recent run-up in stocks and other assets.

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"The resulting drop in asset prices might be particularly large, given the valuations appear elevated relative to historical levels," the Fed cautioned in its report, which outlined a number of risks facing the American economy a decade after the financial crash.

A "significant fall" in asset prices would make it more costly for nonfinancial businesses, which are already highly leveraged, to obtain funding, the Fed cautioned.

The report found that funding risks are relatively "low" compared to the period leading up to the financial crisis. But the Fed pointed to a few potential problems that could leave markets and institutions vulnerable. Among them: "historically high" business debt, deteriorating credit standards and bigger appetite for risk-taking by investors.

Markets have been jittery in the lead up to a critical meeting on Saturday between Trump and his Chinese counterpart, Xi Jinping, at the G20 summit in Buenos Aires.

The meeting comes at a pivotal moment in the trade war between the world's two largest economies. Many people, including Trump, say they are hopeful the two leaders will reach a breakthrough and avoid further tariffs. Trump has threatened to launch a third round of tariffs on $267 billion in Chinese goods if he and Xi fail to end their impasse.

Even in the face of such headwinds, policy makers said a resilient banking system shielded with larger stores of capital and cash cushions would be "less likely to amplify the effects of falling asset prices."

"The risks of destabilizing runs are far lower than the past," Fed Chairman Jerome Powell said in a speech Wednesday. "The institutions at the heart of the financial system are more resilient."

The stock market rallied on the speech, going up more than 400 points, or 1.75%. Financial markets have swooned in recent weeks, erasing much of the gains over the past year. Investors have been bracing for higher interest rates in the face of possible inflation stemming in part from Trump's trade wars as well as the tax cuts he pushed through Congress late last year.

The fresh volatility has prompted Trump to blame the Fed for the wobbling stock market. He has repeatedly bashed Powell, a Republican investment banker he appointed and described last year as a "wise steward." He has more recently called the Fed "crazy" and "loco" over recent interest-rate increases.

In an sweeping interview published Tuesday by The Washington Post, the President blasted his chairman and once again expressed his unhappiness with the Fed, while hastening to add he isn't blaming anyone for his decision to tap Powell for the job.

"I'm doing deals, and I'm not being accommodated by the Fed," Trump said in the interview. "They're making a mistake because I have a gut, and my gut tells me more sometimes than anybody else's brain can ever tell me."

In its report, the Fed warned that markets and financial firms will need to continue to adjust to plans for future rate hikes after years of low interest rates following the financial crisis.

The central bank is expected to raise rates once more next month, bringing the total to four this year.

"Even if central bank policies are fully anticipated by the public, some adjustments could occur abruptly, contributing to volatility in domestic and international financial markets and strains in institutions," according to the Fed report.

In his speech, Powell noted that interest rates remain "just below" the so-called neutral range, the level that central bankers believe will neither accelerate nor halt economic growth.

Other external risks flagged by the central bank include the British government's plan to leave the European Union, China's slowdown and a significant increase in either corporate or sovereign debt by emerging market economies in Turkey and Argentina.

"Should significant problems arise in China or in EMEs more broadly, spillovers, including dollar appreciation, declines in world trade and commodity prices, and a pullback from risk-taking by investors outside the affected markets, could be sizable," said the Fed in its report. "In addition, the effect of a stronger dollar and weaker foreign economies on trade could affect the creditworthiness of U.S. firms, particularly exporters and commodity producers."

The last two recessions were triggered when asset bubbles burst, and critics said the Fed should have done more to control the financial system. Current financial system vulnerabilities are at a "moderate level," the Fed has said.

Leading up to the 2008 financial crisis, mortgage lending practices had relaxed considerably while housing prices skyrocketed. Banks took on more risks without maintaining large enough cushions to absorb losses. And many financial institutions had relied on short-term, uninsured liabilities to fund longer-term investments.

Powell noted the word "bubble" wasn't mentioned in the report, though he said some asset prices, such as corporate debt, were high relative to the past. But Wednesday's report stopped short of drawing "a bottom line conclusion" — a point Powell reiterated in his remarks, adding that the semiannual survey should be viewed as a routine checkup.

"Many baby boomers like me are, however, reaching an age where a good report is, 'Well, there are a number of things we should keep an eye on, but all things considered you are in good health,'" said Powell.

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