"Federal Reserve and White House
officials spent last week quizzing investors and economists about the risks of
a British-style meltdown at home.
“WASHINGTON — Federal Reserve
researchers and officials quizzed experts from Wall Street and around the world
last week about a pressing question: Could a market meltdown like the one that
happened in Britain late last month occur here?
The answer they got back, according
to four people at separate institutions who were in such conversations and who
spoke on the condition of anonymity to describe private meetings, was that it
probably could — though a crash does not appear to be imminent. As the Biden
administration did its own research into the potential for a meltdown, other
market participants relayed the same message: The risk of a financial crisis
has grown as central banks have sharply raised interest rates.
The Bank of England had to swoop in
to buy bonds and soothe markets after the British government released a fiscal
spending plan that would have stimulated an economy already struggling with
punishing inflation, one that included little detail on how it would be paid
for. Markets lurched, and pension funds using a common investment strategy
found themselves scrambling to adjust, prompting the central bank’s
intervention.
While the shock was British-specific, the violent reaction
has caused economists around the world to wonder if the situation was a canary
in a coal mine as signs of financial stress surface around the globe.
Officials at the Fed, Treasury and
White House are among those trying to figure out whether the United States
could experience its own market-shuddering meltdown, one that could prove
costly for households while complicating America’s battle against rapid
inflation.
Administration officials remain
confident that the U.S. financial system is unlikely to see such a shock and is
strong enough to withstand one if it comes. But both they and the Fed are
keeping close tabs on what is happening at a moment when conditions feel
abnormally fragile.
Markets have been choppy for months in the United States and
globally as central banks — including the Fed — rapidly raise interest rates to
bring inflation under control. That has caused abnormally large price moves in
currencies and other assets because their values hinge partly on the level of
interest rates and on international rate differences. Stocks have been
swinging. It can be hard to quickly find a buyer for U.S. government bonds,
although the market is not breaking down. And in corners of finance that
involve more complicated investment structures, there’s concern that volatility
could trigger a dangerous chain reaction.
“In the market, there is a lot of
worry, and everyone is saying it feels like something is about to break,” said
Roberto Perli, an economist at Piper Sandler who used to work at the Fed and
who was not part of the conversations last week. He added that it made sense
that officials were checking up on the situation.
Image
President Biden at an event
promoting the Inflation Reduction Act in California last week. Credit...T.J.
Kirkpatrick for The New York Times
President Biden has repeatedly
convened his top economic aides in recent weeks to discuss market flare-ups, like
the one that roiled Britain.
Fed officials and staff members have
met with investors and economists both during normal outreach and on the
sidelines of the World Bank and International Monetary Fund annual meetings
last week in Washington.
Fed researchers asked about three big possibilities during
the meetings. They wanted to know whether there could be a trade or an
investment class in the United States similar to British pension funds that
could pose a significant and underappreciated threat.
They also focused on whether problems overseas could spill
back over to the United States financial system. For instance, Japan is one of
the biggest buyers of U.S. debt. But Japan’s currency is rapidly falling in
value as the country holds its interest rates low, unlike other central banks.
If that turmoil caused Japan to reverse course and stop buying or even sell
U.S. Treasurys — something that it has signaled little appetite for, but that
some on Wall Street see as a risk — it could have ramifications for U.S. debt
markets.
The final threat they asked about focused on whether today’s
lack of easy trading in the Treasury market could turn into a more serious
problem that requires the Fed to swoop in to restore normal functioning.
None of those areas appear to be at
immediate risk of snapping, analysts told officials. The pension system in the
United States is different from that in Britain, and the government debt market
may be choppy, but it is still functioning.
Yet they also voiced reasons for
concern: It is impossible to know what might break until something does.
Markets are large and intertwined, and comprehensive data is hard to come by.
Given how much central bank policy has shifted around the world in recent
months, something could easily go wrong.
There is a good reason for officials
to fret about that possibility: A market meltdown now would be especially
problematic.
Image
A New York City market. The Fed is
rapidly raising interest rates to bring inflation under control, but a
financial crash could force it to shift that plan. Credit...Elias Williams for
The New York Times
A financial disaster could force the Fed to deviate from its
plan to control the fastest inflation in four decades, which includes raising
rates rapidly and allowing its bond portfolio to shrink. Officials have in the
past bought large sums of Treasury bonds in order to restore stability to
flailing markets — essentially the opposite of their policy today.
Central bankers would most likely
try to draw a distinction between bond buying meant to keep the market
functioning and monetary policy, but that could be hard to communicate.
The White House, too, has reasons to
worry. Mr. Biden was scarred by his experience as vice president throughout the
Great Recession, during which a financial meltdown brought on the worst
downturn since the 1930s, throwing millions out of work and consuming the Obama
administration’s policy agenda for years of a painstakingly slow recovery.
Mr. Biden has pressed his team to
estimate the likelihood that the United States could experience another
2008-style shock on Wall Street. Treasury Secretary Janet L. Yellen and her
deputies have been closely monitoring developments in the market for U.S.
government debt and searching for any signs of British-style stress.
While administration officials noted
that trading has become more difficult in the market for Treasury bonds, they
also pointed out that it was otherwise functioning well. Multiple officials
said this week that they expected the Fed would step in to buy bonds — as the
Bank of England did — in an emergency.
Other administration officials came away from their meetings
in Washington last week with increased worries about financial crises sprouting
in so-called emerging markets, like parts of Africa, Asia and South America,
where food and energy prices have soared and where the Fed’s steady march of
interest rate increases has forced governments to raise their own
borrowing costs. Such crises could spread worldwide
and rebound on wealthier countries like the United States.
Yet administration officials say the
American economy remains strong enough to endure any such shocks, buoyed by
still-rapid job growth and relatively low household debt.
“This is a challenging global
economic moment where stability is hard to find,” said Michael Pyle, Mr.
Biden’s deputy national security adviser for international economic affairs,
“but the U.S. has momentum and resilience behind its economic recovery, and a
trajectory that puts the U.S. in a strong position to weather these global
challenges.”
And there is no guarantee that
something will blow up. A senior Treasury official said this week that
financial risks had risen with high inflation and rising interest rates, but
that a variety of data the department tracked continued to show strength in
American businesses, households and financial institutions.
For now, markets for short-term
borrowing, which are crucial to the functioning of finance overall, look
healthy and fairly normal, said Joseph Abate, a managing director at Barclays.
And officials are working on safeguards to stem the fallout if a disaster
should come. The Financial Stability Oversight Council, which Ms. Yellen leads,
discussed the issues at its most recent meeting
this month, hearing staff presentations on U.S. financial vulnerabilities.
The Treasury Borrowing Advisory
Committee, an advisory group of market participants, has been asked in its latest
questionnaire about a possible Treasury program to buy back government
debt. Some investors have taken that as a signal that they are worried about a
possible problem and may want to be able to improve market functioning,
especially in light of their comments and outreach.
“We are worried about a loss of
adequate liquidity in the market,” Ms. Yellen said last week while answering
questions after a speech in Washington.
And the Fed already has outstanding
tools that can help to stabilize markets. Those include swap lines that can funnel
dollars to banks that need it overseas, and that have been used by
Switzerland and the European Central Bank in recent weeks.
Mr. Abate at Barclays said the
Securities and Exchange Commission, Treasury and Fed seemed to be “on top of”
the situation.
“It’s clear in the marketplace that
liquidity is a concern,” he said. “The regulators are moving to address that.””
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