Fed’s Logan Warns Financial System Vulnerable to Bond Stress, Bostic Open to Rate Hikes

America’s financial system is vulnerable to stress in the government bond market, Federal Reserve Bank of Dallas President Lorie Logan has warned.

Logan delivered a speech at an event hosted by the University of Chicago Booth School of Business.

She explained that the bond market is susceptible to substantial shocks.

Logan alluded to the significant acceleration in the size of U.S. government debt and the changes in who purchases and holds that debt.

“The U.S. financial system has become increasingly vulnerable to core market dysfunction because the supply of intermediation has not kept pace with demand as the Treasury market’s size and complexity have grown,” Logan stated.

If major shocks occur, the authorities must intervene and limit the damage.

Logan encouraged public officials to establish a more formal system to rescue the markets when there is trouble, using the Fed’s pandemic-era stimulus and relief packages to save a collapsing market.

“Central banks should rarely intervene to support the functioning of core markets, but when such interventions are needed, they must be effective,” she said.

Meanwhile, Federal Reserve Bank of Atlanta President Raphael Bostic has stated that he is open to continuing to raise interest rates in the months to come if economic data clocks in stronger than expected.

Bostic spoke with reporters on Thursday, acknowledging that he will update his policy trajectory if consumer spending is robust and labor markets remain tight.

This, he noted, would suggest that the U.S. central bank would need to employ additional tightening instruments.

“There is the case that could be made that we need to go higher,” he said during a roundtable with reporters.

While he refrained from committing to a specific policy rate ahead of this month’s Federal Open Market Committee (FOMC) policy meeting, he did reveal that he supports quarter-point rate hikes.

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“Right now, I’m still very firmly in the quarter-point move camp,” Bostic noted.

But once the Fed lifts the benchmark fed funds rate to a restrictive stance, officials must leave them there.

A potential pause, according to Bostic, could happen by the middle to late summer.

This comes soon after Bostic penned an essay on Wednesday, advocating for boosting the policy rate by 50 basis points to a target range of 5 percent and 5.25 percent and leaving it there “well into 2024.”

Others agree that more work needs to be done to ensure the central bank returns inflation to its 2 percent goal.

“I think it will take time to return to target, and, as a consequence, believe we still have work to do,” said Richmond Fed Bank President Thomas Barkin in a prepared speech to the Stanford Institute for Economic Policy Research’s annual economic summit on Friday.

“The Fed’s objective isn’t to hurt the economy, it’s to reduce inflation.

“And if there is one thing we’ve relearned over the last two years, it is that everybody hates inflation.”

Barkin is confident that inflation will eventually return to the 2 percent target but conceded that he is “doubtful the process will be quick.”

In the early days of the coronavirus pandemic, the Fed slashed interest rates to nearly zero and purchased trillions of dollars in Treasurys, corporate bonds, and mortgage-backed securities.

Fed Governor Michelle Bowman also asserted that the Fed needs to think about effective mechanisms to support financial markets when liquidity is being drained from the system.

“The pandemic experience illustrated that liquidity strains can sometimes be so severe that targeted purchases of the affected assets may be the most effective tool to quickly support market functioning, as was the case in Treasury markets in the spring of 2020,” Bowman told The Chicago Booth Initiative on Global Markets Workshop on Market Dysfunction on Friday.

“A related issue is how to minimize the Fed’s footprint and amount of asset purchases needed to restore market functioning.

“A further consideration is how to construct and communicate an exit strategy to reduce the enlarged balance sheet over time.”

This week, the New York Fed published a paper that urged the authorities to develop a more formalized approach to offering support for the financial markets.

Meanwhile, the institution is confident that the financial system remains flush with cash, writing in its semi-annual monetary policy report that “financial vulnerabilities remain moderate overall.”

This is not the first time a prominent U.S. official has cautioned about possible bond market stress.

This past fall, Treasury Secretary Janet Yellen raised concerns over the potential issues in the Treasury market, telling reporters that “we are worried about a loss of adequate liquidity in the market.”

Because the Federal Reserve has been gradually unwinding its balance sheet, declining nearly 7 percent since a peak of $8.96 trillion, there have been growing liquidity concerns.

In addition, the central bank’s quantitative tightening campaign has removed the Fed from serving as a top buyer of government debt.

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By Nick R. Hamilton

Nick has a broad background in journalism, business, and technology. He covers news on cryptocurrency, traditional assets, and economic markets.

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