Federal Reserve semi-annual monetary policy report: No rush to cut interest rates before inflation returns to 2%, banking industry pressure has greatly eased

The report released by the Federal Reserve on Friday highlighted a series of "significant" vulnerabilities in the financial markets, while also emphasizing that the pressures that engulfed the banking industry a year ago have significantly eased. The Federal Reserve also stated in its latest release of the regular monetary policy report that officials will not begin to lower the short-term interest rate target until they have greater confidence that inflation has truly returned to the 2% target level. In the semi-annual monetary policy report, the central bank pointed out several ways in which increased borrowing levels or leverage in the financial sector could increase risks. It also noted that stock prices are "close to historic highs." The Federal Reserve stated that hedge funds' leverage has stabilized at a high level, while life insurance companies are increasingly relying on non-traditional sources of financing. Meanwhile, despite banks maintaining liquidity and stability in their funding sources, the central bank stated that funding costs are rising. However, despite these rising challenges, the Federal Reserve report stated, "The banking system remains sound and resilient," and "severe pressures in the banking system have receded since last spring." A year ago, the Federal Reserve dealt with a series of large-scale banking issues, forcing it to introduce new liquidity tools to address the surge in demand for central bank credit. Although most of the lending issues are no longer major concerns for the market and central bank, the Federal Reserve will close its emergency funding program for banks dealing with these issues this month. The Federal Reserve report stated that most creditworthy individuals can still access credit, although borrowing costs are higher: "Interest rates on credit cards and car loans are still higher than in the last round of monetary policy tightening cycle in 2018." Economically, the Federal Reserve reiterated its commitment to restoring inflation pressures to the target level, stating that the Federal Open Market Committee "does not believe it appropriate to lower the target range until they have greater confidence that inflation is moving sustainably toward 2%." The Fed's year-end forecasts, along with official comments, pointed towards rate cuts this year, with falling inflation pressures. However, the uncertain path of economic strength and returning to 2% inflation has delayed market expectations for when easing policy will begin, possibly pushing it back to the summer. The reports submitted twice a year to Congress by the Federal Reserve come before Fed Chairman Jerome Powell's two-day testimony next Wednesday and Thursday. Powell may face a series of questions from lawmakers on the Federal Reserve's tightening policy stance and expectations of loosening policy, a sensitive topic in a presidential election year. The reports typically summarize economic developments and actions taken by the Federal Reserve since its last update to lawmakers. The Federal Reserve's concerns about financial market vulnerabilities were already mentioned in the minutes of the January FOMC meeting released last week. At the Federal Reserve's recent policy meeting, central bank staff presented their assessment of the stability of the U.S. financial system to policymakers, with the minutes stating that staff "considered the financial vulnerabilities of the system notable." Some Democratic lawmakers have already begun harshly critiquing high-interest rates, complaining that they exacerbate the already poor housing affordability for low- and middle-income families. Meanwhile, Republicans have been critical of the Federal Reserve's initially slow response to inflation and may rebuke Powell for hinting at rate cuts before the November election. The next rate-setting meeting of the Federal Reserve is scheduled for March 19-20, with policymakers widely expected to keep their benchmark policy rate unchanged at 5.25%-5.5%, a level that has remained unchanged since last July. The upcoming meeting will also include updated forecasts on inflation, employment, and interest rates. In December last year, the Federal Reserve projected three rate cuts, and in comments to reporters on Wednesday, New York Federal Reserve President John Williams said this outlook was a "reasonable" point for policymakers to consider the monetary policy outlook. However, the timing of actions remains uncertain. While stable inflation data in the second half of 2023 initially led to market expectations for rate cuts at the March meeting, temporary delays in the first set of inflation data for 2024 have slowed some momentum and may hinder the pace of price increases. Market pricing now reflects a general view that the first rate cut will occur in June, although a first cut at the April 30-May 1 meeting is also not impossible.