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Cleveland Federal Reserve President Loretta Mester warned on Thursday that proceeding with further interest rate cuts at the current time could expose the economy to a wide range of risks.
She explained that the continued inflation above the 2 percent level targeted by the Federal Reserve makes any attempt to lower interest rates as support for the labor market a step that could prolong the period of high inflation, and may encourage an increase in risk appetite within financial markets.
Hamak noted that financial conditions currently appear clearly accommodative, as stock market prices are experiencing a noticeable rise, while credit conditions are characterized by ease. She explained that further reducing borrowing costs in such an environment could enhance high-risk lending activity and increase the accumulation of risks in the financial system.
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Objections to the October cut and concerns about market distortions.
Hamak mentioned that the interest rate cuts led by the Federal Reserve could also distort asset pricing in markets, which means - according to her - that when the next economic slowdown comes, it may be harsher than if prices had remained unchanged, with greater effects on economic activity and market stability.
She added that some may view the interest rate cut as 'insurance' to protect the labor market, but she emphasized the need to be mindful that this step may come at the expense of increasing future financial instability risks. Although she is not a voting member of the Federal Open Market Committee this year, she opposed the Federal Reserve's decision at the end of October to lower the target range for the federal funds rate between 3.75 percent and 4 percent.
Hamak clarified that the Federal Reserve resorted to this reduction in support of the labor market, which has begun to show signs of weakness, while considering that monetary policy is still capable of contributing to reducing inflation levels that remain high. However, she reiterated her position that monetary policy has barely reached a position that allows it to curb price pressures, and that bringing inflation back to target levels remains a necessary priority after years of deviating from it.
Division within the Federal Reserve and expanding risks due to weak data.
Minutes from the Federal Reserve meeting released on Wednesday showed that the path ahead for policymakers is fraught with disagreements, especially following the government shutdown that deprived them of essential data needed for accurately assessing the economic situation.
Several regional branch officials indicated their opposition to further rate cuts, while financial markets currently believe that the Federal Reserve will hold interest rates steady at next month's Federal Open Market Committee meeting.
Although the issue of the impact of lowering credit costs on financial stability was not a major concern for most Federal Reserve officials, Hamak notably focused on this aspect in her speech. She confirmed that the financial system remains in good shape thanks to well-capitalized banks and solid household balance sheet conditions, but she pointed out the high levels of financial leverage among hedge funds and insurance companies, emphasizing the need to monitor the growth of private credit and the stablecoin sector.
