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The Fed warns there are Geopolitical Risks to the Financial System

The US central bank claims that the war in Ukraine and the Middle East pose a risk of market “spillovers.” Increased risks of higher inflation and weaker growth are brought on by escalating geopolitical tensions, the Federal Reserve cautioned on Friday.

 The US central bank warned of the possibility of “broad adverse spillovers to global markets” in its most recent twice-yearly Financial Stability Report in the event that the Middle East crisis and the war in Ukraine escalate or pressures arise elsewhere.

 The research warned that the escalation of these conflicts or the worsening of other geopolitical tensions “could weaken global economic activity and raise inflation, particularly in the event of protracted disruptions to supply chains and interruptions in production.”

It continued: Losses for exposed businesses and investors, including those in the US, as well as a reduction in risk-taking and asset price falls could have an impact on the global financial system.

The report, which came as Tel Aviv prepared for an anticipated ground offensive into Gaza in response to the attack on Israel by Hamas militants earlier this month, emphasized that the banking system overall remains “sound” and that consumers and businesses have thus far shown resilience in the face of higher interest rates.

Geopolitical tensions “pose important risks to global economic activity” and have “highly uncertain” ramifications, according to Fed Chair Jay Powell, who issued the warning on October 19, 2023.

The Fed’s most recent report coincides with a substantial increase in borrowing prices around the world as financial markets quickly adjust to reflect expectations that a strong US economy will likely keep the Fed’s policy rate elevated for an extended period.

Powell noted on Thursday that a greater emphasis on the size of the US debt load might possibly be at work. The federal deficit has increased from $1.37 trillion in 2022 to $1.7 trillion, according to estimates released by the Treasury department on October 20, 2023.

Borrowing costs globally have surged in recent weeks as Treasury yields of all maturities have risen sharply. The benchmark 10-year bond is now trading close to 5 per cent for the first time since 2007, while two-year yields hover at a 17-year high.

The Fed discovered that Treasury market liquidity overall continued to be below historical levels since its previous report in May, indicating that market participants are “particularly cautious.” While firms and consumers have generally been able to handle rising interest rates, the central bank noted that some risky borrowers are starting to have more significant difficulties.

A top IMF official recently told the Financial Times that there was now a “heightened risk” of some sort of repercussions due to the pace and extent of the most recent increase in interest rates.

The Fed warned of heightened market volatility as well as a “significant economic slowdown” as credit dries up and vulnerable families and firms are compelled to make cuts in case inflation persists unexpectedly and forces central banks to boost rates further.

The commercial real estate industry could be threatened by a downturn of that size, which could result in “significant losses for a range of financial institutions with sizeable exposures, including some regional and community banks and insurance companies.”

Eventually, that would lead some lenders to withdraw even more, which “would further weigh on economic activity,” according to the research.  advised US Treasury bonds ‘Year of the Bond’ is ruined by a painful deal. Jamie Dimon, the CEO of JPMorgan Chase, issued a warning this week that this could be “the most dangerous time the world has seen in decades.” I believe that geopolitics is absolutely an extraordinary topic that we must address,” he remarked.

Since the Fed started to boost its benchmark interest rate in its fight against inflation, losses and delinquencies have so far not increased to excessive levels, which has been good news for banks. The central bank noted this resiliency in its report.

This Thursday, David Solomon, the CEO of Goldman Sachs, issued a warning: “Over the next two to four quarters, the impact of that tightening will be increasingly visible and may cause slowdowns in some industries. In my conversations with CEOs, I have noticed some softening in key consumer behaviors, especially during the past eight weeks, he added.

Goldman Sachs chief executive David Solomon warned this week that “over the next two to four quarters, the impact of that tightening will be more evident and will create slowdowns in some areas. I am hearing, as I interact with CEOs, particularly around consumer businesses, some softness, particularly in the last eight weeks in certain consumer behaviors,” he said.

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