Inflation, Sharp Rise in Interest Rates Pose Financial Risks, Fed Says

Near-term risks highlighted in the report reflect a survey by staff from the Federal Reserve Bank of New York with a range of contacts, including academics, community groups and domestic and international policy- makers, the Fed said.

A combination of higher inflation and rising interest rates could weaken the balance sheets of households and businesses, leading to an increase in delinquencies, bankruptcies, and other forms of financial distress, the Fed said. Households could be affected by job losses, higher interest payments, and a reduction in house prices caused by higher mortgage rates and decreased housing demand.

Meanwhile, business credit quality could be eroded by a steep rise in rates that would increase business borrowing costs, which in turn could have negative consequences on employment and business investment, the Fed said.

The report’s purpose is to identify risks to the financial system, and the scenarios the Fed warns about aren’t necessarily the central bank’s forecast path for the economy.

The Fed said that vulnerabilities from business and household debt are moderate. The financial position of many households continued to improve since the previous stability report in late 2021, supported in part by a strong labor market, high personal savings, remaining pandemic relief programs and rising house prices, the Fed said.

The report also warned that a prolonged conflict in Russia could have adverse consequences to U.S. financial markets, particularly through exposures to tumult in commodities markets, the Fed said.

Russia’s war in Ukraine has sparked large price movements and margin calls in commodities markets and highlighted a potential channel through which large financial institutions could be exposed to contagion, Fed governor

Lael Brainard

said in a written statement. “The Federal Reserve is working with domestic and international regulators to better understand the exposures of commodity market participants and their linkages with the core financial system,” she said.

At present, financial market stresses don’t appear to have significantly disrupted broader economic activity or created substantial pressure on key financial intermediaries, including banks, the Fed added.

Monday’s report comes as the Fed is getting more aggressive in its efforts to tamp down inflation, which was rising as the pandemic eased, and has since been exacerbated by the war in Ukraine lifting prices for fuel and food.

Fed officials approved a rare half-percentage-point interest-rate increase—the largest since 2000—at its rate-setting committee’s meeting last week. The move raised the central bank’s benchmark federal-funds rate to a target range between 0.75% and 1% and comes after the Fed lifted rates by a quarter percentage point from near zero in March.

Investors are trying to figure out how high the Fed might raise rates over the next two years after it held rates at low levels even in the face of growing inflation pressures, supply disruptions and domestic economic demand last year.

Fed Chairman

Jerome Powell

said at a news conference last week that officials broadly agreed that additional half-point increases could be warranted in June and July given current economic conditions. That would lift the rate to a range last seen in 2019, before the pandemic prompted the central bank to open its monetary spigots, and would represent a policy tightening pace as aggressive as any since the 1980s.

Write to Andrew Ackerman at andrew.ackerman@wsj.com

Near-term risks highlighted in the report reflect a survey by staff from the Federal Reserve Bank of New York with a range of contacts, including academics, community groups and domestic and international policy- makers, the Fed said.

A combination of higher inflation and rising interest rates could weaken the balance sheets of households and businesses, leading to an increase in delinquencies, bankruptcies, and other forms of financial distress, the Fed said. Households could be affected by job losses, higher interest payments, and a reduction in house prices caused by higher mortgage rates and decreased housing demand.

Meanwhile, business credit quality could be eroded by a steep rise in rates that would increase business borrowing costs, which in turn could have negative consequences on employment and business investment, the Fed said.

The report’s purpose is to identify risks to the financial system, and the scenarios the Fed warns about aren’t necessarily the central bank’s forecast path for the economy.

The Fed said that vulnerabilities from business and household debt are moderate. The financial position of many households continued to improve since the previous stability report in late 2021, supported in part by a strong labor market, high personal savings, remaining pandemic relief programs and rising house prices, the Fed said.

The report also warned that a prolonged conflict in Russia could have adverse consequences to U.S. financial markets, particularly through exposures to tumult in commodities markets, the Fed said.

Russia’s war in Ukraine has sparked large price movements and margin calls in commodities markets and highlighted a potential channel through which large financial institutions could be exposed to contagion, Fed governor

Lael Brainard

said in a written statement. “The Federal Reserve is working with domestic and international regulators to better understand the exposures of commodity market participants and their linkages with the core financial system,” she said.

At present, financial market stresses don’t appear to have significantly disrupted broader economic activity or created substantial pressure on key financial intermediaries, including banks, the Fed added.

Monday’s report comes as the Fed is getting more aggressive in its efforts to tamp down inflation, which was rising as the pandemic eased, and has since been exacerbated by the war in Ukraine lifting prices for fuel and food.

Fed officials approved a rare half-percentage-point interest-rate increase—the largest since 2000—at its rate-setting committee’s meeting last week. The move raised the central bank’s benchmark federal-funds rate to a target range between 0.75% and 1% and comes after the Fed lifted rates by a quarter percentage point from near zero in March.

Investors are trying to figure out how high the Fed might raise rates over the next two years after it held rates at low levels even in the face of growing inflation pressures, supply disruptions and domestic economic demand last year.

Fed Chairman

Jerome Powell

said at a news conference last week that officials broadly agreed that additional half-point increases could be warranted in June and July given current economic conditions. That would lift the rate to a range last seen in 2019, before the pandemic prompted the central bank to open its monetary spigots, and would represent a policy tightening pace as aggressive as any since the 1980s.

Write to Andrew Ackerman at andrew.ackerman@wsj.com