Fed warns of inflation, Russian invasion as financial risks

In the six months since the Federal Reserve previously issued a report on U.S. financial stability, uncertainty about the economic outlook has increased with higher-than-expected inflation and Russia's invasion of Ukraine, the central bank said.

In its semiannual Financial Stability Report released Monday, the Fed said inflation "has been higher and more persistent than expected, even before the invasion of Ukraine, and uncertainty over the inflation outlook poses risks to financial conditions and economic activity."

Interest rates have also risen more than was expected at the time of the last Financial Stability Report in November, the Fed noted. "Further adverse surprises in inflation and interest rates, particularly if accompanied by a decline in economic activity, could negatively affect the financial system," the Fed said in the report. That could lead to weaker household and business balance sheets, causing an increase in delinquencies, bankruptcies and other forms of financial distress, the Fed said.

The Federal Open Market Committee raised interest rates for the second time in consecutive meetings on May 4, the latter time by 50 basis points after a quarter-point increase in March, in an effort to combat inflation.

Fed Chairman Jerome H. Powell, whom President Joe Biden has renominated to a second term, at a May 4 news conference signaled further rate hikes this year. "Assuming that economic and financial conditions evolve in line with expectations, there is a broad sense on the committee that additional 50-basis-point increases should be on the table at the next couple of meetings," Mr. Powell said.

In its report, the Fed warned that "a sharp rise in interest rates could lead to higher volatility, stresses to market liquidity and a large correction in prices of risky assets, potentially causing losses at a range of financial intermediaries, reducing their ability to raise capital and retain the confidence of their counterparties."

On Russia's invasion of Ukraine, the Fed said the implications for the U.S. and global economies are highly uncertain. But in the near term, "The invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity," it said in the report.