Fed’s Bullard says risk of financial crisis remains

A senior Federal Reserve official has warned that a wave of business failures owing to the pandemic could still trigger a financial crisis, as he justified the central bank’s continuing efforts to prop up capital markets.

“We’re still in the middle of the crisis here,” James Bullard, president of the Federal Reserve Bank of St Louis, said in an interview with the Financial Times on Wednesday.

“Even though we got past the initial wave of the March-April timeframe the disease is still quite capable of surprising us,” he said. “Without more granular risk management on the part of the health policy, we could get a wave of substantial bankruptcies and [that] could feed into a financial crisis.”

Mr Bullard’s comments came as Fed officials were assessing the economic impact of a new spike in infections in large US states including Texas, Florida, California and Arizona, which threatens to derail the nascent rebound from the initial pandemic shock.

“In any crisis, I think we need to keep in mind that there can be twists and turns, there can be another shoe to drop, and that could happen here,” he said. “And for that reason I think it’s probably prudent to keep our lending facilities in place for now even though it’s true that liquidity has improved dramatically in financial markets.”

The Fed has faced criticism that it has gone too far in its efforts to shore up financial markets — artificially inflating asset prices and helping corporate America at the expense of Main Street, while adding to income inequality. 

The Fed now has two facilities in place to buy corporate debt in the primary and secondary markets, including bonds that have fallen into higher-risk “junk” territory — terrain into which the US central bank had never ventured before.

Mr Bullard acknowledged the schemes were “controversial” but said corporate debt liquidity had been “sorely tested” early in the crisis and the Fed facilities served as an important “backstop” even if they were not being used much.

“With all these programmes the idea is to make sure the markets don’t freeze up entirely, because that’s what gets you into a financial crisis, when traders won’t trade the asset at any price,” he said. ” It’s not my base case but it’s possible we could take a turn for the worse at some point in the future.”

Mr Bullard said he believed the worst of the economic hit occurred in the second quarter of the year. He anticipated a transition to a “big quarter for growth” in the third quarter, though “how big” remained a question to be answered in the next 90 days.

Minutes from the Federal Open Market Committee meeting on June 9-10 released on Wednesday showed many US central bankers were converging around the need for firmer guidance on the path of interest rates and asset purchases. Mr Bullard said he did not see the need for a quick move in that direction since the current signalling was “very effective”.

“The situation we’re in now is that the committee expects to stay low, the markets also expect us to stay low, and that it’s probably not going to have inflationary consequences,” Mr Bullard said. “Because of that there really isn’t that much impetus to add additional forward guidance on top of that. We could do that but I don’t think it would really change the situation.”

If the Fed were to make that move, Mr Bullard said he would prefer linking forward guidance to “economic conditions” rather than dates. On so-called “yield curve control” — a policy last used in the second world war whereby the central bank sets targets for Treasury yields and adjusts its asset purchases accordingly — Mr Bullard was sceptical. “At least for me, this is down the list of priorities for the central bank,” he said.

Mr Bullard, 59, is among the longest-serving regional Fed presidents, having taken up the top job for the St Louis district — which spans Arkansas and parts of Missouri, Mississippi, Kentucky, Indiana, Illinois and Tennessee — in 2008, at the height of the financial crisis.

He described the last downturn as “more difficult” for central bankers, since it was far less clear what was happening in the US and globally.

“Here, for all the difficulty and human tragedy around the pandemic this is a well understood shock. It’s not hard to see that a disease has descended upon us and is causing havoc,” he said. “There has been more unity both inside and outside the Fed about what the policy response should be and even globally that’s been true.”