The Federal Reserve isn’t going to let the financial carnage overseas and volatility in U.S. stock markets detract from its view that the economy is on the right track.
Federal Reserve Chairwoman Janet Yellen on Wednesday acknowledged the problems that plummeting oil prices have caused for energy-dependent Russia and Venezuela as well as U.S. oil producers. Some have compared the circumstances to the 1998 drop in oil prices that led Russia to default on its debt and brought down U.S. hedge fund Long-Term Capital Management.
But Yellen made clear that she and other Fed officials believe the U.S. recovery remains intact and that their plans for moving away from crisis-era monetary policy haven’t changed.
“Clearly Russia has been hit very hard by the decline in oil prices, and the ruble has depreciated enormously in value and this is posing a series of difficult conditions in the Russian economy,” Yellen said at a press conference following the end of the Fed monetary policy committee’s two-day meeting. “We discussed what the potential spillovers are to the United States which could occur through trade and financial linkages” at the meeting, she said, but they are “actually small.”
Russia accounts for 1 percent of U.S. exports, Yellen said, and the financial linkages and possibility of contagion from Russia to the U.S. remains small.
Following a 50 percent decline in the price of oil since the summer, the value of the ruble has fallen by 20 percent against the dollar in the past month, prompting runs on consumer goods and foreign currencies in Russia and a scramble to react from the country’s financial authorities.
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The Obama administration has gloated over Russia’s problems. “They are between a rock and a hard place in economic policy,” Obama economic adviser Jason Furman said Tuesday, noting that the sanctions Obama has placed on Russian banks in the wake of Russia’s aggression in Ukraine will constrain President Vladimir Putin’s ability to respond to the crisis.
But the fallout for the U.S. will be small, Yellen said. “In the case of the United States, I see the spillovers as pretty small, but we’re obviously watching that closely,” she said.
Nevertheless, U.S. markets have been rattled in recent weeks. The S&P 500 had fallen by nearly 5 percent before Wednesday’s Fed announcement, in which the central bank swapped out its guidance that it would keep interest rates near zero for a “considerable time” for a promise to be “patient” before raising rates. Stock market volatility, as measured by the Chicago Board Options Exchange Volatility Index, or VIX, more than doubled in December.
Some of the most acute fallout has been among junk bonds for small drillers and oil field servicers working in the U.S. shale boom. They were able to take out loans when oil cost more than $110 a barrel, which now look far riskier.
Yellen acknowledged Wednesday that the drop in oil prices had caused trouble for some oil producers funded with junk bonds, and that fears about their ability to repay that debt had spilled over into the prices of other risky loans as well.
But she added that “for the banking system as a whole, the exposure to oil — I’m not aware of significant issues there.” She noted that the Fed’s examiners have been looking at banks’ books to determine if they face outsized risks from rapid oil price movements.
Throughout the summer and into the fall, U.S. bank regulators have warned that junk bonds and loans used in mergers and acquisitions have become overvalued.
But overall, regulators view the U.S. financial system as well-capitalized and prepared to handle market turbulence without hurting the broader economy.
“Leverage in the financial system in general is way down from the levels before the crisis,” Yellen said Wednesday.
“The Fed likely views financial stability risks as primarily stemming from excess leverage and credit growth in the economy as a whole, conditions that are not readily apparent in today’s environment,” wrote Goldman Sachs economists Sven Jari Stehn and Kris Dawsey in a note previewing Wednesday’s monetary policy announcement.
Donald Kohn, who retired as vice chairman of the Federal Reserve in 2010, told the New York Times Wednesday that financial problems stemming from Russia or other emerging market economies rocked by oil’s drop “doesn’t threaten the banks and other financial institutions because they are considerably stronger than they were a few years ago.”
Following the latest round of stress tests in 2013, the Fed touted that U.S. banks roughly doubled their aggregate capital from $460 billion in 2009 to $971 billion. Maintaining high levels of capital entails that banks could lose more money without defaulting on their obligations to bondholders.
Maintaining high levels of capital and safety in the domestic financial system is the best way to protect against crises in emerging markets, Fed Vice Chairman Stanley Fischer said in a speech at the International Monetary Fund in October. That’s true, he said, even if those crises were brought on by the Fed’s own efforts to stimulate the economy by boosting asset prices.
“As the recent financial crisis showed all too clearly, to achieve this objective, we must take financial stability into account,” Fischer said. “For half a decade, we have been working to understand and better guard against the financial disruptions that were the genesis of the Great Recession.”
