FOMC perceived to have turned less accommodative
The FOMC staff review indicated that domestic financial asset prices between meetings reacted to lower accommodation from the US Federal Reserve. Tax reform hopes have also affected asset prices across the board, resulting in a minor increase in Treasury (GOVT) yields, equity (SPY) prices, and the US dollar (UUP). Reaction to the balance sheet reduction was limited, as markets were prepared for this move.
The staff review indicated that domestic financing conditions remained accommodative. Accommodative financing conditions are important for continued economic expansion. Narrowing corporate bond (LQD) spreads helped corporates seek financing from the markets, and lower credit conditions made easy credit available to households. Easier credit for households improves the demand for housing and the auto industry.
Financing flows from commercial banks for commercial real estate in commercial mortgage-backed securities improved from the previous quarter. Demand for commercial real estate, however, declined in October. The report highlighted lower demand for housing.
Vulnerabilities of the US financial system
The US FOMC staff review included a report on the vulnerabilities of the US financial system, which were moderate. The report said that pressures from asset valuations across markets have risen marginally since the previous assessment in July. Leverage in the nonfinancial sectors was said to be moderate. Higher leverage could lead to higher volatility (VXX) in times of crisis.
The report mentioned possible risks from external economies, where higher levels of corporate and household debt, rising property prices, a weak banking system, and political uncertainties can have an impact on the US financial system.
In the next part of this series, we’ll look at the FOMC’s view of the US economic outlook.