Fed’s Cook Discusses 'Elevated' Valuations and Moving 'Cautiously' on Rates

Published 01/08/2025, 12:48 AM
DX
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  • Federal Reserve board member Lisa Cook discussed the year ahead at a conference this week.
  • Cook discussed monetary policy and stock market valuations, among other topics.
  • She also opined on stablecoins and their vulnerabilities.

The Fed Board governor also talked about vulnerabilities for stablecoins.

Federal Reserve Board Governor Lisa Cook discussed her expectations for the year ahead during an address Monday at the University of Michigan.

In her address at University of Michigan Law School, Cook touched on a variety of subjects, including the markets, inflation, the economy, and areas that should be monitored.

“Overall, the U.S. economy starts the year in good shape,” Cook said. “Economic growth was quite strong in 2024. Inflation has fallen considerably from its peak two and a half years ago, though it remains somewhat above the Fed’s 2 percent objective. The labor market is solid, with the unemployment rate still relatively low and Americans, on average, bringing home paychecks that are growing faster than inflation.”

The inflation rate, as measured by Personal Consumption Expenditures (PCE) ticked up to 2.4% in November, up from 2.1% in September. In 2025, Cooks sees inflation gradually returning — if unevenly — back toward the 2% goal in a sustainable manner. A key will be a reduction in housing inflation.

“I expect more progress in reducing housing services inflation this year as the earlier slowing in growth of rents charged to new tenants feeds through into the growth of average rents,” she said.

“Proceed more cautiously” with further cuts

The Federal Open Market Committee (FOMC) has reduced rates by 100 basis points over the past three meetings to a range of 4.25% to 4.50%.

However, inflation remains a concern heading into 2025, and it warrants a more measured approach to rate cuts, Cook said.

“All along, I envisioned moving more quickly in the early stages of our easing campaign and then easing more gradually as the policy rate came closer to neutral,” Cook said. “In addition, since September, the labor market has been somewhat more resilient, while inflation has been stickier than I assumed at that time. Thus, I think we can afford to proceed more cautiously with further cuts.”

The FOMC’s summary of projections estimated two rate cuts in 2025 and two more in 2026. That is fewer than past projections of four each year. In her address, Cook added that monetary policy is not on a preset course and the magnitude and timing of future rates changes will depend on the incoming data, the evolving outlook, and the balance of risks.

“Valuations are elevated” in some asset classes

The Fed governor also discussed financial stability, which she described as sound and resilient.

“In terms of financial-sector leverage, high levels of capital and liquidity in the banking system are a key source of resilience,” Cook said. “Funding risks in the banking system have declined somewhat: Smaller banks have replaced some of their uninsured deposit funding with brokered and reciprocal deposits, which are less prone to runs but are still less stable than core bank deposits.”

But there are some vulnerabilities. Cook mentioned that some nonbank financial intermediaries (NBFIs), including some large hedge funds, have high leverage, or, in other words, debt. In addition, they could be exposed to liquidity stress brought on by market volatility or other factors. Further, Cook discussed vulnerabilities related to overvalued stocks.

“Valuations are elevated in a number of asset classes, including equity and corporate debt markets, where estimated risk premia are near the bottom of their historical distributions, suggesting that markets may be priced to perfection and, therefore, susceptible to large declines, which could result from bad economic news or a change in investor sentiment,” Cook said.

Stablecoins are “vulnerable to runs”

Cook closed the address by discussing several areas to monitor in 2025, including stablecoins.

Stablecoins have a small footprint in the U.S., with about $170 billion in assets under management. They are generally used for digital asset investments, but lack a comprehensive federal regulatory framework, so many US dollar-denominated stablecoins operate abroad.

But Cook said that stablecoins “could scale quickly,” particularly if supported by access to an existing customer base.

However, because stablecoins are pegged to a reference asset, Cook said they are vulnerable to runs.

“If a run on a large stablecoin were to occur, liquidation of the assets backing the stablecoin could be disruptive, especially if those assets were linked to other funding markets, like commercial paper or certificates of deposit,” Cook said.

She noted that some stablecoins have restrictions on redemptions, which can reduce vulnerabilities. Cook also discussed other areas to monitor, specifically private credit, cyber events, and generative AI in banking and finance.

“I will, of course, remain vigilant with respect to vulnerabilities that appear to be evolving as well as emerging risks, but I see a system that is sound, resilient, and able to support the needs of households, communities, and businesses,” Cook said. “The good position of the financial system is consistent with a broader economy that is strong, with a solid labor market and moderating inflation.”

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