U.S. Fed policy report warns on possible financial sector risks

Fed report highlights financial market vulnerabilities, inflation concerns, and potential rate cuts amid economic uncertainty.

The U.S. Federal Reserve report released on March 1 flagged a range of what it deemed "notable" vulnerabilities in the financial markets while adding the stress that roiled the banking sector a year ago has faded considerably.

The Fed also used the latest release of its periodic Monetary Policy Report to say that officials will not start moving their short-term interest rate target down until they gain greater confidence inflation is truly moving back to the 2% target.

In the report, the central bank noted several ways in which borrowing levels, or leverage, were increasing risks in the financial sector. It also said stock prices were "close to historical highs."

The Fed said leverage at hedge funds had stabilized at high levels, while life insurers were facing a situation where they were becoming more reliant on non-traditional sources of funding.

Meanwhile, while banks' sources of funding remain liquid and stable, funding costs were on the rise, the central bank said. But even with those rising challenges, the Fed report said "the banking system remains sound and resilient" and "acute stress in the banking system has receded since last spring."

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A year ago, the Fed contended with bank problems of a magnitude that forced it to launch a new liquidity facility, amid surging demand for central bank credit. Much of that borrowing has faded away as a major concern for markets and the central bank, and the Fed will close this month the Bank Term Funding Program stood up to deal with the troubles.