Fed Monetary Policy Report flags solid economy, elevated markets

By Michael S. Derby

(Reuters) -The Federal Reserve's latest Monetary Policy Report to Congress, released on Friday, was upbeat about the state of the economy but warned about some concerning aspects of the financial system.

The report, which comes ahead of next week's testimony before Congress by Fed Chair Jerome Powell, said central bank officials remain committed to getting inflation back to 2% and noted that when it comes to interest rate policy changes officials “will carefully assess incoming data, the evolving outlook, and the balance of risks.”

The release described the overall economy as doing well amid a solid and better-balanced job market and declining inflation pressures.

The Fed report said the financial system is broadly speaking "sound and resilient." But it also noted "valuations remained high relative to fundamentals in a range of markets, including those for equity, corporate debt, and residential real estate."

It also said "valuation pressures increased somewhat from already high levels" while flagging that "vulnerabilities associated with financial leverage remained notable."

The report did not appear to suggest any broad threat to the economy from the financial system and said that "credit continued to be broadly available" to mid-sized and large businesses, most households and local governments. Credit was "relatively tight" for small firms and those with credit issues.

When it comes to overall borrowing levels, total debt levels for households and non-financial firms "continued to trend down to a level that is very low relative to that in the past two decades."

The Monetary Policy Report, which comes twice yearly, was based on data available to the central bank as of Thursday. The report generally summarizes topics already well known to Fed watchers and market participants.

The report comes as the Fed faces a highly uncertain environment due to large-scale policy changes now contemplated or underway from President Donald Trump.

The central bank was able to lower its interest rate target by a full percentage point last year amid easing inflation pressures. Future cuts, however, are highly uncertain as Trump pursues trade and workforce policies that most economists believe will drive up inflation at a time when price pressures remain above target. Some in the Fed have pointed directly at the government as a source of uncertainty limiting the guidance officials can provide about the monetary policy outlook.

The Fed report had limited comments on the prospects for Trump trade policies but did note "some market participants also pointed to potential increases in U.S. tariffs on imports as a factor pushing the dollar higher in recent months."