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Jenny Paris

The Federal Reserve's Next Act Will Test Market Stability

No one can say whether more aggressive tightening of monetary policy will disrupt the financial system's plumbing and force the central bank to alter course, as it has in the past.

The market’s plumbing is about to get stress tested.

The market’s plumbing is about to get stress tested.

Photographer: Express/Getty Images

The Federal Reserve's resolve to fight inflation could be tested even before a recession hits by dislocations in certain corners of the market that are not well understood. This is about more than just a bear market in stocks or an implosion in cryptocurrencies. Rather, this is about the “plumbing” that keeps markets running smoothly and facilitates the flow of money in and out of the financial system. Because it’s when cracks occurred here in the past that the Fed has been forced to adjust course -- often with little advance warning.

A look at the episodes in the past that prompted the Fed to alter its policy path or take emergency action reveals that disruptions in the smooth functioning of the money markets and the US government debt market have been the main triggers. Concern about these markets, which are essential to the stability of the financial system, will only grow as the Fed in just a few weeks begins to withdraw liquidity from the markets by reducing its $8.9 trillion balance sheet.