One Bank Is Confused: The Fed’s Rate Hikes Have Resulted In The Loosest Financial Conditions Since 2014

Jon Economy

In its latest weekly Economic Indicators Update, Goldman charts the ongoing paradoxical divergence between the Fed’s professed tightening path and what is actually taking place in the US stock market, where it finds that financial conditions are the easiest they have been in two years.
One month ago, Goldman discussed this topic in depth when Jan Hatzius implicitly asked if Yellen has lost control of the market, and warned that in order to normalize fin conditions, the Fed may be forced to follow through with a “policy shock.”
Overnight, Deutsche Bank also focused on the ongoing divergence between Fed intentions and market reality, noting that despite another weak Q1 for US growth and several soft inflation prints in recent months, “the Fed has for the most part stuck to the script for policy over the remainder of the year.” The German bank notes “recent communication has continued to signal that at least one rate hike – the first likely coming at next week’s June FOMC meeting – and a reduction in the balance sheet are still likely by year-end.” It posits one reason why the Fed has remained on message “is that financial conditions have persistently eased despite two rate hikes since December. In fact, our financial conditions index has recently neared the loosest (i.e., most supportive of growth) levels since 2014.”
We consider these questions through the lens of our financial conditions index (FCI). In brief, our high-frequency FCI is a composite of various financial market indicators – the trade-weighted dollar, equities, the 10-year Treasury term premium, VIX, mortgage spread, and corporate bond spread. The variables are transformed when needed (e.g., by taking growth rates), standardized by their pre-crisis mean and standard deviation, and then aggregated into an index using weights based on each variable’s historical relative ability to forecast out-ofsample real GDP growth. The index is constructed such that positive values indicate that financial conditions are supportive of growth, while negative values are consistent with tight financial conditions that exert a drag on growth.

This post was published at Zero Hedge on Jun 6, 2017.