This move allows the Fed to move away from other models of financial conditions, such as those formulated by Goldman Sachs.
The Federal Reserve is changing the way it assesses financial conditions, a move that could have major repercussions for future policy. According to the new model, presented in a paper released on June 30th, current conditions are among the tightest since the 2008 financial crisis. That could mean the Fed has less work to do in inflation control compared to what can be deduced from the public statements of policymakers.
In terms of investing, there are also potentially game-changing implications of the Fed relying less on stock market signals and more on a range of other indicators, meaning Wall Street’s rallies aren’t working against central bank policy in times like these. The Fed has used interest rate hikes to tighten financial conditions and ultimately reduce inflation.
Crucially, this move allows the Fed to move away from other financial conditions models, such as those formulated by Goldman Sachs and the Chicago Federal Reserve. It will be called Financial Conditions Impulse on Growth (FCI-G) and will be used to approximate the impact that changes in various factors have not only on current conditions but also one year on. These metrics include the federal funds rate, the 10-year Treasury yield, the 30-year mortgage interest rate, the BBB corporate bond yield, the Dow Jones Industrial Average, Zillow home prices, and the US dollar index. They will be weighted against the various models used by the Fed to assess conditions.
“While existing financial condition indicators typically measure whether financial conditions are tight or accommodative relative to their historical distributions, the new index assesses the extent to which financial conditions represent a headwind or tailwind to economic activity,” he says. These weightings will give less weight to things like stock prices, which tend to have a relatively modest impact on the FCI-G index and the business outlook.
In other words, the Fed is less likely to oppose the stock market race - unless it gets completely out of hand - than was widely feared. The current reading is approximately 0.60269. Any reading above zero implies tight financial conditions and the value implies a potential percentage point headwind on GDP growth versus trend. The most recent peak was in December 2022, when it exceeded 0.95, while it fell to -1.77607 in July 2021, when conditions were extremely accommodative.
In the months following the Covid pandemic, monetary policy was extremely accommodative, but the current reading indicates that conditions are tight. In contrast, the current reading of the Chicago Federal Reserve Index is -0.28, implying relatively accommodative conditions. Capital Economics noted that the FCI-G "does a better job of illustrating the tightening of financial conditions in the United States than various other measures." However, the forecasting firm advised its clients to continue tracking Capital’s proprietary financial condition index, as it "has had a better performance at capturing turning points in real activity over the past few decades, is timely and more versatile".
Original article published on Money.it Italy 2023-07-20 07:00:00. Original title: Fed, ecco il nuovo indice per misurare le condizioni finanziarie
