Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Chart of the Week : Financial Condition Indexes
Christopher Dembik
Head of Macroeconomic Research
Summary: In today’s ‘Macro Chartmania’, we focus on the financial condition indexes. All the data are collected from Macrobond and updated each week.
Click here to download this week's full edition of Macro Chartmania composed of more than 100 charts to track the latest macroeconomic and market developments.
With the Fed’s new monetary stance and the recent increase in market volatility, attention has turned to financial conditions. The below charts show three common gauges of broad financial conditions in the United States (the National Financial Condition Index, the Kansas City Financial Stress Index and the Office of Financial Research Financial Stress Index or OFR FSI). There is little methodological difference in the construction of these three indexes. The OFR FSI is updated on a daily basis while the two others are updated on a weekly basis. We tend to closely monitor the OFR FSI because it can track almost in real time a sudden increase in financial stress with major negative implications for financial assets, typically equities. The OFR FSI is now at minus 1.79 – a negative reading means that stress levels are below average. In comparison, it climbed to 10.26 at the start of the pandemic in March 2020. This was below the historical peak of 29.32 reached in October 2008 in the aftermath of the bankruptcy of Lehman Brothers. All of these indexes show current U.S. financial conditions are comparatively accommodative. There is still enough liquidity in the market, though it is decreasing. This partially explains the recent market turmoil. We know that the U.S. Federal Reserve will watch closely for any sign of financial stress resulting from the ongoing monetary regime change. This will certainly influence the pace of monetary policy normalization more than any major statistics (such as unemployment and even inflation data). The last time the OFR FSI turned positive (meaning that stress levels are above average), the Fed had no other choice than to stop its rate-hiking cycle and ultimately reverse it. It was in December 2018. If history is any guide, expect that the Fed will likely stop its hiking cycle which is about to start from March onwards when the OFR FSI will be close or in positive territory. It could happen sooner than most expect.
This is a daily market-based snapshot of stress in global financial markets. It is constructed from 33 financial market variables, such as yield spreads, valuation measures, and interest rates. The OFR FSI is positive when stress levels are above average, and negative when stress levels are below average.
This is a weekly measure of risk, liquidity and leverage in money markets and debt and equity markets as well as in the traditional and “shadow” banking systems. Positive values of the NFCI indicate financial conditions that are tighter than average, while negative values indicate financial conditions that are looser than average.
This is a monthly measure of stress in the U.S. financial system based on 11 financial market variables. A positive value indicates that financial stress is above the long-run average, while a negative value signifies that financial stress is below the long-run average.
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