Financial stress is increasing and financial conditions tightening

Three economic stress indicators from the Federal Reserve banks of Cleveland, St Louis, and Kansas City show an increase in financial stress. The Chicago Fed financial conditions index shows a tightening of conditions. Each is constructed differently but all are trying to capture the same phenomena is there more stress in the markets? 

The stress indices are correlated with economic bad times. While we are not at levels seen in late 2011 and early 2012, the direction is clear. All are showing higher levels from a year ago. It would be hard to say that credit and Fed policy should be tightened in a growing stress environment; however, this places more structure around the current language of the Fed. The nice part of looking at the stress measures is that it gives historical precision to any discussion on current financial conditions. It is not a matter of "feel".

The financial condition index from the Chicago Fed is also increasing. This is not a stress index, but conditions will usually tighten when there is stress, or stress will show up as tighter financial conditions. Financial conditions as measured by the Fed is more than just credit availability.

Good prediction is about getting the direction and timing right. You can be right but too early; nevertheless, any investors should be aware of signs of changes in direction and intensity. Since confidence and stress are an important part of growth, we can say that there will be less risk-taking if stress continues to move higher and financial condition deteriorate. Financial conditions are the worse since the Financial Crisis and stress is at level that created a need for an extension of Operation Twist QE3. We will watch these stress numbers closely.