Financial conditions indicators are usually stable and will not provide many portfolio allocation adjustment signals. However, the current changes show a world in turmoil. The Russian implosion of financial conditions is expected given a war. The same can be said for eastern Europe, but the trends around the world are all headed to tighter conditions. The exception is China, but the financial conditions index may not fully account for the country's real estate problems.
The dispersion in financial signals can be used as a further indicator on future cross-asset return differences. The trends in financial conditions create added signals on relative country performance. Buy (sell) countries with the strongest (weakest) financial conditions.
We have seen a delinking between the real and financial economy as asset prices moved higher over the last decade; however, the real- financial link may be very different when financial conditions tighten. Of course, financial condition indices are driven by asset prices, credit spreads, and volatility, so any selling-off with higher volatility will translate into a decline in financial conditions. Still, financial price signals still provide a warning signal on what may be store for real growth.
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