Wednesday, March 27, 2024

New Fed Financial Conditions Index points to more liquidity


The Fed has developed a new measure for financial conditions. This is not the first measure, and it is not clear this is a better measure. There are several financial condition indices from brokerage firms and Bloomberg. The objective is the same for all these indices. They try and provide some indication on whether financial conditions are loose or tight. If the FC index is showing tight conditions, there may be a reason for the Fed to lower rates. Alternatively, if FC conditions are loose, there may be a reason for the Fed to tighten. See: "A New Index to Measure U.S. Financial Conditions."

The new Fed financial conditions index has a different take on what is measured. It looks at what is defined as the financial conditions impulse response to growth. It looks at the change in seven input variables which the Fed funds rate, the 10-year yield, the 30-year mortgage rate, the BBB corporate bond yield, the DJ stock index, the Zillow house price index and the nominal dollar index which are weighted using an impulse response coefficient that measure the cumulative effect of unanticipated permanent changes in each of the inputs with real GDP over some forward period. which is then called the FCI-G or financial conditions impulse on Growth. The index looks at the contribution to GDP growth for 1 or 3-years using three-month changes. 

Right now, the Fed FC index is showing loose conditions after a 2022 which showed tight conditions. Note that these financial variables will be impact by stability and their contribution to wealth creation. If the Fed follows this index as a guide, it provides a focus on financial well being. 

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