Fed economists have developed a new Financial Vulnerability Index (FVI) that aims to provide a better long-term view of structural risks in the economy. The Fed’s Financial Conditions Index offers a short-term view of the financial environment. Still, the Fed’s new Financial Vulnerability Index (FVI) aims to capture structural issues and provide a longer-term perspective on sensitivity to stress. The index comprises 39 components across four sub-indexes: valuation pressure, household and business borrowing, financial leverage, and funding risk.
This looks like a nice addition to the existing NFCI index.
One hopes this will become part of the FRED database and be updated on a regular cycle.
1. Valuation Pressures
- Focus: Overvalued asset markets.
- Function: Monitors whether asset prices (such as equities, real estate, and corporate bonds) are unsustainably high relative to economic fundamentals. High pressures mean the market is prone to sudden, damaging price corrections.
2. Household and Business Borrowing
- Focus: Nonfinancial sector leverage.
- Function: Tracks total debt levels building up within families and corporations. When businesses and households are over-extended, even minor drops in income can trigger widespread defaults.
- Focus: Financial sector risk-taking.
- Function: Measures the degree of debt and leverage being used within the financial sector itself (banks, broker-dealers, and hedge funds). High leverage means small asset losses can quickly wipe out a firm’s capital.
4. Funding Risk
- Focus: Systemic liquidity and structural maturity mismatches.
- Function: Evaluates the presence of volatile, short-term wholesale funding that could evaporate rapidly in a crisis (e.g., severe deposit runs or sudden freezes in overnight lending markets).
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