Financial Conditions Now Easier Than When the Fed Started Raising Interest Rates

Apollo Chief Economist

Fed measures of financial conditions show that Fed hikes since March 2022 have been offset by a rising S&P500, tighter IG spreads, and tighter HY spreads, and overall financial conditions are now as easy as they were before the Fed started raising interest rates, see charts below.

With inflation still in the 4% to 6% range, the risks are rising that easy financial conditions will boost consumer spending, capex spending, and ultimately inflation. In other words, it looks like more Fed hikes are needed to get inflation all the way back to the Fed’s 2% inflation target.

Source: Federal Reserve bank of Kansas City, Bloomberg, Apollo Chief Economist. Note: 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. Variables included are Treasury REPO Spread (spread between GCF REPO rate and three-month Treasury bill rate), Two-year swap spread (spread between two-year US interest rate swap rate and two-year Treasury yield), Spread between off-the-run 10-year Treasury yield and on-the-run 10-year constant maturity Treasury yield, Spread between Aaa corporate bond yield and 10-year constant maturity Treasury yield, Spread between Baa and Aaa corporate bond yields, Spread between High-yield Bond and Baa spread, Spread between fixed-rate credit card ABS yield and five-year constant maturity Treasury yield, Negative value or correlation between total return on S&P500 and total return on two-year Treasury bonds, Implied volatility of overall stock prices, Idiosyncratic volatility of bank stock prices, Cross-sectional dispersion of bank stock returns.
Source: Federal Reserve bank of Chicago, Bloomberg, Apollo Chief Economist. Note: The NFCI provides a comprehensive weekly update on US financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems. The National Financial Conditions Index (NFCI) is a weighted average of a large number of variables (105 measures of financial activity) each expressed relative to their sample averages and scaled by their sample standard deviations.
Source: Federal Reserve bank of St. Louis, Bloomberg, Apollo Chief Economist. Note: The index measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress.
Source: FRB of New York, Apollo Chief Economist (Note: Corporate bonds are a key source of funding for US non-financial corporations and a key investment security for insurance companies, pension funds, and mutual funds). Distress in the corporate bond market can thus both impair access to credit for corporate borrowers and reduce investment opportunities for key financial sub-sectors. CMDI offers a single measure to quantify joint dislocations in the primary and secondary corporate bond markets. Ranging from 0 to 1, a higher level of CMDI corresponds with historically extreme levels of dislocation. CMDI links bond market functioning to future economic activity through a new measure.
Source: Bloomberg, Apollo Chief Economist. Note: The Bloomberg Financial Conditions Index includes Ted Spread, Commercial Paper/T-Bill Spread, Libor-OIS Spread, Baa Corporate/Treasury Spread, Muni/Treasury Spread, High Yield/Treasury Spread, Swaption Volatility Index, S&P500 Share Prices, VIX Index.

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