Financial Conditions Tightest in 15 Years, Fed Says

“Worst performance in 15 years” was the judgment of a half dozen researchers at the Federal Reserve when it came to financial conditions that could reduce economic growth.

The researchers were working on a new financial conditions index (FCI), a category of metric that is supposed to reflect what can be known from a collection of financial variables. The intent is to create a single number that can succinctly reflect a broad view of the economy, like the Federal Reserve Bank of Chicago’s National Financial Conditions Index or the Bloomberg FCI.

“The main drawback of such an approach is that the weights used to aggregate the underlying financial variables are based on statistical models and do not necessarily have a straightforward economic interpretation, nor do they map changes in financial variables directly into measures of economic activity,” they wrote.

And so, the group created a new number called the FCI-G, which “depends on the recent history of three-month changes in seven financial variables: the federal funds rate, the 10-year Treasury yield, the 30-year fixed mortgage rate, the triple-B corporate bond yield, the Dow Jones total stock market index, the Zillow house price index, and the nominal broad dollar index.” With the 30-year fixed mortgage rate and Zillow house price index, there is significant contribution from real estate data.

“These models relate households’ spending and businesses’ investment decisions to changes in short- and long-term interest rates, house and equity prices, and the exchange value of the dollar, among other factors,” they wrote. Another difference from other FCIs is that the FCI-G decreases the weights of past changes.

It doesn’t represent all things or types of financial information that might be of interest, but the researchers say that movements of the FCI-G can help measure “whether financial conditions have tightened or loosened, to summarize how changes in financial conditions are associated with real GDP growth over the following year, or both.”

Researchers suggesting new economic measures will typically look at the past to see the accuracy of the representative and predictive powers. And that’s where current economic performance comes under scrutiny. “For historical context, the recent readings of the FCI-G are at their tightest levels since the Global Financial Crisis,” they wrote. That was about 15 years ago.

Given the brief but intense recession that started with the Covid-19 pandemic and the common perception that it was the worse since the GFC, that current conditions are the tightest in 15 years seems straightforward.