How Market Volatility Affects GDP
The Fed says it isn't at the beck and call of the markets, but they may not have a choice.
Ask the Federal Reserve who it is responsible to, and the central bank might say Congress, the economy, or the public. Goldman Sachs adds investment markets, whether or not the central bank likes it.
The Fed and its officials insist they don’t cater to outside influences. After the Federal Open Markets Committee at the end of July, Chair Jerome Powell told reporters at the press conference that the central bank would not bend to the political pressure historically common in election years. There have been colorful stories, like when President Lyndon B. Johnson reportedly pushed then-Fed Chair Bill Martin up against a wall as part of his, uh, persuasion.
And Austan Goolsbee, president of the Federal Reserve Bank of Chicago, recently addressed pressure from investors and markets. “We’ve got to be monitoring the real side of the economy: There’s nothing in the Fed’s mandate that’s about making sure the stock market is comfortable,” he told the New York Times in a recent interview.
That is directly true but might not be indirectly so if Goldman Sachs Economics Research is right. In a recent note to clients, it said that tighter economic conditions remained “at a relatively normal level by historical standards.” There was also another section of the report titled “How Market Moves Could Affect the Economy and the Fed.”
Using its financial conditions index, or FCI, the bank noted that between the August 2, 2024, release of the government July jobs numbers and Tuesday, August 6, equities markets had dropped about 5% in value while the 10-year Treasury yield fell 21 basis points. Its FCI model implied that the changes and some others would reduce net GDP growth over the next 12 months by 12 basis points. Furthermore, an additional 10% equities sell-off would cut another 45 basis points from economic growth next year. “If we include the moves in other asset classes that usually accompany equity market selloffs when growth fears arise, the total hit is around 85bp,” they said.
The FCI includes equity prices, short-term and long-term interest rates, credit spreads, and the trade-weighted dollar. While things have been rebounding since the crash earlier this month, there is an apparent relationship in which pressure on the stock market negatively affects future GDP growth, in turn having a depressing impact on everything financial, including CRE markets.