US Financial Conditions Profile: 6 May 2022

Recession anxiety continues to roil expectations for the US economy, which inspires a periodic review of financial conditions. When macro risk is rising, early warnings may show up as changes in this corner. At a time when the Federal Reserve is increasingly committed to raising interest rates to fight inflation, it’s timely to check in on how financial conditions are evolving.

To gauge financial conditions, we’ll briefly review five indicators in terms of the current reading vs. the historical distribution of values. As a preview, four of the five indexes still point to relatively liquid/loose financial conditions, although there are hints that a period of tighter conditions are approaching. Meanwhile, one indicator has shifted to a slightly above-average state of tight conditions, a possible sign of things to come. Overall, it’s clear that the loose conditions of the recent past are fading and so we could see a broad shift to tighter conditions in the near term.

To start, the first chart shows the St. Louis Fed Financial Stress Index, which is constructed from 18 indicators, including interest rates and yield spreads. The current reading is well below zero, which points to below-average financial market stress.

The second chart shows the Chicago Fed National Financial Conditions Index, which reflects financial conditions in money markets, debt and equity markets and the traditional and “shadow” banking systems. The current below-zero value indicates financial conditions that are looser than average.

The third chart is the Chicago Fed Adjusted National Financial Conditions Index, which “isolates a component of financial conditions uncorrelated with economic conditions to provide an update on how financial conditions compare with current economic conditions.” On this front, conditions are now slightly tighter than average, marking a break with an extended run of loose conditions for well over a year. Of the five indicators presented, this is the first one to tip into tighter-than-average conditions. Let’s see if and when it’s counterparts follow in the weeks ahead.

The fourth chart is the Chicago Fed National Financial Conditions Credit Subindex, which drills down and “captures volatility and funding risk in the financial sector.” Slightly loose conditions still apply, if only barely.

Finally, the Chicago Fed National Financial Conditions Risk Subindex “captures volatility and funding risk in the financial sector.” On this basis, conditions are still moderately loose and an imminent change to tighter conditions doesn’t appear likely on this front.


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