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The Federal Reserve recently introduced another financial conditions index, adding to the numerous existing gauges that measure the relaxation or restrictiveness of financial conditions. This is not the first, second, or third index within the Federal Reserve system, as even Norway has one these days. Financial conditions indices all evaluate similar factors, making them backward-looking and of limited usefulness as indicators. However, the newly designed FCI by the Federal Reserve could have implications for monetary policy, given its authority and approval. This makes it market-relevant and worth closer examination.
Financial conditions indices, in essence, are like dreams and assholes. Everyone has them, they’re not as unique as you’d think, and people are much more enthusiastic about studying their own than anyone else’s.
Unlike other FCIs created by regional banks, the Fed’s FCI carries more weight and implications for monetary policy. The authors of the index highlight its assessment of how financial conditions either impede or support economic activity, as well as its inclusion of past changes to estimate future effects on the economy. Goldman Sachs notes a few differences between the Fed’s FCI and its own, such as the lag between financial conditions and economic growth, the inclusion of the Zillow monthly index, and the bidirectional relationship between market prices and growth.
The Fed’s FCI suggests that current financial conditions are tighter than other indices indicate, signaling potential challenges for future growth. However, this also means that the Fed may not need to raise rates significantly and might be more tolerant of stock market gains, as long as they have a modest impact on the FCI-G index and economic outlook. In essence, the Fed is less likely to oppose the stock market rally unless it becomes excessive.
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