Several measures of financial conditions, including those produced by the central bank, have shifted in way that signals reduced restraint on the economy, at a time when central bank officials believe more work may be needed to lower inflation.
Taking in to account everything from stock prices to measures of borrowing costs for the government, businesses and households, financial conditions matter to monetary policy. That is because the Fed relies on markets to transmit changes in its short-term interest rate target to the broader economy.
The current slackening in these gauges means markets and the Fed are starting to go on separate paths.
“Easy financial conditions obviously boost near-term growth,” and can encourage more risk-taking of the sort that can lean against the restraint the Fed is trying to impose on the economy, said Benson Durham, head of global policy at Piper Sandler.
On Friday, the Federal Reserve reported that its Financial Conditions Impulse on Growth for June moved to 0.458, from May’s 0.603 reading.
The index, now the lowest since August 2022, seeks to describe whether financial conditions are aiding or restraining growth, so the latest reading points to them providing less drag on the US economy.Meanwhile, Goldman Sachs’ closely watched Financial Conditions Index has been easing fairly steadily since May. As of the end of July, that measure was also at levels last seen in late August of last year, while the Chicago Fed’s latest index has also pointed to easier conditions.
Since March of last year, the Fed has been engaged in a historically aggressive campaign of short-term interest rate increases, taking its target rate from near zero levels to between 5.25% and 5.5% after a quarter percentage-point increase on Wednesday.
An explicit goal has been to tighten financial conditions. Mortgage rates have soared to around 7%, while other borrowing costs are up. Rate hikes also slammed the stock market, at least for a time, while pushing up the dollar relative to other currencies.
Tighter financial conditions have helped accomplish the Fed’s desire to slow down the economy in a bid to lower inflation pressures from multi-decade highs. But now things are shifting the other way, which could create issues for the Fed as it approaches the endgame for its tightening cycle. Reuters
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