Credit Conditions Easing in the Face of Tighter Monetary Policy

May 18, 2017

Credit Conditions Easing in the Face of Tighter Monetary Policy Photo

The Federal Reserve (Fed) Bank of St. Louis provides investors a weekly gauge of financial stress in the markets with its publication of the St. Louis Fed Financial Stress Index. The Index is constructed using 18 different financial market indicators: seven interest rate series, six yield spreads and five others indicators, including equity and fixed income market volatility. Readings above zero indicate above-average financial stress while values below zero suggest below-average financial stress.

The Financial Stress Index has been declining steadily since oil prices bottomed in February, 2016. Even as credit conditions tightened rapidly with oil and other commodity prices in free fall during the first quarter of 2016, the Financial Stress Index never entered positive territory. This is almost certainly the result of more than eight years of extraordinary global monetary policy accommodation. The challenge now for central banks will be to gradually normalize interest rate policies without creating excessive turbulence across the equity and credit markets.

Key Takeaway:

Even though the Federal Reserve is now 18 months into a tightening cycle, the recent decline in the St. Louis Fed Financial Stress Index suggests monetary policy in the United States is far from tight. The Fed still has plenty of work yet to do to normalize interest rate policy, especially in light of tightening labor market conditions and most inflation measures at or above the Fed's 2% target. We expect the Fed to maintain its path towards tighter monetary policy until financial conditions finally begin to feel the effects.

Tags: Chart of the Week | Federal Reserve | Volatility | Monetary policy | Interest Rates | Fixed income | Yield spreads | Financial Stress Index

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This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.  This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.

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