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Written by: Troy Bombardia
Investors and traders love to fixate on the absolute level of interest rates.
Instead, investors and traders should focus on how interest rates are impacting various aspects of the economy right now. Focus on the RELATIVE relationship.
The reality is that nobody knows when interest rates will start to impact the economy and stock market. But we certainly know that interest rates currently have a minimal adverse impact on the economy and stock market.
The Chicago Fed’s National Financial Conditions Index looks at U.S. financial conditions on a weekly basis. This Index has 3 components.
1. Risk Subindex . This looks at volatility and funding risk in the financial sector
2. Credit Subindex . This looks at measures of credit conditions.
3. Leverage Subindex . This looks at debt.
The National Financial Conditions Index ( NFCI ) and its components demonstrate that financial conditions are still too easy in the U.S. for a recession and bear market to start. Financial conditions need to tighten significantly before this equities bull market can end.
National Financial Conditions Index: conditions are too easy
The Financial Conditions Index is too low right now. Historical equities bear markets (1973, 2000, and 2007) started when the Index was at least 0. The Index is currently at -0.55.
In addition, historical recessions that led to “significant corrections” in the stock market also started when the Index was at least 0.
National Financial Conditions Risk Subindex: conditions are too easy
The Risk Subindex is too low right now. Historical equities bear markets (1973, 2000, and 2007) started when the Subindex was at least close to 0. The Subindex is currently at -0.76.
In addition, historical recessions that led to “significant corrections” in the stock market also started when the Subindex was at least close to 0.
National Financial Conditions Credit Subindex: conditions are too easy
The Credit Subindex is too low right now. Historical equities bear markets (1973, 2000, and 2007) started when the Subindex was at least close to 0. The Subindex is currently at -0.71.
In addition, historical recessions that led to “significant corrections” in the stock market also started when the Subindex was at least close to 0.
Conclusion: Financial Conditions going forward
Financial conditions will definitely tighten and deteriorate as the Fed raises interest rates. But financial conditions are still too easy to start a recession or bear market in stocks. You can see this fact through other data series. Banks are loosening their lending standards despite rising interest rates.
There’s no point in guessing “when” financial conditions will tighten enough to hurt the stock market and economy. It’ll happen sometime over the next 1-2 years. All we can do right now is know that financial conditions will remain easy for the immediate future. Take things one step at a time. Don’t try to predict 10 steps into the future. Predict the market’s next 1-2 steps.