Pro Perspectives 3/26/24






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March 26, 2024

Yesterday we talked about the Fed’s overly tight policy stance, and the downward pressure it puts on the economy.  And related to that, we looked at the recent percentage point decline in the Atlanta Fed’s Q1 GDP projection.

With that, let’s revisit the Fed’s new financial conditions index, which gauges the impact of financial conditions on future economic growth.

They just made an update to the index last week.  Let’s take a look …

Remember, this index is designed to incorporate the lags of monetary policy, and project (in this case) one-year forward what the impact will be on real GDP growth.

If the line is above zero, it’s a drag on growth (restrictive policy).  If it’s below zero, it’s a boost to growth (stimulative policy).  As you can see to the far right of the chart, it’s still projecting a drag on growth one-year forward. 

They introduced this “new” index back in June, and Jay Powell included a footnote directing attention to this index in a speech he made back in early December.  We discussed it in my December 4th note (here) and stepped through some analysis of the turning points of the index, and the subsequent return on stocks.

Here’s a revisit of that analysis: 

1) Financial conditions were at historically tight levels, as you can see in the chart above (“Oct ’23”).

2) Each of the periods in the chart that shared the characteristic of “historically tight levels,” were soon followed with some form of Fed easing (either rate cuts, QE, or in the case of 2015-2016 – walking back on projected rate hikes). 

And, 3) in each of the turning points in financial conditions, denoted in the chart, stocks did very well in the subsequent 12-month period — and small caps outperformed