Analysis-Loosening financial conditions threaten central bank inflation fight
The U.S. Federal Reserve is hiking interest rates at the most aggressive pace in a generation, but the financial conditions it needs to tighten to tame soaring inflation are heading in the wrong direction.
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A rally in equities and falling government bond yields since the Fed's June hike means financial conditions are actually loosening, despite the U.S. economy having been hit with a combined 150 basis points of rate hikes at that meeting and the next one.
Financial conditions reflect the availability of funding in an economy. They dictate spending, saving and investment plans of businesses and households, so central banks want them to tighten to help control inflation, which is now running far above their target levels.
A widely followed U.S. financial conditions index (FCI) compiled by Goldman Sachs, which factors in borrowing costs, equity levels and exchange rates, has loosened some 80 basis points (bps) since the Fed's June meeting.
A similar index from the Chicago Federal Reserve, which tracks financial conditions independent of prevailing economic conditions, has turned negative, implying conditions are loose relative to what the current economic picture would usually suggest.
In the euro zone, conditions have also loosened by about 40 basis points, according to Goldman Sachs, and money markets have priced out most of the 2023 rate hikes they had previously expected.