Chart of the week

As financial conditions loosen, another hike ahead?

This week’s chart looks at why easing financial conditions—and stronger financial markets—may be problematic for the Fed.

June 2, 2023

Stocks and financial conditions

Source: Bloomberg Finance, L.P., as of May 31, 2023. The Bloomberg Financial Conditions Index gauges overall conditions in U.S. financial and credit markets; positive values indicate more accommodative financial conditions.

  • Investors cheered the likely passage of the bill to raise the U.S. debt ceiling, which removed a major macro risk that had been in place the past several months. Fed rate hikes, another macro risk, also faded as policymakers signaled they would likely hold the Fed funds rate steady at their June meeting.
  • While the debt ceiling debate is firmly in investors’ rearview mirror, the threat of additional Fed rate hikes is likely a more temporary relief. Inflation data continues to trend lower, yet services inflation remains stubbornly high, driven by resilient economic data and a strong labor market.
  • To this end, the prospect of another rate hike in July is very much in play as financial conditions have turned increasingly accommodative since the regional bank stress in March. As the chart shows, the Bloomberg Financial Conditions Index (orange line) is at its least restrictive point since September 2022, despite 500 basis points in Fed rate hikes over the past cycle.1
  • Rising markets and easing financial conditions place policymakers in a conundrum, clearly counteracting the Fed’s efforts to reduce inflation and increasing the likelihood of further rate hikes.
  • Against this backdrop, investors would be wise to remain prepared for additional volatility across equity and fixed income markets. A more active Fed could have substantial implications across investment styles and sectors. 

  • Bloomberg Finance, L.P., as of May 31, 2023. The Bloomberg Financial Conditions Index gauges overall conditions in U.S. financial and credit markets; positive values indicate more accommodative financial conditions.

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