Endgame for Fed's tightening cycle challenged by easing financial conditions
By Michael S. Derby
(Reuters) — Less tight financial conditions as exhibited by the red-hot stock market may increase the chances that the Federal Reserve hikes rates again before the end of the year, some economists reckon, even as financial markets put little odds on that happening.
Several measures of financial conditions, including those mceproduced by the central bank, have shifted in way that signals reduced restraint on the economy, at a time when central bank officials believe more work may be needed to lower inflation.
Taking in to account everything from stock prices to measures of borrowing costs for the government, businesses and households, financial conditions matter to monetary policy. That is because the Fed relies on markets to transmit changes in its short-term interest rate target to the broader economy.
The current slackening in these gauges means markets and the Fed are starting to go on separate paths.
“Easy financial conditions obviously boost near-term growth,” and can encourage more risk-taking of the sort that can lean against the restraint the Fed is trying to impose on the economy, said Benson Durham, head of global policy at Piper Sandler.
On Friday, the Federal Reserve reported that its Financial Conditions Impulse on Growth for June moved to 0.458, from May’s 0.603 reading. The index, now the lowest since August 2022, seeks to describe whether financial conditions are aiding or restraining growth, so the latest reading points to them providing less drag on the economy.
Meanwhile, Goldman Sachs’ closely watched Financial Conditions Index has been easing fairly steadily since May. As of the end of July, that measure was also at levels last seen in late August of last year, while the
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