Easing US financial conditions put investors on alert – Financial Times

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US financial conditions have eased to their loosest levels in decades, according to numerous popular barometers, despite a shift in central bank policy that investors fret could have a consequential impact on markets.

Measures from the St Louis and Chicago Federal Reserves and a number of banks including Goldman Sachs show a rally in US stocks and weakness in the dollar, as well as ample access to credit, have helped ease business conditions and financial market stress.

Financial conditions refer to the impact of currency movements, bond yields, volatility, money flows and the stock market on the real economy.

With policymakers set to rein in bond-buying programmes and raise interest rates off historic lows, investors are agonising over how the shifts will filter back into markets and the economy.

“The liquidity provided by global central banks will still be positive, but significantly less than we’ve seen in the past,” said Joshua Lohmeier, head of US investment grade credit at Aviva. “A lot of people are worried that the Fed will get hawkish . . . If the Fed is hiking, do they run the risk of stalling [the economy]? Financial conditions are one of the first places you look to see that effect.”

Markers from the two regional Fed banks put financial conditions at their easiest since 1993.

The run-up in stock prices has been one of the primary drivers of the recent easing, according to Goldman, and follows years of central bank stimulus as policymakers worked to spur economic activity. About $14tn has been pumped into financial markets by central banks in Europe, the US and Japan since the financial crisis.

Economists with Deutsche Bank estimate the size of bond-buying programmes from the European Central Bank and Bank of Japan will be significantly reduced over the next year. At the same time, the Fed is expected to accelerate the unwinding of its $4.5tn balance sheet and raise interest rates this month.

Mona Mahajan, an investment strategist with Allianz, noted that the easing conditions have “been puzzling to the Fed”. Long-term corporate borrowing costs remain low, despite the US central bank having tightened policy.

Jeff Shen, BlackRock’s active equities chief investment officer, added that strong earnings growth from the corporate sector and easy financial conditions had given global central banks “a bit more leeway” to reduce their extraordinary stimulus.

“As long as it is done in an orderly fashion, global financial markets can absorb this quite easily,” Mr Shen said. “Clearly there is still the risk of a policy mistake that can introduce volatility . . . which will feed into financial conditions and which would be negative for the market.”

For others, including Jan Hatzius, Goldman’s chief economist, quickening economic growth and easy financial conditions are becoming a point of concern. The US economy expanded at its fastest pace since 2014 in the third quarter.

“The easing in financial conditions is starting to become too much of a good thing,” Mr Hatzius said. “There is a sense that the 4.1 per cent unemployment rate . . . is starting to become a sign that the economy is beginning to overheat.”


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