In This Article:
(Repeats Wednesday item)
By Jamie McGeever
LONDON, Oct 16 (Reuters) - It sounds counterintuitive, but the recent slide on Wall Street will be met with some relief at the Fed as long as it remains a 'correction' and doesn't morph into a panic-fueled rout.
U.S. financial conditions had become surprisingly loose as the surge in stocks to new highs more than offset the parallel rise in bond yields and the dollar.
By some measures, U.S. financial conditions just before the recent equity selloff were the easiest in almost quarter of a century, a red flag for policymakers concerned about the build up of leverage and risk-taking in the financial system.
The Chicago Fed's National Financial Conditions Index had fallen to -0.89 in the week ending Oct. 5, the lowest since January 1994. By this measure, the availability of, and access to, financing had never been easier in nearly 25 years.
Given the well-documented rise in U.S. bond yields and the dollar in recent months, that is remarkable.
"Near-term risks to global financial stability have increased somewhat," the IMF said last week. "Overall, market participants appear complacent about the risk of a sharp tightening in financial conditions."
According to the IMF, financial conditions "generally refer to the ease of obtaining financing". They reflect the "costs, conditions, and availability of domestic funds to the local economy".
The selloff on Wall Street in the first two weeks of October wiped as much as 10 percent off the three main indices, injected some two-way risk into markets, and cooled investors' euphoria.
According to economists at Morgan Stanley, U.S. financial conditions tightened by about 10 basis points last week, and have tightened by about 50 bps since the end of September. Around half of that 50 bps increase is a result of lower equity prices.
Erik Nielsen at Unicredit estimates that the combination of a 10 bps rise in long-dated bond yields and a 5 pct drop in the S&P 500 is a tightening in financial conditions equivalent to a quarter percentage point rise in interest rates.
Since Oct. 3, the 10-year Treasury yield rose as much as 20 bps and the Nasdaq fell by as much as 10 pct, suggesting the cumulative tightening effect could have been equivalent to around a half-point rate rise.
In that time, high yield credit spreads also widened by around 30 bps and investment grade corporate spreads widened by up to 10 bps. Analysts agree that this is well within healthy correction territory - equities were coming off very high levels and spread widening were coming from relatively low levels.