MACRO AND MARKET PERSPECTIVES

A tale of tighter conditions

Dec 11, 2018

Financial conditions – which have tightened significantly since the summer – describe the changes in financial asset prices and the impact they have on economic growth. The more financial conditions tighten, the more they weigh on economic growth. The more they ease, the more they boost growth. Many existing measures of financial conditions are misleading, in our view – so we have created our own financial conditions indicator (FCI). It provides a measure of the impact that financial conditions are exerting on the growth outlook, as indicated by our BlackRock Growth GPS.

Highlights

  • The sell-off in financial markets since September has led to much tighter financial conditions. This – along with other factors such as slowing fiscal stimulus and trade concerns – impacts growth.
  • Our FCI suggests that the median Federal Reserve projection of four more rate hikes by the end of 2019 would tighten financial conditions enough to arrive at a sustainable level of growth – without the expected effects of other factors on growth.
  • The fading boost to GDP from fiscal stimulus – which alone could lower US GDP growth by 25-75 basis points – and trade tensions will together likely weigh on growth and reduce the requirement for Fed hikes, we believe. And another financial market sell-off would further tighten financial conditions.
  • Existing FCIs can be misleading, we believe. This is because unadjusted financial asset prices tend both to reflect growth news as well as drive growth news. After we apply our adjustments to rates and yields the FCI reaction is more as one would expect – an unexpected rise in rates and yields reduces growth expectations.
  • Our FCI also provides a more intuitive depiction of past financial episodes – it does a better job of picking up the tightening in conditions well before the financial crisis. But it is just one aspect affecting the monetary policy outlook.

Snapshot

The aim of our FCI is to provide a measure of the impact that financial conditions are exerting on the growth outlook – as proxied by the BlackRock Growth GPS. Tighter financial conditions suggest that growth in the US and Europe will likely decelerate in the coming twelve months. The sell-off in financial markets since the summer and ongoing Fed policy tightening would be consistent with US GDP growth slowing to just under 2.5% next year from almost 3% now. The market sell-off since September has alone caused a tightening in financial conditions equivalent to a 35 basis point decline in the US Growth GPS.

Chart: Tighter times
Jean Boivin
Global Head of Research, BlackRock Investment Institute
Jean Boivin, PhD, Managing Director, is Global Head of Research for the Blackrock Investment Institute and is a member of the EMEA Executive Committee.
Elga Bartsch
Head of Economic and Markets Research, BlackRock Investment Institute
Portfolio Manager and Head of Research for Diversified Strategies, BlackRock Multi-Asset Strategies