Financial Stress In U.S. Financial Markets Remains Low By 3 Statistical Measures, And Has Been Trending Downward

Includes: DIA, QQQ, SPY
by: Mark J. Perry

The charts above show three different statistical measures of financial stress that were released this week by the Federal Reserve district banks of Chicago (weekly), St. Louis (weekly) and Kansas City (monthly). None of these three financial stress indexes are suggesting any conditions in the financial markets that would indicate that the U.S. economy is in a recession already, and none of them are exhibiting any upward trends that would point to a pending recession. In fact, all three stress measures have been trending downward through 2012, indicating that there is less financial stress now than at the beginning of the year. Here are descriptions and more details for each stress index:

1. The St. Louis Fed Financial Stress Index (STLFSI) is calculated using the principal components procedure based on 18 weekly data series that include seven interest rates, six yield spreads, and five other financial variables. For the last nine weeks, the STLFSI has been below zero (lower values indicate less stress, see blue line in top chart), and has generally been trending downward for the last year. The current measure of financial stress for the week ending last Friday at -.194 is below the historical average of zero.

2. The Chicago Fed National Financial Conditions Index (NFCI) is based on 100 financial indicators consisting of 47 weekly, 29 monthly, and 24 quarterly variables, and has proven to be a highly predictive and robust indicator of financial stress at leading horizons of up to one year. Empirical analysis indicates that the NFCI is 95 percent accurate in identifying historical crises contemporaneously. Increasing risk, tighter credit conditions and declining leverage are consistent with tightening financial conditions are associated with positive values for the NFCI, while negative values indicate the opposite. The NFCI has been negative for the last three years, and has been trending downward for the last year (see red line in top chart). At -0.71 for the first week of November, the NFCI is well below its historic average of -0.40.

3. The Kansas City Fed Financial Stress Index (KCFSI) is a monthly composite index of 11 financial variables (yield spreads and asset prices) and the KCFSI is calculated using the principal components analysis. According to Thursday’s press release, the Kansas City Financial Stress Index for the month of October continues to indicate that financial stress in the U.S. financial system remains low. The October KCFSI was -0.40 in October, a slight increase from September’s index, but below its long-run average of zero. For the last nine months starting in February, the KCFSI has been negative (lower values indicate less financial stress), and the general trend over the last year has been downward.

Bottom Line: Based on statistical measures of financial market stress from three district Federal Reserve banks, financial stress in the U.S. financial system remains low through the end of October (for the monthly KCFSI) and into the first week of November (for the weekly indexes). Past recessionary periods have been associated with rising index values for all three financial stress indicators, and we’re now seeing the opposite – all three indexes have been trending downward for the last year. Taken together, these three stress measures provide no evidence that the U.S. economy is in recession now, and no evidence that a recession is pending.