Saturday, March 23, 2024

Financial Conditions look excellent


Here’s a very short post to highlight the excellent shape of today’s financial conditions. At the very least this adds up to one important conclusion: there is NO shortage of liquidity, and financial markets are thus free to do what they do best: namely, to redistribute risk away from those that don’t want it to those who value risk. This is a very important function of free markets, since it reduces the market’s overall level of anxiety, thus minimizing the risk of disrupting influences and panic.

Chart #1

Chart #1 shows Bloomberg’s index of financial conditions. The components of this index are at the bottom in fine print, and they represent a comprehensive array of risk indicators. By this measure, today’s markets have almost never been so healthy.

Chart #2

Chart #2 shows corporate credit spreads, the difference between the yield on corporate bonds of different quality and Treasury yields of comparable maturity. Spreads have rarely been tighter than they are today, which adds up to a strong vote of confidence on the part of the market regarding the future health of corporate profits, and by extensions, the prospective health of the economy. 

I would only add that the Vix Index (aka the Fear Index) is about as low as it gets. We are living in “untroubled” times by these measures. 

9 comments:

  1. Plenty of liquidity despite an inverted yield curve
    https://fred.stlouisfed.org/series/BOGZ1FL193020005Q

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  2. What worries me from going more long equities here is the increase in centralized, arbitrary power globally. Seems there is a risk of instability geopolitically in that context and that Biden is too blame IMHO. Trump would hardly be stabilizing either. Until a third alternative seems likely, and I hope it will, we may have a correction at any moment.

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  3. "We are living in “untroubled” times by these measures"

    So clear blue skies and sunshine. Umbrellas must be cheap now. I maybe should buy one or two just in case the weather shifts.

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  4. Scott, I'm curious as to your comments on this article:

    https://www.ftportfolios.com/blogs/EconBlog/2024/3/25/welcome-to-state-run-capitalism

    I feel like Brian and Robert's perspective on the role of M2 in inflation lines up with yours, but they seem to be a little less bullish on whether we're out of the inflationary woods or not, and whether a recession in the next 12 months is inevitable or not.

    I think their comments on debt lines up with yours, however.

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  5. Re: we are living in "untroubled" times: Let me clarify that I am remarking here on the mood of the market, which is not necessarily the way I would characterize reality. In a sense, things are "priced to perfection," and thus I worry that the market is vulnerable to any sign that things are no longer perfect. In other words, when the market is just not worried at all, that is when I start to worry. I don't think a correction is imminent, but being a little cautious seems like a good idea at times like these.

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  6. Variant, re Brian Wesbury's outlook: I think the major difference between us is how to interpret the growth of M2. My view has been that we had a huge M2 bubble created in 2020-2021 that has since been deflating, and that's a good thing. The excess supply of money is being reduced, and that has disinflationary consequences. Brian sees the decline in M2 as a harbinger of recession; I don't. If anything, I see it as a harbinger of lower inflation and possibly deflation. Do I worry about deflation? Not necessarily, but any deviation from stable prices is problematic since that causes ripple effects throughout the economy, and that acts as a headwind to growth.

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  7. Scott - I'm of the view that prices are wildly distorted, mostly because of excess money printing (2020-2021) and the cascade of increasing government control/involvement and debt. I don't disagree AT ALL that inflation is as Milton said "always a monetary phenomenon". We haven't seen this type of gov direct intercession into the economy through gov debt expansion and FED printing since the 70's. The idea that JUST the FED tightening money supply back to a NORMAL 6% can fix the "effects" of distorted prices seems to stretch the bounds of logical reason. My fundamental belief is that price discovery is the MOST important aspect of a health economy and I believe we have unhinged price discovery from any REAL world data. It is gonna take a lot more than a sane-printing press (while I applaud) to get back to efficient capital allocation.

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  8. As Grannis said, when things are looking "untroubled", that's exactly the time for making an exit strategy for investments.

    The financial conditions indices I'm aware of are often in significant disagreement, and they seem to be "circular" and/or coincident indicators- i.e. they don't have much predictive value. They may have contrary predictive value at extremes.

    It seems that there is some kind of imbalance/dysfunction in financial conditions vs. borrowing costs. The Fed has to thread the needle between all the plumbing (that I don't understand): reverse repos, fed funds, QT/QE, etc.

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