The Fed’s Finacial Stress Index Is At All-Time Lows!! Is This The Quiet Before The Storm?
What Is This Index Telling Us?
The St Louis Fed’s Financial Stress Index weighs 18 weekly data variables (7 interest rates, 6 yield spreads, and 5 other measures) to purportedly gauge the level of stress in the financial system. That it currently stands at (by far) its lowest level since calculations began in 1994 beggars belief, given the presence of an array of economic challenges, most notably inflation and rapidly rising interest rates.
Why does this indicator suggest financial stress is low? It is difficult for us to fathom. Perhaps interest rates are still at such low levels that they are not yet deemed to present a serious risk. Perhaps the lack of investor concern (yield spreads and the VIX are variables considered) has mitigated the apparent risk. Perhaps the current recession is not yet sufficiently developed to exert enough of a negative influence to turn the indicator higher. Lastly, perhaps the indicator is telling us that our concerns are misguided and that we are living in the best of times.
We are still inclined to believe that the various measures have yet to catch up with the economic reality and that they will ultimately turn and push the Index considerably higher.
One of the lessons we’ve learned from our years as a money manager is to pay attention to extreme points on charts because they often serve to precede important trend changes. So, it may be in this case, that we may expect the Index to rise as the current recession takes hold.
For investors, we think this very benign appearing chart is more a worry than a comfort, for it reflects an elevated level of optimism that eventually results in significant market volatility.
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