Very Easy Financial Conditions

Now that the pandemic is within weeks of ending in the US and many of the innovation stocks have corrected sharply, it seems like the economy and markets are more normal than they had been in the prior 15 months. The market is never truly normal because there are always countervailing trends that will cause asset prices to be severely different in the following few years. However, the last 15 months have been much more unusual than normal dislocations.

Despite the global pandemic, shutdowns, and reopenings, the craziest factors were Fed policy and record-breaking retail investor participation in the market. The Fed had never bought corporate bonds; free addicting stock trading apps that encourage everyone to follow hot stocks were never this popular. We haven’t mentioned how addicting the apps are prior to this. You can argue that having a clunky UI is a feature because it discourages over-trading and checking your stocks multiple times per day.

While the market is adjusting to the post-pandemic world, the Fed still has a recession-type policy in place. Many critics believe the Fed should pull back since markets have recovered and the pandemic is close to done. On the other side, the Fed believes it must maintain extreme policies ($120 billion QE per month & 0% Fed funds rate) until the labor market reaches full employment. It’s tough to determine the Fed’s impact on markets. You can’t say the Fed caused x% of the stock market’s increase last year. However, we can say for sure the Fed has strongly impacted the financial conditions index.

As you can see from the chart above, the financial conditions index is near its 10 year low. This implies conditions will probably tighten within the next few quarters which would be in line with the Fed ending QE and potentially hiking rates thereafter. Some investors believe that as the Fed turns more hawkish, stocks will be a sell. That’s dramatically incorrect. The Fed has already gotten more hawkish in the past 6 months.

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Disclaimer: The content in this article is for general informational and entertainment purposes only and should not be construed as financial advice. You agree that any decision you make will be ...

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