The chart above shows two different weekly, statistical measures of financial stress that were updated this week by the Federal Reserve district banks of Chicago (National Financial Conditions Index, red line) and St. Louis (Financial Stress Index, blue line). As the year comes to a close and we approach the fiscal cliff, neither of these two 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 neither of them is exhibiting any upward trends that would point to a pending recession. To the contrary, both financial stress measures have been trending downward through 2012, and both have fallen back to pre-recession levels, indicating that there is less financial stress now than at any time since 2007. The Chicago Fed National Conditions Index is now at the lowest level since May of 2007, the St. Louis Fed Financial Stress Index is at the lowest level since August 2007.
Here are descriptions and more details for each stress index:
1. 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 since mid-2011 (see red line in chart). The current reading of -0.82 for the week ending December 14 indicates that financial stress is at the lowest level since the week of May, 11, 2007.
2. 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 15 weeks starting in September, the STLFSI has been below zero (lower values indicate less stress, see blue line in chart), and has generally been trending downward for more than a year. The last time the STLFSI measure of financial stress was this low was in early August 2007.
Bottom Line: Based on these two weekly statistical measures of financial market stress from the Federal Reserve District Banks of Chicago and St. Louis, the stress in the U.S. financial system has returned to the pre-recessionary levels that prevailed in 2007. Past recessionary periods in the U.S. have been associated with rising index values for both of these financial stress indicators, and we’re now seeing the opposite – both indexes have been trending downward for more than a year, and both are now at their lowest levels in more than five years. Neither of these financial stress measures provides any evidence that the U.S. economy could be on the front end of a recession, and in fact both indexes indicate that stress in the U.S. financial system is now below the historical average for both measures.