Con­di­tions Have Gone From a Head­wind to a Tail­wind for the US : Gold­man

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New York: Re­mem­ber when fi­nan­cial con­di­tions were poised to serve as a drag on US growth? Or when the equiv­a­lent of three in­ter­est rate hikes had been de­liv­ered be­fore the Fed even went through with liftoff ?

Well times have changed, ac­cord­ing to Gold­man Sachs Group Chief Econ­o­mist Jan Hatz­ius.

In fact, Gold­man Sachs’ Fi­nan­cial Con­di­tions In­dex (FCI), which tracks equity prices, the US dol­lar, Trea­sury yields, and credit spreads, has de­clined to lev­els seen in Au­gust — right be­fore mar­kets were roiled in the wake of the de­val­u­a­tion of the Chi­nese yuan:

The think­ing here is that tighter fi­nan­cial con­di­tions crimp cor­po­rate bor­row­ing, net ex­ports, and consumer spend­ing, while looser fi­nan­cial con­di­tions are con­ducive to the re­verse. “This round trip in the level of the FCI im­plies a sharp im­prove- ment in the change in the FCI, a key short-term driver of the busi­ness cy­cle,” writes Hatz­ius.

This ex­er­cise shows how quickly sen­ti­ment can change in mar­kets, and the dif­fi­culty of mak­ing fore­casts — or set­ting mon­e­tary pol­icy-based on fi­nan­cial con­di­tions that can prove fleet­ing.

Crit­ics might ar­gue that the Fed over­re­acts to non- per­sis­tent price ac­tion, but on the other hand, per­haps it was the US cen­tral bank’s change of heart that laid the ground­work for this im­prove­ment in fi­nan­cial con­di­tions, help­ing to spark a wide­spread mar­ket rally. The jury’s still out on that front. Hatz­ius as­serts that some of the lack­lus­ter US data over the past few quar­ters should be seen through the prism of th­ese fi­nan­cial head­winds. The lagged ef­fect of this im­prove­ment in fi­nan­cial con­di­tions, if en­dur­ing, should be a net ben­e­fit for eco­nomic growth to the tune of about 0.25 per­cent­age points in 2017 — a huge swing from re­cent his­tory:

“In prac­tice, this cal­cu­la­tion is likely too pos­i­tive,” con­cludes Hatz­ius, who thinks that the Fed will hike rates on a quicker timetable than mar­kets are cur­rently pric­ing in. “Nev­er­the­less, we think fi­nan­cial con­di­tions have turned from a sig­nif­i­cant down­side risk to our growth fore­cast in early 2016 to a mod­er­ate up­side risk at present.”

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