Despite ongoing calls for the Federal Reserve to slash rates, the American economy continues to show resilience: Growth is near its potential, unemployment is still low at 4.3%, inflation is rising but under control, and financial conditions remain conducive for investment.
In fact, the RSM US Financial Conditions Index continues to signal a moderate level of accommodation in the financial markets.
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The money and bond markets seem to have accepted the new status quo of a slowing labor market and increased spending, while the equity market appears to be discounting the potential impact of tariffs on corporate earnings.
The Fed is tasked not only with maintaining reasonable levels of inflation and employment, but also with facilitating the normal operation of the financial markets. This is accomplished by monitoring financial conditions.
If financial conditions become too restrictive (with rising risk levels inhibiting investment), the Fed is expected to lower the cost of credit by reducing its overnight policy rate.
If financial conditions become too lax (with not enough risk factored into investment), the Fed is expected to increase the cost of credit to cool excessive spending or speculative investment.
The Fed’s most recent assessment of the economy and financial markets in September suggested a gradual and modest resetting of its policy rate to address the downside risk to employment in an economy growing just below its potential.
All this remains subject to the deployment of tariffs and their impact on price stability, and the potential impact of a geopolitical shock on the more speculative equity market.
