Financial conditions continue to deteriorate as uncertainty and volatility creep back into the equity, bond and money markets.
The five-week drop in our RSM US Financial Conditions Index, which was designed to capture the impact of increased risk in the financial markets, implies slowing economic growth in the coming quarters.
This change is in line with the Federal Reserve’s stagflation-lite forecast linked to uncertainty around tariffs and their impact on the economy and financial markets.
Those risks are likely to stimulate an increased bout of risk aversion, which may create a self-perpetuating negative feedback loop until investors, businesses and other decisionmakers can ascertain the new rules of the road on trade and global finance.
The money markets are showing their first signs of caution as investors position themselves for a potential large trade shock that causes slower growth, higher inflation, higher unemployment and reduced productivity.
Read more of RSM’s insights on the economy and the middle market.
In the longer term, the bond markets are dealing with an increase in volatility and are factoring in the potential responses by the Federal Reserve to the uncertainty regarding growth and inflation.
The perceived timing of further rate cuts or hikes will have a direct effect on the front end of the yield curve, while the slowing in the Fed’s quantitative tightening program—the runoff of Treasury securities will slow to $5 billion per month—will most likely have a more moderate impact on longer-term bond yields.
Two-year bond yields dropped by 6 basis points after the Fed’s announcement on Wednesday, while 10-year yields dropped by 4 basis points.
The most visible story, however, has been the equity markets that have given back the gains made since last November and then some as investors attempt to ascertain risks to the outlook.
Most impactful were the drops in the tech-centered Nasdaq index, which by March 14 had lost more than 14% of its value after peaking in mid-December, and in the Russell 2000 index of small-cap corporations that had lost 18% of its value since its peak in late-November.
It remains to be seen if the shock of the loss of wealth becomes a loss of confidence in U.S. financial assets.
