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U.S. financial conditions tightening due to equities rout

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U.S. financial conditions have tightened in recent days as investors have pulled back on riskier assets, causing the S&P 500 to shed 4.3%, the Dow Jones Industrial Average to drop 3.32% and the NASDAQ to fall 6.1% over the past three trading sessions.

As these conditions have tightened, the risk to the economy has grown.

The Bloomberg Financial Conditions Index is now roughly .285 standard deviations below neutral, and the Bloomberg Financial Conditions Index Plus, which includes housing and technology, stands at neutral.

This implies that there is a modest to neutral drag on overall growth conditions heading into the last month of the current quarter. We have warned for some time that the domestic equity markets were overbought and that the over-concentration of wealth in both the markets and the economy implied a risk to the outlook should investor sentiment shift rapidly.

Much of this is likely because of a pullback on shares in the tech-heavy NASDAQ and in the S&P 500, where a small number of stocks comprise a quarter of the indexes’ value. The over-concentration of wealth in such a small number of equities denotes some risk of further declines should investors fear further derivative-based losses in complex options markets.

Tightening financial conditions imply a modest to neutral drag on overall growth…

The Japanese firm SoftBank, which bought roughly $4 billion worth of options tied to shares of large U.S. tech companies, saw a decline in its share prices of roughly 7% in overnight action. Based on current valuations, that decline wiped out more than $8 billion in market value.

Given that domestic financial conditions have been a tailwind to the nascent U.S. economic rebound in the current quarter, the evolution of the domestic financial markets demands attention in the coming days.

So far, this decline appears to be confined to the equity markets as both the interest rate and commodity complexes have behaved quite well during the end-of-summer trading sessions.

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About Joseph Brusuelas

@JoeBrusuelas

Joe Brusuelas, “chief economist to the middle market,” is the preeminent voice championing issues and policies facing midsize companies in the United States and around the world. An award-winning economist, Brusuelas has more than 20 years’ experience analyzing U.S. monetary policy, labor markets, fiscal policy, international finance, economic indicators and the condition of the U.S. consumer.

A member of the Wall Street Journal’s forecasting panel and the UCLA Anderson School of Management's Board of Directors, Brusuelas regularly briefs members of Congress and other senior officials regarding the impacts of federal policy on the middle market and the factors by which middle market executives make business decisions. He also frequently offers his insights on the U.S., Canadian and global economies in the financial media. In 2020, he was named one of the 100 most influential economists by Richtopia. In December 2023, Brusuelas and the economics team were recognized on Bloomberg's list of Best Bond Forecasters after correctly predicting where the benchmark Treasury would end the year.

Before joining RSM in 2014, Brusuelas spent four years as a senior economist at Bloomberg L.P. and the Bloomberg Briefs newsletter group, where he co-founded the award-winning Bloomberg Economic Brief. Earlier in his career, he was a director at Moody's Analytics covering the U.S. and global economies for the Dismal Scientist website. He also served as chief economist at Merk Investments L.L.C. and chief U.S. economist at IDEAglobal.

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