From Morgan Stanley U.S. Interest Rate Strategist Matthew Hornbach:
We pay very close attention to the Chairman’s references to financial conditions. We believe that they are the main driver of policy action in the current environment where the Fed is missing on both of its mandates. Financial conditions have been shown to influence economic behaviour and the future state of the economy; therefore, we believe that they help shape the economic outlook as well as the risks surrounding the outlook. As financial conditions tighten – as they have been – not only do the risks to the Fed’s economic outlook worsen, but the chances increase that the Fed revises its outlook downward.
Hornbach pointed to these quotes from Ben Bernanke’s June 20 press conference:
I wouldn’t accept the proposition, though, that the Fed has no more ammunition. I do think that our tools, while they are nonstandard, still can create more accommodative financial conditions, can still provide support for the economy, can still help us return to a more normal economic situation.
But I do think that monetary policy still does have some capacity to strengthen the economy by easing financial conditions.
“The market is laser-focused on the outcome of the July- August FOMC meeting, given the continued poor run of economic data which culminated in an advanced reading on second quarter real GDP at +1.5%,” wrote Hornbach.
The Federal Open Market Committee will meet on Tuesday, July 31 and publish its statement on Wednesday, August 1.
However, Hornbach thinks its highly unlikely that the Fed will announce any new easy monetary policy at the time.
From Hornbach’s latest note:
We assign a 20% probability to FOMC action on August 1. Our Financial Conditions Index (FCI) shows only slightly tighter levels relative to the June 19-20 FOMC meeting. We expect the FOMC will require much tighter financial conditions relative to the June 19-20 FOMC meeting before deciding to implement another “substantive” program.
Here’s a look at Morgan Stanley’s proprietary Financial Conditions Index
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