The US Federal Reserve (Fed) is raising interest rates at the most aggressive pace in a generation, but financial conditions that need to be tightened to curb soaring inflation are out of whack. Rising U.S. corporate stocks and falling government bond yields following the Fed’s June interest rate hike mean that financial conditions are indeed improving, even though the U.S. economy has been hit by combined rate hikes—cumulatively around 150 base rates during that period. points. session and next. Financial conditions show the presence of finance in the economy. They dictate the spending, savings and investment plans of businesses and households, so central banks want to tighten them to curb inflation, which is now well above the target level. The widely watched US Financial Conditions Index (FCI), which is compiled by Goldman Sachs and measures borrowing costs, stock price levels and exchange rates, has fallen by about 80 basis points since the Fed’s June meeting. A similar indicator from the Federal Reserve Bank of Chicago, which tracks financial conditions regardless of prevailing economic conditions, turned negative, suggesting that conditions are weaker than the current picture of the economy usually depicts. In the eurozone, conditions also improved by about 40 basis points, according to Goldman Sachs.

Despite the Fed’s rate hike.

“Going back to June, we thought that economic conditions in the United States were broadly where they needed to be to create the necessary slowdown to get activity, wage growth and inflation back on target,” said Daan Strueven, chief global economist. at Goldman Sachs. “Our best guess is that they probably relaxed too much.” The change in conditions is driven by recessionary fears, which have prompted markets not only to scale down the rate hike they expect from the Fed, but also to factor in a reduction in borrowing costs in 2023. In addition, Fed Chairman Jerome Powell’s statements following the July rate hike were taken by investors as a transition to restraint. Money markets are finally now expecting the Fed’s cost of borrowing to stall at around 3.6% per annum in March, compared to the +4% expected before the June hike.