US economy

Charts of the Year: US financial conditions have ‘tightened considerably’


US financial conditions are loose overall but have tightened significantly over the past two years. This is often a bad omen for the economy.

Investors are focused squarely on the extent to which the Federal Reserve will raise rates next year. But a series of rises that began in 2015 is starting to have a more profound effect on overall monetary conditions as a sell-off in US Treasuries has picked up pace.

As Neil Shearing, chief economist at Capital Economics, points out in his Charts of the Year submission, it is often the rate of change, and not the absolute level, that “influences shifts in the real economy.”

The chart above highlights how the real US two-year Treasury yield, which takes into account inflation, has shot 2 percentage points higher since late 2016. In past episodes, this has frequently been followed by recession.

He explains (emphasis ours):

Much ink has been spilled on how close US interest rates are to “neutral”, but we shouldn’t lose sight of the fact that monetary conditions have already tightened considerably in the world’s largest economy. Real two-year bond yields in the US have now increased by more than 200 basis points since late 2016. And history suggests that it may be the change rather than the level of real interest rates that influences shifts in the real economy.

As [the chart] shows, there have been four previous occasions since the mid-1980s when real two-year yields in the US have increased by more than 2 percentage points within the space of two years — and three of these ended in recession. With the effects of this year’s tax cuts also likely to fade, we expect the US economy to slow sharply in 2019.

fastFT rounds up some of the biggest developments — along with analysis from investors and strategists — in its annual Charts of the Year series. Do you have a chart that you think should be included? Email fastFT@ft.com.



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