THE ST. LOUIS FED FINANCIAL STRESS INDEX

AM | @agumack

Economists at the Federal Reserve Bank of St. Louis have developed a 'Financial Stress Index' designed to track signs of distress in financial markets. This is just one among many so-called financial conditions indexes (see the list of components here). 

The STLFSI measures the degree of financial stress in the markets and is constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. Each of these variables captures some aspect of financial stress. Accordingly, as the level of financial stress in the economy changes, the data series are likely to move together.

We can build our own 'Financial Conditions Index' at the Finance Club. I would take some of the elements of the St. Louis Fed index, but I would give more weight to credit spreads—as opposed to the S&P500. In other words: it would look more like a credit/money market type of index. The idea is to track its behavior against stocks. I would include an FX component too, perhaps one the Fed's own dollar indexes. This is especially relevant in light of the interpretation of Germany's very low interest rates as a hedge against a eurozone breakup (*).

Also, I would include fixed-income ETFs, as we know that some investors are taking advantage of the liquidity in these instruments to hedge their positions, thereby reducing their reliance on the CDS market (which is more subject to regulations).

(*) Miles Johnson: "German bonds offer the best way to bet on a break-up of the euro", Financial Times, 10 January 2017.

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