The Big Idea

Gauging financial conditions in a noisy environment

Stephen Stanley | May 2, 2025

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

Most financial market participants would take it as given that financial conditions in the US have tightened considerably in recent weeks, as the Trump administration’s unpredictable tariff policy and brusque attitude toward its trading partners has generated concern that global investors could abandon dollar assets. Indexes of financial conditions did indeed tighten considerably in early April but have already partially reversed. What remains to be seen is whether the fallout from Liberation Day will prove to be fleeting or will have a lasting impact.

Monetary environment

Fed Chair Powell and other Fed officials have continued to argue that the current policy rate setting is restrictive. The last quarterly set of FOMC forecasts compiled in March showed that the median projection for the long-run funds rate was 3.00%, so the current target of 4.375%, while down from a peak of 5.375%, is still considered by the FOMC to be restrictive. Arguably, however, the Fed’s rate setting is not as tight as the committee believes, as I would peg the long-run neutral policy setting at more like 3.5%, and long-dated SOFR forward rates put it between 3.5% and 4%.

Financial conditions indices

Nonetheless, for some time, there has been a stark contrast between a policy rate setting broadly considered to be at least modestly restrictive and favorable broad financial conditions. Looking at several different financial conditions indices offers insight into how this dissonance nets out. Two of the favorites of financial market participants are the Bloomberg and Goldman Sachs financial conditions indices. Both are relatively simple indices that consist of a handful of market indicators and are updated daily. The Bloomberg index includes a few money market spreads, several bond spreads, and, for equities, the S&P 500 and the VIX. The Goldman index, meanwhile, is a weighted average of short-term and long-term interest rates, the trade-weighted dollar, credit spreads, and a P/E ratio for stocks.

The GS index—100 is neutral, up is tight, down is easy—suggests that financial conditions were historically easy in 2021, when the FOMC was still conducting QE and before it began raising rates (Exhibit 1). This gauge tightened considerably in 2022, leveled off for much of 2023, tightened significantly that fall, and then settled into a modestly easy range throughout 2024 and early 2025.

Exhibit 1: Goldman Sachs U.S. Financial Conditions Index

Source: Goldman Sachs, Bloomberg.

For all of 2024, the GS index averaged 99.15. It showed that financial conditions began to tighten in late February, likely around the time that investors realized that President Trump was serious about imposing large tariff increases. The index rose (tightened) by about four tenths of a percentage point over the course of March and then spiked by nearly a full point between April 2 (Liberation Day) and April 8.

The measure fell by over a half a percentage point on April 9, the day that Trump announced a 90-day pause on reciprocal tariffs because financial markets had gotten “yippy.” By the end of April, the GS gauge was running at 99.44, about where it was at the end of March and only modestly tighter than last year’s average. The level of the composite suggests that, for now, financial conditions are still modestly easy by historical standards.

For the Bloomberg gauge, up is easier and down is tighter (Exhibit 2). Zero represents average conditions over the period from 1994 to July 1, 2008, and the index is scaled so that +1 represents one standard deviation easier than the mean and -1 represents one standard deviation tighter.

As the graph shows, this index tends to be far more volatile than the GS index. It tightened far more in the spring of 2023, when SVB and other banks ran into trouble, and in early August 2024, when the markets underwent a brief spasm associated, at the time, with an unwind of the carry trade. And the move in recent days was drastic. For the Bloomberg gauge, the 2024 average was +0.9, i.e., financial conditions were easier than the historical average by nine tenths of a standard deviation.

Exhibit 2: Bloomberg Financial Conditions Index

Source: Bloomberg.

As with the GS measure, the Bloomberg index remained in that range through mid-February and then began to tighten. By April 2, Liberation Day, the composite had moved to close to zero. Then, over the course of the next six days, it sank to a low of -1.58, indicating that financial conditions had tightened since mid-February by 2.5 standard deviations.

The Trump reversal on April 9 boosted the index by about eight tenths in a single day, and it continued to improve over the balance of last month, ending April at -0.22.

These two gauges show important differences over the recent episode. The Bloomberg index has tightened by more on balance over the past two months than the GS measure. It also sits on the tight side of the historical average, while the GS gauge is still signaling modestly easy financial conditions. I suspect that one important reason for the differing behavior of the two aggregates is that, unlike the Bloomberg version, the GS basket includes the trade-weighted dollar. A sharp weakening in the dollar in recent weeks has provided a partial offset to the impact of tighter domestic conditions.

Chicago Fed Financial Conditions Index

Chair Powell and other Fed officials have repeatedly noted when they discuss the topic that they like to take a broad view of financial conditions, spanning more than just a single indicator like 10-year Treasury yields or stock prices. A financial conditions index that closely replicates that approach is the Chicago Fed National Financial Conditions Index. This composite, my favorite measure of financial conditions, casts a far wider net, including 105 measures of financial activity. In addition to a large number of market-based prices and spreads, this index includes many other variables, such as responses from the Federal Reserve Board’s Senior Loan Officer Survey, the NFIB small business survey, and the University of Michigan survey of consumers. As a result, unlike the other two measures, this index does not update daily. Rather, it is calculated weekly (with revisions), and a number of the components are reported even less frequently (at the extreme, the Senior Loan Officer survey is conducted only once a quarter). Thus, its drawback Is that it is not as timely as the other two gauges.

In any case, the Chicago Fed National Financial Conditions Index is shown in Exhibit 3. For this measure, up is tighter and down is looser, with 0 representing the long-term median of conditions and, like the Bloomberg composite, it is scaled to standard deviations. The chart shows that by this measure, financial conditions steadily loosened from late 2022 through early 2025, with a brief hiccup during the bank failures in the spring of 2023.

Exhibit 3: Chicago Fed National Financial Conditions Index

Source: Chicago Fed.

Unlike the other two gauges, which are based purely on financial market prices and spreads, this index takes a longer view. For that reason, it is fair to say that it may not yet be fully reflecting the fallout from the events of April. For example, if the Fed’s Senior Loan Officer survey records a sharp tightening of lending standards in the second quarter, we would not see that until August, at which time, the Chicago Fed readings for the second quarter would presumably be revised. With that caveat, it is worth noting that this broader gauge has deteriorated by far less so far than the more volatile daily indices. In late April, it had tightened by about two tenths of a standard deviation from early in the year and was at a level that is less than one tenth of a standard deviation tighter than the 2024 average.

Short-term versus long-term

The indices discussed in this piece suggest that financial markets have largely weathered the tightening in conditions seen in early April, reversing much of the sharp moves recorded during that week. This is good news for the moment. However, the economic fallout from tariffs, both in terms of a drag on activity and a boost to prices, is yet to come. Moreover, it is an open question whether the attractiveness of U.S. assets to global investors will take a persistent hit on the back of President Trump’s aggressive trade strategy. Thus, investors may be able to take a deep breath and relax for now, but no one should be considering a declaration of victory any time soon.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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