A new Goldman measure of financial stress — Financial Stress Index or FSI — said that while conditions had tightened, they remained "at a relatively normal level by historical standards." (Credit: Knut/Adobe Stock)
If much of the financial news has been like a reissue of Chic's disco hit "Le Freak" with the repeating chorus of "Freak out," a new client note from Goldman Sachs Economics Research suggests it's time for some historical calm.
The past week has been volatile and painful for many. From Friday, equities sold off about 5% and the 10-year Treasury yield was down 21 basis points. The Goldman Financial Conditions Index (FCI) growth impulse model suggested the effect on GDP growth would be a net -12 basis points. Also, every 10% sell-off would cut GDP growth by an estimated 45 basis points. Add other asset classes that move with equities and the total might be -85 basis points.
However, a new Goldman measure of financial stress — Financial Stress Index or FSI — said that while conditions had tightened, they remained "at a relatively normal level by historical standards." The Goldman FSI is similar to financial stress indices from the Federal Reserve Banks of St. Louis and Kansas City but is available daily instead of weekly or monthly. There is also more detail on the Treasury market.
The major drivers of the tightening have been expected volatility in equities and bonds. Look at short-term assets like 1-month, 2-month, and 3-month Treasurys and the yields are fairly stable.
"So, while market stress is noticeably higher than a week ago, our FSI suggests that there have been no serious market disruptions to date that would force policymakers to intervene," Goldman wrote.
Conditions have continued to vary since Monday. What had looked like rebounds for the S&P 500, Dow Jones Industrials, and Nasdaq petered out. All three are roughly where they were on Monday's close after the Friday jobs market disappointment. Yields on the 10-year Treasury are moving back to 4%, meaning bond prices are dropping. As CNBC reported, traders are pricing in a 60% chance of the Fed cutting rates by 50 basis points in the September meeting.
Another factor not mentioned so much has been shocks from the carry trade. The carry trade is the practice of borrowing money in a low-interest-rate market and investing it in a higher-rate market. It's like financial arbitrage, profiting off the difference in conditions between two markets. Japan has been one of the main markets in the carry trade because of its long-term low rates but the Bank of Japan has raised rates to 0.25%. Not high compared to most of the world, but enough of a change to likely force many traders to sell assets so they could close out positions.
While conditions may seem chaotic, according to Goldman, they probably aren't that bad.
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