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Financial Conditions and implications for the Fed, RBA

• Will tighter financial conditions stemming from the failure of recent banks offshore (e.g. SVB) see central banks contemplate pausing earlier? To help answer this question in this Weekly, we update financial condition indices for Australia and the US and outline the competing influences from financial stability and price stability.
• Our assessment is that while headline Financial Conditions Indices (FCIs) based on market measures have moved higher, they have not tightened materially. In the US, a fall in yields has offset a move higher in credit spreads to leave conditions higher than at the start of February but below their recent highs in October 2022, while equity markets have not sold off. Market-based FCIs of course do not immediately capture changes in bank lending appetite or standards, where the largest implications of the recent banking developments are likely to be evident.
• For central banks:
  • Inflation globally is too high and so far demand remains resilient. With possible financial stability concerns, central banks will be evaluating whether other policies that can protect against financial stability risks are sufficient, and if so  that would leave monetary policy being able to focus on getting inflation down
  • If financial stability concerns in themselves dominate monetary policy, then interest rates may not get to a level sufficiently restrictive to get inflation to target. Of course a tightening in financial conditions can do some of the work for central banks. Our market-based measures they have not tightened materially, though it will be important to monitor bank lending channels.
• NAB expects the FOMC to increase rates by 25bp this week, although a pause would not be a surprise if markets remain under stress. The RBA has the benefit of distance from the direct impacts and 2 weeks before its April meeting. Markets have moved sharply, re-pricing the outlooks for the Fed and RBA.
• Absent a broadening of banking stresses, the primary channel for recent developments to impact the path for policy looking forward is through the impact of tighter bank lending on activity (and in-turn inflation). With the US more directly impacted, that should lower the path for US rates more than that for Australia, even if both turn out to be lower than they otherwise would have been.

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