The Financial Stress Index is reported by the St. Louis Federal Reserve. It’s an important component of my Control Panel since it has spiked during periods that the stock market dropped and skyrocketed during the financial crises of 2008 and 2020. The series runs from 1994 to the present.
The Financial Stress Index began falling in January 2022 and is now at a historic low. This doesn’t seem right. The STLFSI3 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.
Since interest rates began rising at that time the index should be rising, not falling. Rising interest rates increase stress on stocks (by affecting corporate borrowing), on bonds and on mortgage rates.
I just learned that the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 established an Office of Financial Research (OFR) principally to support the Financial Stability Oversight Council and its member agencies. This is a completely separate government office that is independent of the Federal Reserve.
The OFR has its own Financial Stress Index. This covers 2000 to the present. The OFR FSI measures systemic financial stress — disruptions in the normal functioning of financial markets. Each variable in the index measures a feature of financial stress.
The OFR Financial Stress Index began climbing over the “normal” value of zero in January 2022. This is what I would expect to see in a rising interest rate environment with a stock bear market. The OFR FSI includes equity valuation and volatility and these have been rising. The level of stress is lower than during the European debt crisis of 2010-2011, and dramatically lower than the 2008 and 2020 financial crises.
I’m really puzzled as to why the St. Louis Fed FSI is dropping when it should be rising. I will add the OFR FSI to the Control Panel since it seems to be more reliable.
Neither FSI shows worrisome (let alone crisis level) financial stress. Just as the stock market has slipped into bear territory but could get much, much worse as it has in the past.
I will continue to monitor both of these FSIs in the Control Panel. If they both begin to rise rapidly together – hold onto your hat.