One rant I’ve been meaning to have for a while concerns the idea that US monetary conditions remain extremely accommodative. (Warning, incoming thread)) 1/
This conclusion tends to be based on the traditional use of financial conditions indices, which are the analytical equivalent of a chocolate teapot/ Arsenal central defender. 2/
Empirically, US FCIs have tended to be best viewed as contrary indicators for the US business cycle, as was borne out by their performance during the GFC. 3/
The GS US FCI was at its point of max accommodation on 31st Oct 2007 (which should supposedly be positive for future growth) and was at its maximum level of restrictiveness (when the growth outlook should be most bearish) on 9th March 2009. 4/
It’s not hard to see why FCI’s are such poor predictors of demand. In their construction short-rates are downplayed in favour of 10yr yields. This is consistent with those that talk of the UST10yr being the critical US interest rate for growth…5/ 
…but 10yr USTs and the shape of the UST curve are critically a function of the level of short-rates in relation to the neutral rate. (This spread is in my view the best macro guide to the UST slope going back to the mid-1990s)… 6/
…as such when policy rates start to bite, the 10yr yield tends to be anchored if not moving lower, which provides a misleading signal via FCIs that broad financial conditions are loose. 7/
The current US market embodies this issue, with the Fed Funds arguably 1 hike away from neutral (assuming a 25bp upward impact on neutral due to fiscal easing) and, unsurprising, the curve flat in spot and esp in forward space. 8/
Focussing on the FCI could therefore provide an illusory form of comfort regarding monetary conditions and could also understate the downside risk to US growth once the incremental momentum of fiscal easing tapers off. 9/
Another way to look at current monetary conditions is to take the mkt’s rather than the Fed’s estimate of where the current neutral rate is. 10/
This chart shows the USD inflation swap 5fwd 5yr real yield which is the mkt’s live estimate of the neutral rate (and closely tracks the Fed’s Laubach-Williams estimate). The 2yr real yield is a proxy for expected monetary conditions. 11/
The chart shows that earlier this yr, the re-pricing of US interest rates saw the mkt price-in neutral-to-restrictive monetary conditions for the first time since the GFC. In essence, the mkt has priced out the tail-wind of Fed accommodation 2 yrs fwd. 12/
In my mind, this helps explain some of the pick-up in mkt vol events in 2018 and also makes me worried about the impact on risk mkts were we to see another upward pricing of US rates and a move into further restrictive territory. 13/
It also raises the bar on whether the Fed has learned the lesson from it’s past cycles and this time is able to avoid over-tightening based on flawed FCI concepts. 14/
