The St. Louis Fed’s Financial Stress Index rose noticeably in the August 9 week to -1.233 after -1.355 in the prior week and returned to levels seen in June before it was clear that the Fed was going to lower short-term interest rates. At present, the heightened uncertainty was from belligerent talk regarding trade policy with China and the branding of China as a currency manipulator. Markets were concerned about the rhetoric sparking a currency war. Some of that talk has eased off in the current week, but fears of greater likelihood of recession are more pronounced in this week.
Equity markets have walked back the gains seen in July and bond markets saw yields decline sharply as investors fled to safer havens. The inversion of the 3-month/10-year yield curve in the August 9 week was the largest since March 2007 when the credit crisis was fully evident. While the 2-year/10-year yield had not inverted last week, it was as close as it has been since early 2007.
For the moment, overall stresses in financial markets are low, but the risks of a recession appear elevated and could lead to further erosion of conditions.
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