Financial market conditions were becoming less accommodative last year, but the trend reversed course this year, according to a chart published by the International Monetary Fund in conjunction with its spring meeting.
The chart shows movements in a financial conditions index for the U.S., including interest rates, house prices and corporate valuations.
The chart shows that the steady and slow rise in U.S. central bank interest rate hikes began to bite in 2018 and financial market conditions became less stretched. Then, in the fourth quarter, the market selloff left financial market conditions as close to restrictive as they’d been for three years.
However, just as quickly, financial market conditions have eased this year, as the central bank pivoted to a “patient” monetary policy.
Read: IMF worried financial conditions could change abruptly
The central question for the Fed is will this trend toward easier financial market conditions continue as they hold off rate hikes?
In fact, U.S. equity valuations are much less stretched in the first quarter, despite the easing financial conditions, a separate IMF chart showed. At the moment, equity prices DJIA, +0.26% SPX, +0.05% in most major markets seem close to fair values, the IMF chart shows, using an equity valuation model including expected future earnings, earnings uncertainty and interest rates.
That’s because the bond markets has contributed to the easier conditions seen this year. Treasury yields have not recovered as quickly as equities from the market turmoil of the fourth quarter. The yield on the 10-year U.S. Treasury note TMUBMUSD10Y, -0.14% is about 67 basis points lower than its recent peak seen last fall.
Still, a top IMF official has suggested that stretched asset valuations may force the central bank to raise interest rates to promote financial stability even with inflation low.
Read: Why a senior IMF official fears the Fed may at some point need to hike rates.