The Bloomberg U.S. Financial Conditions Index is a Z-score tracking the overall level of financial stress in the U.S. money, bond, and equity markets to help assess the availability and cost of credit. A positive value indicates accommodative financial conditions, while a negative value indicates tighter financial conditions relative to pre-crisis norms.
All indicators in the compositeindex are normalized by subtracting the mean and dividing by the standard deviation for each series. The mean and standard deviation are calculated from observations during the pre-crisis period, which is defined as the period from 1994 to July 1, 2008. The normalized values are then combined into the compositefinancial conditionsindex, which is itself normalized relative to its pre-crisis values. As such, the BFCIUS index is a Z-Score that indicates the number of standard deviations by which current financial conditions deviate from normal (pre-crisis) levels.
Factors behind the BFCI include:
1. the US Ted spread (difference between Libor and Tbills rate)
2. the Libor/OIS spread (an important metric of whole sale liquidity availability measuringthe difference between the Libor rate and the interest rate swaplevel of an equivalent tenor. Libor measures the cost of lending with exchange of principal while the swap rate (OIS)is "just" an interest rate level at which interestrate risk can be undertaken or hedged in the derivatives market without exchange of principal i.e. without actual lending of borrowing of money.During the 2007 crisis, it was possible to exchange interest rate risk ...but not borrow moneywhich ledto a sharp increase in the Libor/OIS spread.
3.the commercial paper/T-bills spread (difference in credit spreads between corporate and government paper in the money market curve (1 to 12 months tenor). During the crisis, everybody rushed into T-bills with fewinterestedby corporate credit risk (commercial paper) even and sometimes in particular in short term maturities.
4. US High Yield /10Y Treasury spread measuring the long term credit spread between US treasuries and US High yield.
5. US Muni/10Y Treasury spread measuring the long term credit premium between US municipal bonds and US treasuries
6. Swaption Volatility index
7. S&P500 (stock market level)
8. VIX (Spot Option volatility on the S&P500)
The Bloomberg Financial Conditions Index+ includes all elements of the Bloomberg Financial Conditions Index plus indicators of asset prices bubbles which also have an effect on financial conditions. These include tech-share prices, the housing market and deviations from equilibrium levels.
