“Financial conditions” are closely watched by the Fed — and at the moment, very complicated

Fed Chair, Jerome Powell has been repeating a two-word phrase a lot lately: “financial conditions.”

​In his last three press conferences, he’s used the phrase no fewer than 29 times as he’s tried to explain how hiking interest rates to slow the economy down tames inflation.

Financial conditions are the things that influence the cost of money; for businesses to make payroll, for consumers to buy new furniture with credit cards. They are important because the Fed’s manipulation of short-term interest rates doesn’t shape the economy all by itself. The markets’ reaction to Fed policy is just as important.

“So, it includes the banking market — which is clearly under pressure — the bond capital markets, and includes equity capital markets,” said Jay Hatfield at Infrastructure Capital Advisors.

In other words, stocks. Financial conditions have tightened since interest rates started rising, according to former Fed economist Claudia Sahm.

“Banks were being more cautious in their lending, they’ve started to tighten up their standards,” she said. “It gets harder for some people to go out and take out a mortgage or a small business loan.”

Now add bank runs, failures and Fed rescue plans, and there is heightened risk and market instability.

Nathan Stovall at S&P Global Market Intelligence said this about the banks’ game plan: “If we’re worried about having enough cash on hand, we’re going to slow down lending. Because the easiest way to make sure you have enough cash, is keep it in the bank.”

But the Fed can’t let financial conditions tighten up so much that credit stops flowing altogether, said Joe Brusuelas at consulting firm RSM.

“The Fed has to ensure that trust within the banking system remains, while at the same time cooling the economy and allowing inflation to begin to trend down,” Brusuelas said.

Bottom line: “financial conditions” just got a lot more complicated, as the Fed plots its next moves.

Additional reporting by Trina Mannino.