Morgan Stanley: Middle East War Has Equivalently Raised Rates by 35 Basis Points

The Federal Reserve stood still, but the market has already completed a round of tightening on its own.

Morgan Stanley's latest analysis points out that since the outbreak of conflicts in the Middle East, the actual tightening of U.S. financial conditions is equivalent to the Federal Reserve raising interest rates by about 35 basis points. The financial condition index they built based on the FRB/US model tracks the potential impact of asset price changes on future economic activity, including five daily variables: the 10-year U.S. Treasury yield, S&P 500 index returns, BBB corporate credit spreads, the U.S. Dollar Index, and oil prices, and translates the above inputs into an equivalent federal funds rate.

Morgan Stanley notes that since the outbreak of conflicts on February 28th, the tightening of financial conditions has completely erased all the effects of the loosening since the beginning of the year. The previous easing mainly occurred between the two FOMC meetings from December last year to January this year, driven mainly by the weakening of the U.S. dollar. The main driving force behind this round of tightening is quite different - the sharp rise in the 10-year U.S. Treasury yield is the foremost, the appreciation of the U.S. dollar and the rise in oil prices also contributed, the strong stock market performance and narrowing credit spreads have partially offset the upward pressure.

After the ceasefire announcement on April 7th, the situation improved. Morgan Stanley said that financial conditions have come down by about 37 basis points since the ceasefire, and some of the most intense market pressures at the beginning of the conflict have been partially repaired.

This analysis reveals the deep dilemma that current monetary policy is facing: even though the Federal Reserve has never officially raised interest rates, geopolitical risks, oil prices, U.S. Treasury yields, and the dollar have been linked to fluctuations sufficient to create a de facto tightening in the real economy. Forget the Federal Reserve——the market has taken matters into its own hands.