Financial stress indicators are used as the proverbial canary in the coalmine: they help to assess whether Fed tightening is causing financial stress, in which case it may end up tipping the economy in a recession.
The chart shows two indicators: the spread over US treasuries of US BBB corporate bonds and the financial stress indicator of the Federal Reserve Bank of St Louis (a composite of 18 series). Using these indicators to forecast major growth slowdowns or recessions is tricky: in the 2001 recession the composite indicator hardly moved whereas the peak of the corporate bond spread only occurred towards the end of 2002 although the economy was already recovering by then. In the 2008 recession, both indicators shot through the roof. Giving the volatility of the series, it seems that by the time the signal from the stress indicators is sufficiently clear, the onset of a recession is imminent. When the canary stops singing, drop everything and run for the exit.
by William DE VIJLDER