Understanding the Leading Credit Index
The Conference Board models credit conditions in the economy as one of the constituents for the Leading Economic Index (or LEI). This constituent of the LEI is an economic model, constructed by modeling changes in six financial market instruments.
These six components of the Leading Credit Index track the lending conditions in the economy. The six constituents of this index follow:
- 2-year swap (SHY) spread (real time)
- LIBOR three-month (SCHO) less three-month Treasury-Bill (VGSH) yield spread (real time)
- Debit balances at margin account at broker-dealer (monthly)
- AAII Investors Sentiment Bullish (%) less Bearish (%) (weekly)
- Senior Loan Officers C&I loan survey – Bank tightening credit to large and medium firms (IWM) (quarterly)
- Security repurchases (GOVT) (quarterly) from the total finance-liabilities section of the Federal Reserve’s flow of funds report.
Performance of the Leading Credit Index
The Leading Credit Index for February was reported at ~-1.2, declining from the January reading of ~-1.7. This is the first decline for this index in seven months, signaling that financial lending could tighten in the months ahead. This index reflects the possible increase in the pace of rate hikes from the Federal Reserve, which could further increase short-term borrowing costs for businesses.
A negative value of the leading credit index is considered to have a positive impact on the economy. The lower the value, the easier it is to obtain credit. This credit index has a weight of ~8.2% on the LEI. In the December report, the Leading Credit Index had a net positive impact of 0.11 (or 11.0%) on the overall LEI improvement.
Credit conditions could be tightened further
Increasing interest rates have a negative impact on businesses as their borrowing costs could rise rapidly. Although the Fed has not made clear its intentions about the fourth hike in 2018, increasing inflation, lower unemployment, and the deluge of bond issuances by the Department of the Treasury could have an impact on lending conditions in the months ahead.
In the next part of this series, we’ll analyze how the bond markets impacted the LEI in February.