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What to Make of the Rebound of the Credit Index in May

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Jun. 25 2018, Updated 1:56 a.m. ET

Understanding the Leading Credit Index

The Conference Board LEI (Leading Economic Index) includes the credit conditions in the US economy as one of its constituents. Changes to six financial market instruments are modeled to construct this credit index. The six components of the Leading Credit Index follow:

  1. two-year swap (SHY) spread (real-time)
  2. LIBOR three-month (SCHO) less three-month Treasury bill (VGSH) yield spread (real-time)
  3. debit balances at margin account at broker-dealer (monthly)
  4. AAII Investors Sentiment Bullish (%) less Bearish (%) (weekly)
  5. senior loan officers C&I loan survey: bank tightening credit to large and medium firms (IWM) (quarterly)
  6. security repurchases (GOVT) (quarterly) from the Total Finance-Liabilities section of the Federal Reserve’s Flow of Funds report
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Performance of the Leading Credit Index in May

The Leading Credit Index expanded for the first time in four months in May with a reading of -0.86. This reading was higher than the downward revised April reading of 0.17. This is an inverse index in which a lower credit index reading reflects better credit conditions.

In the LEI, a lower credit index reading has a positive impact on the index, as improving financial conditions make it easier to obtain credit. This credit index has a weight of ~8.2% on the LEI. In the May LEI report, the Leading Credit Index had a net impact of 0.07 (or 7.0%) on the overall LEI reading.

Credit conditions could tighten further

The June FOMC (Federal Open Market Committee) meeting resulted in a rate hike of 25 basis points. The Federal Reserve has communicated two more rate hikes in 2018, paving the way for tightening credit conditions in the near future. Improving economic conditions with low unemployment and rising prices could force the Fed to tighten sooner than expected, which could lead to tighter financial conditions in the near future. 

In the next part of this series, we’ll analyze the continued flattening of the yield curve and its impact on the economy.

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