MNI: New OFR Fin Stress Index Incl Global Focus, Daily Updates

--Daily FSI To Offer More Complex, Diversified Alternative To VIX, Other Gauges

By Vicki Schmelzer

     NEW YORK (MNI)   - The Office of Financial Research's new Financial Stress

Index (FSI) will offer global investors a more complex, diversified alternative

to current risk gauges and includes a global focus, a researcher at the OFR told

MNI. 

     "The global scope of the index translates into different sets of variables,

so we have a whole category of safe assets - not just the Treasury, trying to

capture the flight to safety behavior that is common amongst financial stress

events," said Phillip Monin, researcher at the OFR, in an exclusive interview

with MNI. 

     "Also, the global nature translates into several foreign exchange

variables. So, we have FX volatility, we have cross-currency basis spreads,

which helps us understand the nature of the demand for the dollar globally," and

"we have broader volatility categories," he said.   

     Last week, the OFR unveiled two new tools for monitoring risk, the

Financial Systems Vulnerabilities Monitor, to be released quarterly, and the

FSI, to be released daily.

     The FSVM, which "improves upon and replaces" the OFR's Financial Stability

Monitor, "focuses only on vulnerabilities for clear and earlier signals of

potential risks, while the FSI focuses on monitoring stress," the OFR noted in a

statement introducing the two tools. 

     Various U.S. banks (Goldman Sachs, BOA Merrill Lynch, Citibank, etc.) offer

their own in-house financial risk indicators, but these are available only to

clients and generally with a lag to the media. 

     The OFR's new FSI is welcomed mainly because the chief risk barometer

monitored currently by many market participants, the CBOE's volatility index or

VIX, has not offered as much insight into risk sentiment as in the past. The VIX

measures expectation of stock market volatility as implied by movements in S&P

500 options. 

     At levels near 10.29 Tuesday afternoon, the VIX was closer to the life-time

low of 8.84, posted July 26, than to the 2017 high of 17.28, seen August 11,

which was the highest reading since Nov. 9, the day after the U.S. election,

when the VIX peaked at 21.48. And these levels remain easily in sub-20,

risk-friendly territory, rather than at risk-averse levels above 40. 

     The OFR's FSI model consists of 33 financial market indicators in five

categories of 1) Credit, 2) Equity Valuation, 3) Funding, 4) Safe Assets, and 5)

Volatility. https://goo.gl/aaiQta

     There are several key differences between the OFR's FSI and other financial

stress barometers.  

     "Unlike financial stress indexes produced by others, the OFR's FSI can be

decomposed into contributions from each of the five categories. It also can be

broken down by the region generating the stress," the OFR statement said. 

     The FSI model regions consist of "emerging markets," "other advanced

economies," and the United States, the OFR said.

     The OFR's FSI presents more a broader, more global slant than the Kansas

City and St. Louis Fed's Financial Stress Indexes, which have 11 and 18

variables respectively and are more U.S. centric.  

     FSI is published each morning, using the prior day's closing levels for the

calculation of the various variables.

     Unlike the St. Louis and Kansas City Fed indexes, which change historical

readings each time the FSIs are updated, weekly and monthly respectively, the

OFR's FSI will remain permanent once published.

     Another key difference is that the OFR's FSI "uses a dynamic process to

account for changing relationships among the variables in the index," the OFR

statement said.

     This means, for example, that if the market discontinues using LIBOR in

favor of an alternative, the OFR model will be able to adjust to incorporate the

new variable. 

     "We came up with a methodology that can accommodate drops of variables

today and additions of other variables without having to sacrifice the entire

history of the index and recalculate the whole thing again," Monin told MNI. 

     In terms of reading the risk gauge, the FSI "is positive when stress levels

are above average, and negative when stress levels are below average," the OFR

statement explained. 

     The latest FSI stood at -3.747, as per Oct. 30, not far from the -3.769

reading seen Oct. 20, which was the most risk-friendly reading in many years. 

     Current levels show "that overall stress in the financial system is near

its lowest level since the 2007-09 financial crisis." In the first half of 2007,

the OFR's FSI traded on -4 and -5 "handles" before ending the year at 4.15 as

the crisis began to unfold. 

     The OFR's first FSI reading was 2.081, seen Jan. 3, 2000. The most

risk-friendly reading was -5.343, seen Feb. 22, 2007 and the most risk-averse

reading was 29.316 on Oct. 10, 2008. 

     On current readings, "extremely low volatility is the largest contributor

to the low stress level. Low volatility may lead investors to take more risk,"

the OFR statement said. 

--MNI New York Bureau; tel: +1 212-669-6438; email: vicki.schmelzer@marketnews.com

[TOPICS: M$U$$$,MT$$$$,M$$FI$,M$$FX$]