Economic Indicators
The Market Signals That Reveal Stress, Liquidity, and Risk**
Purpose
Explain the financial-market indicators that reveal underlying stress, credit conditions, and investor expectations. These metrics show what the market “believes” about the future before the real economy feels it.
Core Principle
Financial Indicators = The Economy’s Early Warning System**
Financial markets react faster than:
jobs
inflation
GDP
business investment
Because markets price in expectations, not current conditions.
Financial indicators reveal:
risk appetite
liquidity conditions
credit stress
recession probability
global capital flows
They move ahead of the real economy.
The Four Financial Indicators
These are the most important signals of financial system health:
1. Yield Curve — The Bond Market’s Recession Signal
The yield curve shows the difference between long-term and short-term interest rates.
Normal curve: long rates > short rates
Inverted curve: short rates > long rates
Inversion signals:
tight monetary policy
pessimism about future growth
elevated recession risk
The yield curve is one of the most reliable leading indicators in economics.
2. Credit Spreads — The Price of Risk
Credit spreads measure the difference between corporate bond yields and safe government bond yields.
Spreads widen when:
investors fear defaults
liquidity tightens
recession risk rises
Spreads narrow when:
confidence improves
credit flows freely
risk appetite returns
Credit spreads reveal the health of the lending system.
3. Equity Valuations — Market Expectations of Future Earnings
Equity valuations (P/E ratios, price-to-sales, etc.) measure how much investors are willing to pay for future profits.
Valuations rise when:
confidence is high
earnings growth is expected
liquidity is abundant
rates are low
Valuations fall when:
earnings weaken
uncertainty rises
rates increase
risk appetite disappears
Valuations don’t just reflect the economy — they influence it through wealth effects.
4. Dollar Strength — Global Capital Flow Indicator
The U.S. dollar strengthens when:
global investors seek safety
U.S. interest rates rise
global risk aversion increases
A strong dollar pressures:
emerging markets
commodities
global liquidity
A weak dollar boosts:
global risk assets
emerging markets
U.S. exports
Dollar direction often signals broader market sentiment.
The Financial Equation
Financial conditions can be summarized as:
Financial Stress = (Credit Spreads + Dollar Strength) – Yield Curve Slope
Higher stress → tighter credit, slower growth.
Lower stress → easier credit, faster growth.
What This Explains
Understanding financial indicators clarifies:
why markets move before the economy turns
why yield curve inversions precede recessions
why widening credit spreads signal trouble
why equity markets react to Fed guidance
why a rising dollar tightens global financial conditions
why financial shocks (2008, 2020) move faster than economic shocks
Why This Completes the Dashboard Section
You now understand:
Growth → direction of the economy
Labor → strength of the foundation
Inflation → stability of prices
Financial indicators → stress signals and expectations
Together, these metrics form the “cockpit dashboard” of the economy — everything you need to read conditions clearly and objectively.