In this report, we launch our new BBVA US Financial Conditions Index (FCI). See the appendix for a detailed description of our methodology. During the pre-GFC era, central bank policy was primarily and almost exclusively driven by policy rates. Since the GFC, however, we have seen the central bank use its balance sheet and public communication to manage policy and thus financial conditions. Financial conditions have therefore become a key predictor of financial markets and an important input towards making investment decisions.

In this note, we use our FCI to determine asset allocation between US bonds and equities, MSCI ACWI sectors and BBVA QIS risk premia strategies. We find that using financial conditions as a leading indicator can result in greater alpha than static allocation and even dynamic allocation without the use of the FCI.

According to our model, financial conditions are currently at a level near last decade’s lows. Our model suggests a higher equity allocation in portfolios. Across sectors, the current level points to a higher cyclical equity allocation, particularly towards the technology and industrial sectors. Within the risk premia space, the current level points to a higher allocation towards carry strategies, particularly in FX.