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As these two charts show, bank lending to small- and medium-sized businesses has been booming for the past several years. But it got a kick-start early this year, right around the time the Fed started tapering its QE3 program. In earlier posts this year I've noted that the increase in bank lending was a good sign that the Fed was correct to begin tapering QE3, because the banks were regaining their confidence and the demand for safe, cash-equivalent assets was declining. Bank savings deposit growth, for example, has declined to a 4% annualized rate in the past three months. A few years ago, savings deposits were growing at strong, double-digit rates.
As confidence rises and the demand for money declines, the need for an actual tightening of monetary policy (tapering is not tightening, it's just a lessening of the degree of ease) increases.
I sense there is pressure building up with 5-yr and 10-yr Treasuries yields at a measly 1.7% and 2.3%, respectively. The bond market should be anticipating more in the way of an eventual Fed tightening, especially if these trends continue. Otherwise, there will be a growing imbalance between the supply of money and the demand for money (i.e., too much money relative to the demand for it), and that is the stuff of which higher inflation is made.
6 comments:
Count me as deeply and vastly and completely inconcerned about inflation.
1. Bring on boom times.
2. See global supply lines, competition and a deunionized work force ramp up supply with very low inflation.
3. Even if inflation reaches 3%, so what? Prosperity, not a subjective nominal price index, is what counts.
I say to the Fed, "Pour it on!"
With worldwide economic softness, and low intermediate and long end interest rates, the Fed wouldn't have to raise short rates very far to induce a flat to inverted yield curve.
Could you explain why the demand for money would decline with rising levels of confidence?
The charts indicate an increasing amount of loans, which suggest to me a rising demand for money and confidence.
BTW, thank-you very much for posting this information. It's very interesting. Appreciate the effort that goes into this blog.
Re "demand for money." It's easy to get confused on this subject, so let me try to clear it up.
The "demand for money" is not the same as the "demand for loans." In fact, it is precisely the opposite.
When one has a strong demand for money, he or she wants to stockpile money, usually in the form of currency, bank savings deposits, T-bills or MMFs. Liquid, easily spendable forms of money. Wanting to hold a lot money means not wanting to spend it. Holding money is equivalent to being "long" money. It's a belief that there is value in simply holding money.
In contrast, wanting to borrow as much as possible (in order to spend it) is the opposite. Borrowing money is equivalent to being "short" money. Borrowing money to spend it is like borrowing a stock to sell it: it reflects a belief that the value of money will decline, that there is little value in stockpiling money.
So the strong growth in bank lending reflects a belief on the part of borrowers that they will be better off if they don't hold money; if they are short money and instead own something they buy with the money.
Money demand has been very strong for most of the current recovery, as evidenced by 1) significant growth in bank savings deposits, and 2) significant household and corporate deleveraging.
We now see money demand weakening, because 1) the growth of bank savings deposits is declining, and 2) household deleveraging has come to an end, and 3) businesses are starting to leverage up instead of deleveraging.
re "the Fed wouldn't have to raise short rates very far to induce a flat to inverted yield curve."
It all depends on how quickly and by how much the Fed raises rates.
The current steepness of the yield curve assumes the Fed will raise rates in a gradual fashion and that eventually—in 3-5 years—the curve will become flatter.
If the Fed were to raise rates sooner and by more than the market expects, the curve could actually steepen, because the market might come to believe that the Fed had "fallen behind the curve," and that short rates would have to rise by a lot before the curve flattened. Longer term rates would rise by much more than short rates initially because the market would have to reprice for higher short term rates in the future.
The yield curve's reaction to the Fed's tightening will all depend on the context of the tightening and the prospects for the future.
If the world economy is in the doldrums, then the Fed won't need to do much, and the curve would likely flatten.
But if the US economy is picking up strength and inflation expectations are rising, then the Fed will need to do a lot, and the curve would likely steepen.
Scott, I agree situation resembles what you describe in your second from last paragraph.
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