Thursday, June 18, 2020

The housing market is alive and well

30-yr fixed-rate mortgage rates are back down to record-low levels: a bit less than 3.4%, according to the nationwide average calculated by the Mortgage Bankers Association (see Chart #1). And they could fall further, given that the spread between current yields and the 10-yr Treasury yield are are exceptionally wide. If past norms were to return, 30-yr fixed rate mortgages could be trading at 2.4-2.7% (see Chart #2, which shows mortgage rates and 10-yr yields on the top portion, and the spread between the two on the bottom portion).

Chart #1

Chart #2

After a sharp drop in sales in March and early April, applications for new home mortgages have surged to levels last seen almost 12 years ago (see Chart #3). The housing market is responding to incentives in a healthy fashion. The economy is still weak, but home prices needn't fall much if at all, thanks to the positive impact of low and falling mortgage rates, and given the reasonable expectation that the economy will eventually return to normal.

Chart #3

As further evidence of the housing market's resilience, the Bloomberg index of home builders' stocks is now up year-to-date, though still about 14% below its February high (see Chart #4).

Chart #4

Friday, June 12, 2020

TSA throughput is surging

The most timely indicator of just how fast the US economy is recovering has to be the TSA throughput statistics, which are released every day with only a 1-day lag. As Chart #1 shows, Americans are rapidly returning to the skies. Passenger traffic at US airports, as we can infer from these numbers, has doubled since May 16, and has quadrupled since the April 17th low. Traffic is still very low compared to last year at this time, but nevertheless things are improving rapidly.

Chart #1

Chart #2 contains data as of last week, so it's not quite as timely as the TSA data. But it paints a similar picture: people are rapidly getting back on the road.

Chart #2

UPDATE (June 18th): Here is a new and updated version of Chart #1:


I've added earlier data and I've used a log scale for the y-axis to better appreciate the rate at which things are improving. TSA is processing almost 5 times as many people today as it did at the lows of April. But there is still a long way to go to return to last year's levels. 

Thursday, June 11, 2020

How bad is the national debt?

Yesterday Treasury released budget stats for the month of May '20, and they were, as expected, godawful. A simple virus, potentiated by aggressive shutdown mandates, has caused government spending to explode and revenues to crater. Measured on a rolling 12-month basis, the federal deficit in the past two months has more than doubled, reaching the obscene level of $2.126 trillion, and it will be higher still when the June numbers are tallied. Our national debt now stands at $20.1 trillion (the correct measure being the portion that's owed to the public). As a percent of GDP, our national debt is about as high as it was during the height of World War II—about 110%, and that's as high as it's ever been in recorded history. 

The raw numbers are frightening, to be sure. But we are not doomed yet. The charts tell the story:

Chart #1

Chart #1 shows the 12-month moving average of federal spending and revenues. The past two months show a very sharp—but not unprecedented in size—deterioration in each from their long-term trends.

Chart #2
 Chart #1 shows total revenues and its major components. By far the biggest contributor to a revenue shortfall has come from a reduction in individual income tax receipts. Payroll tax receipts are quite likely to deteriorate in the current month.

Chart #3

Chart #3 shows federal revenues by month for the current and two previous years. The shortfall in April revenues was gigantic.

Chart #4 

Chart #4 shows the federal deficit as a percent of GDP, with the nominal value of the deficit (green) highlighted in green. I've calculated the value for Q2/20, but my estimate of actual number, which won't be available for over a month, is only very approximate. I'm assuming GDP in the second quarter declines at a 40% annualized rate. But it's highly likely that this quarter's numbers will be the worst in history, as the chart suggests.

Chart #5

Chart #5 shows federal debt held by the public (the correct measure excludes debt owed to the social security system). Looked at using a log scale for the y-axis over a long period, the growth of debt does not look all that unusual.

Chart #6

The huge jump in federal debt relative to GDP (Chart #6) is due not only to the big increase in debt outstanding, but also to the unprecedented decline in nominal GDP in the current quarter. We are revisiting the huge debt levels registered near the end of World War II. We survived that episode of massive indebtedness thanks to a slowdown in spending and a surge in economic growth. We could see a repeat of that performance in the months and years to come.

Chart #7

Chart # shows the true measure of the burden of our federal debt: interest payments on the debt as a % of GDP. It should come as a shock to most people: how can the burden of debt be so low when the actual debt is at record levels relative to GDP? Answer: it's because interest rates on the debt are at historically low levels. If interest rates remain low for the next two years, as the Fed recently predicted, and the economy recovers and federal spending is reined in, it should be easy to avert disaster.

The burden of federal debt is calculated the same way you would measure a household's debt burden: by dividing annual debt service payments by annual income. Overall, and as a nation, we are currently spending about 3% of our annual income on our national debt. In the great scheme of things, that is a drop in the bucket—rare is the household with such a low debt burden!

Saturday, June 6, 2020

Recommended reading

Steve Moore, a long-time supply-side friend from my Art Laffer and Jude Wanniski days, as well as the founder of the Club for Growth (of which I was a charter member), is now at the helm of the Committee to Unleash Prosperity. They put out a daily newsletter which I've been reading and enjoying. It focuses on current topics of interest and initiatives that can enhance the economy's ability to grow and (of course) prosper. Caveat: it does have a conservative bias.

You can subscribe here, and it's free.

Covid-19 is yesterday's news

The Chinese virus (aka Covid-19) is no longer a big source of concern for the market. The growth rate of new cases and deaths is decelerating just about everywhere in the world. The infection fatality rate is increasingly estimated to be as low as 0.2% or even in the range of 0.06% to 0.16%—which is similar to that of the seasonal flu. Long-time readers of this blog will remember that I first floated this suspicion in late March.

One reason it has not proven to be as fatal as originally feared could be that a significant portion of the world's population was not susceptible to the virus to begin with, due to having "resistance at the T-cell level from other similar coronaviruses like the common cold."

In any event, what was once thought to be a catastrophic pandemic is now understood to be dangerous mainly to the aged and the infirm, leaving the vast majority to pursue their lives as before; not without risk, but not condemned to huddle at home in fear. For many, the virus may even be losing its potency.

The shutdown of the US economy, which I have been calling "the most expensive self-inflicted injury in the history of mankind," is no longer a source of concern either, from the market’s perspective. (But governments may well find themselves in the crosshairs of those angry at the shutdowns; see the recent report condemning the German government's handling of the Covid-19 crisis here.) Many states are reopening, of course, but more importantly, as I've been pointing out since March 19th, key financial market and economic fundamentals have been improving on the margin, at the same time our fear of Covid-19 has been tempered. The May jobs report made it clear that the economy is doing much better than feared. It's changes on the margin, like this, that move the market.

So, as investors we need to forget about Covid-19, the shutdown, and the economy, since these are all on the mend; it's no longer a question of when things start to improve, the question now is how fast they will improve.

Looking ahead, the critical areas of concern, in my mind, are 1) can Trump recover from his currently depressed levels of approval and go on to beat Biden in November, thus avoiding the economically-disastrous policies (e.g., higher taxes, increased regulation, and multiple "green" initiatives) that Biden is proposing? and 2) can the Fed react to the dramatic improvement in the economy—and the rebound in confidence which is sure to follow—by raising interest rates in a timely fashion and thereby averting an unexpected surge in inflation?

I have already begun to address this second question here, here, and here, and at the bottom of this post, but more observation is clearly needed. I will begin to address the first question in the months to come. In the meantime it is still important to track key measures of financial and economic fundamentals, some of which I update in the following charts:

Chart #1

In Chart #1, the Vix index is a good proxy for the market's level of fear. What we have seen in recent months is a perfect inverse correlation between fear and equity prices. Fear rises, prices fall; fear declines, prices rise.

Chart #2

Chart #2 shows two market-based indicators which tend to track the market's outlook for economic activity. 10-yr Treasury yields have fallen to record lows, driven by collapsing estimates of economic activity. Similarly, the ratio of copper to gold prices (which tends to increase when the market's economic growth expectations increase) recently fell to record lows but has since rebounded. Together, these two indicators seem to be signaling a major turn for the better in the market's expectation for economic growth.

Chart #3

TSA screenings continue to rise, and are up 240%, on a 7-day moving average basis, from their April all-time lows. There is still lots of room for improvement, since at this time last year screenings were averaging about 2.38 million per day. But it's clear that activity is increasing significantly on the margin.

Chart #4


Chart #4 shows Bloomberg's index of US airline stock prices, which has turned up significantly the past few days. American Airlines stock is up 65% in the past three days. Wow. Confidence in the future is improving dramatically.

Chart #5

Chart #5 shows the spread between High Yield and Investment Grade Credit Default Swap Spreads, commonly referred to as the "junk spread," or the additional yield that investors demand to move from the relative safety of investment grade to the more risky high sector sector of the corporate bond market. These spreads have decline significantly in a relatively short period of time. The Covid-19 credit crisis has reversed dramatically. This is another way of saying that investors' confidence is returning.

Chart #6

Chart #7

Chart #6 shows the 3-month annualized rate of change in money demand, for which, as a proxy, I use the sum of bank demand and savings deposits. These deposits pay almost nothing, and thus are attractive to economic actors only as a store of value, since they are relatively default-free and liquid. These deposits have increased by $1.8 trillion (+16%) since March 9th. Not coincidentally, this is almost exactly equal to the recent $1.7 trillion increase in excess bank reserves (which reflects, in turn, the Fed's recent purchases of securities), as shown in Chart #7. What this means is the Fed's purchases have gone almost completely to support the public's sudden, increased demand for safe money.

Note also that the first three episodes of Quantitative Easing did not correspond with any sudden increase in money demand on the part of the public (the growth of money demand as shown in Chart was somewhat elevated from 2008 through 2013, but not sudden, as we have seen recently). Thus, the initial rounds of QE were mainly designed to accommodate the banking industry's demand for safe assets (e.g., bank reserves), because banks needed to shore up their balance sheets in the wake of the near-collapse of the global banking industry. This time around, QE efforts have largely accommodated the public's demand for safe assets.

Going forward, all eyes will be watching the aftermath of the recent gigantic increase in demand and savings deposits. How long will the public want to maintain these outsized deposits? When optimism returns and the demand for money declines, where will the $1.8 trillion go? The only way that money can "disappear" is if the Fed reverses its asset purchases—by selling securities and absorbing/extinguishing bank reserves in the process. If the Fed doesn't reabsorb the money it has created as the demand for that money declines, then the unwanted money will find its way into asset prices and the general price level (i.e., rising inflation). Recent increases in stock prices could be an early sign of declining money demand, but it is too early to come to that conclusion, especially since, as I noted in my previous post, the market in general does not appear to be overly optimistic.

Wednesday, June 3, 2020

Lots of green shoots

Economic fundamentals are definitely on the mend. It's no wonder stocks are rising nearly everywhere: the virus is burning out and lockdowns are ending. People are anxious to get out and go back to work, and it shows. Numerous high-frequency indicators show sharp turnarounds, and the stock market appears to be pricing in a substantial recovery. There's a whiff of a market "meltup" in the air, in the sense that those who cashed out when the cannons were blasting are now worried about whether and when to get back in. But it's not at all clear that prices are overbought or that investors are over-confident.

Chart #1

As Chart #1 shows, equity prices have recovered a substantial portion of what they lost in March. The Vix Index (fear) is still elevated however, so it's tough to say that investors are throwing caution to the wind, especially given the still-low level of 10yr Treasury yields (0.75% as of today).

Chart #2

Chart #1
Both the 10yr Treasury yield and the ratio of copper to gold prices have turned up a bit of late (see Chart #2), and this is a good sign that global economic conditions are beginning to improve. Still, there is lots and lots of room for further improvement.

Chart #3

As Chart #3 suggests, consumption of motor gasoline has rebounded significantly. This is a good measure of the extent to which consumers are still sheltering at home and working at home.

Chart #4

Thanks to aggressive Fed action to supply much-needed liquidity to the banking system, over financial conditions have improved dramatically, as Chart #4 shows. We've never seen such a rapid rate of financial healing after a recession.

Chart #5

Chart #5 shows that credit spreads have narrowed significantly and rather rapidly. When liquidity is abundant and the economy is expanding, the risks to corporate profits decline. Spreads are still somewhat elevated, but they have retreated meaningfully from the edge of the abyss.
 
Chart #6

As Chart #6 shows, Eurozone equities have also rallied significantly. However, US stocks continue to be the strongest. The S&P 500 index has outpaced its Eurozone counterpart by roughly 100% over the past decade.

Chart #7

Earnings are very likely to be weak for the remainder of the year, but even discounting that, the equity risk premium is at least 3%. Investors are still willing to give up a substantial amount of yield in exchange for the safety of Treasuries. Again, no sign here that caution has been thrown to the wind.

Chart #8

The business activity subset of the ISM service sector surveys (Chart #8) shows a significant rebound in the month of May. This should move higher still with this month's survey.

Chart #9

Chart #9 shows an index of new mortgage purchases (mortgages taken out for an initial home purchase, as contrasted to mortgage refinancings). Home sales must be doing quite well these days, despite the shutdowns.

Chart #10

Chart #10 shows the national average of 30-yr fixed rate mortgage rates. Mortgage rates for conventional mortgages have never been lower in the history of the US. However, they do have room to decline further, since the spread between this index and the 10-yr Treasury is still unusually wide.


Chart #11

On a 7-day moving average basis, TSA screeners as of yesterday had processed three times the number they processed just two months ago. Still a long way to go to get back to normal, but there is a noticeable increase in the demand for air travel.

I still worry about a potential surplus of money. Monetary expansion has been off the charts in the past two months, and that is fine as long as the market wants precautionary and safe haven money balances. But as confidence returns the demand for money will inevitably decline, and it will be critical for the Fed to respond to this by raising short-term interest rates. Whether this will play out soon or later this year is an open question.

I can point to some evidence of declining money demand which is showing up as rising prices for stocks, commodities, and risk assets in general. But as yet it's not clear that prices for any of these things is irrational, as might prove the case when and if the Fed is slow to offset declining money demand with higher interest rates. But I am keeping a sharp eye out for this.

In the meantime, the chance of an unexpected rise in inflation has probably never been so likely, given that hardly anyone is concerned about this at a time when the fundamentals could definitely support higher inflation. That increases the attractiveness of debt in general, and of real estate and other hard assets.

Wednesday, May 27, 2020

Monetary expansion Argentina-style

We are definitely sailing in uncharted monetary waters. In all of US history we've never come even close to today's monetary environment. Chart #1 is one that no economist ever expected to see coming out of the US:

Chart #1

In the 3 months leading up to May 11th (latest data available), the M2 measure of the US money supply has increased at an 82% annualized rate. In the past six months, it's up at a 40% annualized rate, and in the past year, M2 has increased by over 23%, and these numbers will go higher in the next week or two. This is serious, Argentine-style money growth. The big question now is whether so much monetary expansion will give us Argentine-style inflation.

Chart #2

Chart #2 shows the year over year growth rate of Argentina's M2 money supply, which is up 97% in the past year. From late 2010 through early 2018, Argentina's money growth averaged about 30% per year, and inflation was in the neighborhood of 25-30% per year. Given the recent surge in money creation, inflation in Argentina is going to be approaching 100% before too long.

Chart #3

Chart #3 shows what a decade or so of rapid money growth has done to the value of the Argentine peso. Since early 2007, the peso has fallen from just over 3 to the dollar to now 117; that translates into a 97.5% loss of value vis a vis the dollar. Since the Argentine government locked down the economy fiercely in order to fight Covid-19, revenues have all but dried up. The only way it can pay the bills is to literally print money. 

I've been an avid student of monetary policy and inflation ever since I spent four years living in Argentina in the late 1970s. Back then, inflation averaged about 125% per year, and during a visit to the country in the mid-1980s I was fascinated to watch hyperinflation unfold: prices almost tripled within the span of three weeks. In 2015 I wrote a post on the subject of inflation and Argentina, in which I explained that the conditions in Argentina that allowed a huge increase in inflation didn't exist in the U.S., despite the Fed's massive expansion of its balance sheet and the creation of trillions of dollars of bank reserves. Unlike the US, the government of Argentina relies on direct printing of money to finance its deficit, whereas the U.S. government finances its deficit by selling  bills, notes and  bonds. When the Argentine government needs to finance a budget shortfall, it can "borrow" money directly from its central bank in exchange for an IOU, which in practice is never repaid. In essence, the Argentine central bank simply runs the printing presses whenever the government needs money, and the government pays its bills with monopoly money.

Will the same happen to the US? I sincerely doubt it, but it's not impossible.

In 2013 I wrote a post entitled "The Fed is not printing money," which addressed in detail why the Fed's monetary expansion in the wake of the Great Recession was not inflationary. Over the years since then I have consistently argued that the Fed's huge expansion of bank reserves was unlikely to lead to higher inflation since the Fed was correctly supplying reserves to accommodate the banking sector's demand for safe assets (bank reserves are functionally akin to T-bills). Inflation only happens, as Milton Friedman taught us, when the supply of money exceeds the demand for it. And indeed inflation has remained relatively low and stable for most of the past decade—which in effect proves that the Fed was not "printing money."

The key feature of the US monetary system is that the Fed can not create money directly—only banks can do that. The Fed can, however, make it easier for banks to create money by increasing the supply of bank reserves. Banks need reserves in order to collateralize their deposits. The Fed creates reserves by buying securities (e.g., Treasury bills, notes and bonds, and more recently, mortgage-backed securities and some corporate bonds). In effect, the Fed buys securities and pays for them with bank reserves. But crucially, reserves are not money that can be spent anywhere. The Fed simply swaps reserves for notes and bonds, thus transmogrifying longer-term securities into short-term, risk-free securities. Reserves have become equivalent to T-bills, since they are default-free and pay a floating rate of interest.

In times of great uncertainty and surging money demand, like today, the Fed fills the market's need for short-term safe securities by buying riskier securities and paying for them with risk-free reserves. If banks don't want to hold the reserves they can use them to support increased lending, which indeed does result in a monetary expansion. But if that expansion exceeds the market's demand for money, then higher inflation will be the result. The fact that inflation so far has not risen is proof that the Fed's actions have not been inflationary. Excess reserves—which now total $3.2 trillion—have served to satisfy the banking system's demand for risk-free, short-term assets, and more recently to satisfy the public's demand for a massive increase in bank savings deposits and checking accounts, as shown in Chart #4, which in turn has been turbo-charged by all the uncertainties and disruptions caused by the Covid-19 panic:

Chart #4

Looking ahead, the most important question becomes, "What happens when the Covid uncertainties decline and the demand for risk-free assets declines?"

If the Fed does not reverse course in a timely manner (e.g., by selling notes and bonds and extinguishing bank reserves), then we will find ourselves flooded with unwanted money. And as Argentina has demonstrated, that can lead to a big increase in inflation.

And that is what my friend Nuni Cademartori is illustrating in the cartoon which follows. Too much money erodes the value of money. I've got stacks of million-peso Argentine notes printed decades ago that today are worth about the same as toilet paper.

Let's hope this does not come to pass in the US:



Monday, May 18, 2020

Demand for money; what went up will soon come down

There are two macro variables that loom large these days: 1) the amount of money in the economy has exploded, thanks to the Fed's aggressive QE4 actions, and 2) GDP growth has plunged, thanks to widespread government-mandated shutdowns. When money goes up and economic activity goes down, the result can be described as an increased demand for money (or a reduced velocity of money), which is a typical response to recessions and uncertainty. People tend to stockpile cash during periods of great uncertainty, and—we must NOT forget—they tend to reduce those stockpiles as their confidence returns.

For the past two months we have been experiencing the fastest and steepest decline in economic activity in the history of this country. Estimates of 2nd quarter GDP range from -31% (New York Fed) to -48% (St. Louis Fed). (Note: these are annualized rates of decline.) I'm going to be optimistic and guess that Q2/20 growth will post a 30% annualized decline, which is equivalent to a 6.8% nominal decline. Meanwhile, the M2 measure of the money supply is on track for something like a 50% annualized rate of increase in the current quarter. The following charts show you what these numbers look like:

Chart #1

Chart #1 shows the actual history of these variables and my estimated values of M2 and nominal GDP for Q2/20. The current disparity between the two is historical.

Chart #2

Chart #2 shows the ratio of M2 to GDP, which is a proxy for money demand. Think of it as you would your personal finances: How much cash and cash equivalents do you want to hold as a percent of your annual income? Since the onset of the Great Recession in late 2007, that value for the average person has increased fully 80% (from 50% to 90%). That's a lot of money being stockpiled, mainly because this has been a rather crazy period in history. 

Chart #3

Chart #3 shows the inverse of Chart #2, which can be thought of as the number of times a dollar is spent every year—a proxy for the velocity of money. People today are holding on to their cash like never before. 

So M2 has gone way up and GDP has gone way down because the forced shutdown of the economy has caused the demand for money to soar. That's completely natural and predictable. The Fed has done the right thing by expanding the supply of money in order to accommodate the increased demand for money. The fact that inflation expectations, the dollar, and industrial commodity prices have been relatively stable for the past six weeks confirms that the Fed has accommodated soaring money demand, and has NOT been madly printing money. I've made similar arguments quite a few times in the past on this blog. Quantitative easing is NOT stimulus, it's a badly-needed remedy for a huge increase in the demand for money. 

But what comes next? With increased signs that the economy is reopening and activity is increasing, it's quite likely that the demand for money will begin to decline as confidence slowly returns. Money that has been socked away in bank accounts is increasingly going to be spent on goods and services. Will the Fed be able to reverse its QE4 efforts in a timely fashion? Will the public's desire to reduce their money balances lead to rising inflation?

I won't be surprised to see restaurants reopening with higher prices on the menu. The government will mandate that the supply of restaurant tables be limited (e.g., maximum occupancy rates of 25% and maybe 50%) at a time when many consumers with pent-up demand will be seeking tables. When demand exceeds supply, higher prices are almost inevitable. Especially since few if any restaurants can be profitable at much lower occupancy rates than they have enjoyed in the past—occupancy mandates will force restaurants to raise prices.

But not everything will be supply-constrained. Airlines are going to have a huge surplus of seats for a long time. Hotels will have a vacant rooms galore. Malls and stores won't be full until the fear of contagion and crowds disappears. But we are already seeing positive signs of improvement which are quite likely to continue.

We've seen the worst of the covid-19 crisis. Looking ahead, the 800-lb gorilla that will dominate the economic and financial landscape for the balance of the year will be the need for the Fed to begin to reverse its massive monetary expansion of recent months. Curiously, I see many analysts worrying that a Fed reversal will jeopardize the recovery. On the contrary, I think it would be very worrisome if the Fed did not realize that they need to "tighten" as the demand for money begins to decline.

Wednesday, May 13, 2020

High frequency data show a strong rebound

On March 19th I ventured to guess that we had probably seen the worst of the Covid panic. On April 6th I pointed to Covid green shoots. On April 19th I noted the beginning of the end of the shutdown. On April 27th I noted that things were looking up. A week ago I pointed to signs that showed the economy beginning to reopen. In today's post I show further evidence of what is looking like a fairly strong rebound in economic activity. All of the charts in this post use data that is as recent as today and no older than two weeks. All of the charts—with one exception—reinforce the view that that there has been a significant amount of financial market healing and a meaningful recovery in economic activity. I show the charts in no particular order:

Chart #1
 

Apple has compiled data from millions of user's iPhones all over the world to show that people are getting out of their homes and engaging in more driving, walking, and travel (see Chart #1). In the US, shown here, the low point in driving activity was Easter Sunday, April 12th. Since then, and using a 7-day moving average of the data (there is a distinct weekly pattern to the data, with the weekly low always falling on Sunday), there has been a substantial rebound of over 50% in the number of requests for driving directions. Not bad!

Chart #2

Chart #2 uses weekly data (last datapoint being May 8th) to show that the amount of motor gasoline supplied to the US market has increased 46% in the past four weeks. From that we can infer a significant increase in miles driven by individuals. Impressive!

Chart #3

Chart #3 uses data from TSA to show that the number of passengers processed at US airport security checkpoints has almost doubled since the mid-April low (again, I'm using a 7-day moving average to eliminate weekly patterns). Of course, that is still more than 90% below the level of activity from a year ago, when 2.34 million people passed through TSA checkpoints every day on average. But the longest journey begins with a first step!

Chart #4

Chart #4 is my favorite for tracking how the level of market fear and panic influence the stock market. Things have definitely improved since prices hit bottom almost two months ago, but there is still a lot of  caution in today's prices. Will the rebound we've seen so far continue? Will there be a new, sudden wave of infections? Another shutdown? How fast can businesses respond to the lifting of lockdowns? I would be worried if the market weren't worried about these sorts of things. There are so many variables in play that no one can confidently predict how things will evolve. My main guidepost is an intuitive trust in the resilience of the US economy, the resourcefulness of America's entrepreneurs, and the desire of the average person to work hard and enjoy life.

Chart #5

Chart #5 shows an index of key financial market indicators, compiled daily by Bloomberg. Here again we see a sharp rebound/improvement. This is extremely important, since healthy financial markets are essential to an eventual economic recovery. We're not out of the woods yet, but we have without question pulled back from the edge of the abyss that was looming in late March.

Chart #6
Chart #6 shows one of the indicators included in Chart #5, 2-yr swap spreads. I always keep tabs on this critical, leading indicator of financial market health which has frequently anticipated changes in economic activity. Swap spreads in the US are exactly where we would like to see them, while similar spreads in Europe are somewhat elevated, but not dangerously so. The disparity simply highlights the fact that the US economy is more dynamic and generally healthier than the economies of Europe.

Chart #7

Chart #7 compares the level of 10-yr Treasury yields (red) with the ratio of copper to gold prices (blue). Both of these indicators have shown a tendency to respond to changes in the global economic outlook. Both are still distressingly low, unfortunately, but neither one has deteriorated further since late March.

Chart #8

Chart #8 shows the level of the M2 measure of the US money supply. It's plotted using a semi-log scale on the y axis. Note how for the past 25 years M2 has risen at a fairly steady 6.2% annualized pace. Until recently, that is, when the Federal Reserve pulled out all the stops in an attempt to satisfy the world's sudden and gargantuan demand for money, money equivalents, and safe, liquid assets.

Chart #9

Chart #9 shows the year over year growth of M2. The recent surge, which began in mid-March, is without precedent in US monetary history.

Chart #10

Chart #11

Chart #10 shows the composition of M2. Bank savings deposits account of over 60% of M2, and they have increased by $930 billion since mid-March. This is strong evidence that the demand for safe money has soared as a result of the Covid crisis. Savings deposits pay little or no interest, so people hold them only if they value their safety and liquidity far more than their yield. Demand deposits and checking accounts, close cousins to savings accounts, have increased over $800 billion. Together, the increase in these three components account for almost all of the $1.9 trillion increase in M2 since mid-March. The Fed facilitated this increase by purchasing notes and bonds in exchange for bank reserves (see Chart #11, which is equivalent to transmogrifying notes and bonds into T-bill substitutes. (I've explained this process numerous times in the past.) But this is not the same as "printing money."

What the Fed has done was absolutely essential, since the Covid crisis and the sudden plunge in economic activity created an explosive demand for liquid, safe assets. As long as this demand persists, the huge expansion of the M2 money supply will not be inflationary. Indeed, recent inflation statistics suggests that prices of late have been falling. 

Inflation will pose a threat only if the Fed fails to withdraw its liquidity injections when and if the world's demand for safe, liquid assets begins to subside. For now, that is a tale for future, not for today.

UPDATE (May 22): Here's an updated version of the TSA Throughput data (Chart #3 above). On a 7-day moving average basis, TSA screening activity is up 150% compared to the low of April 17th. From this we can infer a significant recovery in air passenger traffic in the past 5 weeks.

Chart #12