Tuesday, March 22, 2022

M2 growth slows, but it's still too fast


This is a quick post, but on a very important and almost completely overlooked statistic: the growth of the US money supply. I have been highlighting this for at least the last 18 months. Until recently, money growth was at all-time and very inflationary highs—well into the double digits. This all but guaranteed that the inflation which appeared to be ignited by supply-chain bottlenecks would instead be durable and pervasive.

With the release today of the M2 numbers, I'm breathing a bit easier. The Fed is still extremely accommodative, but on the margin monetary policy is becoming less so. Monetary policy is far from being "tight" but it is now becoming "less easy."

The tapering of Fed asset purchases is good, but they need to reverse course as soon as possible, and they need to raise rates much more than they have been hinting up until recently. It's encouraging to see several members of the FOMC saying the same thing, and the market has been reacting appropriately, by bidding up short-term interest rates rather aggressively. 5-yr Treasury yields—a proxy for what the market expects the Fed funds rate to average over the next 5 years, have risen by 80 bps so far this month. And despite this, the stock market has rallied.

In the past I have rarely agreed with Larry Summers, but in an interview last week with Bloomberg, he expressed similar views. We both think that as a first approximation, the Fed needs to raise short-term rates to at least 4-5%. I think we would both agree that ultimately, the Fed needs to raise rates until they are above the rate of inflation. Negative real rates are inflationary, since they make borrowing (which is what expands the money supply) profitable.

In any event, the market is saying what I've said all along: if there is a good reason for the Fed to raise rates, and they do so, this is good news, not bad news. We are still far from seeing conditions that would signal an imminent recession. Credit spreads are still relatively low, swap spreads are square in neutral territory, and the yield curve is still positively sloped. There is no sign that liquidity is in short supply—and that's all-important. This economy is not being starved of liquidity, so it's very unlikely to suffer a collapse. It's still worrisome, however, to see commodity prices moving higher, and real rates still deep in negative territory. 

We haven't seen the end of this story.

Chart #1

Chart #1 is my choice for "most important chart." It shows the growth of M2—the best measure of the money supply—less the currency component, which is about 10% of M2. I've subtracted currency because whatever the supply of currency is, it is always equal to the demand for currency, and thus it's not inflationary. But if the growth of the rest of M2 exceeds the demand for it–which I suspect is true—then this is inflationary. Regardless, it is very encouraging to see that in the past few months the growth of this key indicator has fallen from 12-13% annual rates to now 8-9% annual rates. That's still rapid, but on the margin it represents change for the better. A good portion of the slowdown in recent months, I should note, is due to downward revisions of previous data.

We'll have to see more such declines before we're out of the inflation woods, of course, but anything that is positive in today's environment is quite welcome. 

15 comments:

marcusbalbus said...

stop the stock market cheerleading.

Greg said...

I've subtracted currency because whatever the supply of currency is, it is always equal to the demand for currency, and thus it's not inflationary.”

Scott - This sentence seems wrong to me in a general sense. I may be reading it differently than you wrote it. Can you explain a bit further?

wkevinw said...

Interesting video on inflation, economics, etc. going forward and long term trends for past several decades.

https://www.advisorperspectives.com/videos/perspectives_220308_woody_brock_bob_huebscher%20%281080p%29.mp4

I agree with most, but not all of it.

Interesting is that the suggestion is that future inflation will be driven by bailing out socialsecurity/medicare- maybe a form of MMT? (helicopter money created/printed to send to recipients). I have been expecting something like this for many years.

The bottom line is that the prediction is for long term/secular inflation is turning up and will be "promoted" by the government.

Bill Snarf said...

Rates above 4% how do equities rally? Housing already demonstrating a few signs of peaking. Housing stocks and price of lumber are perhaps signaling a red flag. Yes the markets have baked in higher rates (thus a bear mkt rally of oversold stocks in the short term is possible) but the market cannot manage 4%. Housing affordability is at 2006 levels.
The yield curve is not inverted but almost flat and short rates are going higher so inversion is inevitable. Yes equities rally initially after an inversion but we have never had such a manufactured economy (cheap real rates and QE) over 12 years like this so I would think marginal tightening and QE unwind has major implications. Egg shells. Good news is the current sentiment is negative but that only helps in the short term.
Always love the posts and great respect for information that is not found elsewhere.

Scott Grannis said...

Greg, re currency: Banks cannot force people to hold currency. If someone ends up with more currency that he or her is interested in holding, the solution is to return it to a bank. The bank in turn returns any unwanted currency to the Fed, and the Fed "extinguishes" the money by giving banks bank reserves in exchange. Bank reserves are not money, by the way. But bank deposits are another thing. Banks can create deposits (money) at will, as long as they have reserves on hand to collateralize the deposits. If I have $1000 in my bank account and use it to buy something, that money deposit must be held by someone else. To shrink deposits, banks would have to stop making loans and people would need to pay off existing loans.

Benjamin Cole said...

Nice post. Probably the world's major central banks have overreacted, but then they were provoked by the global government overreaction to C19.

Now Ukraine.

It is too bad there does not appear to be a way to maintain very tight job markets in the US and also trim back inflation.

I prefer a surfeit of jobs and a reduction of welfare to other policy options.

If we have another recession, we will see a job shortage and more welfare.

As the great B.B.King sang,"There must be a better world somewhere."

honestcreditguy said...

drought is going eat inflation for lunch and burb it out worse, buy properties in great lakes....

the far west is toast, the great migration is near, California, Oregon, Nevada, Arizona all ran by dystopian leaders, with dystopian ideas but not addressing core issues.

Biden, the pale white horse....nato the chariot....what a crock of u know what...

Salmo Trutta said...

re: "supply-chain bottlenecks".

Powell created the supply shocks during 2018 and 2019 tight money periods. It's just like Bankrupt-u-Bernanke decimated the housing market by 2 years of a contractionary money policy.

Ataraxia said...

The housing and rental markets need to turn.

Adam said...

Hello,Scott.
Are there any other factors for M2 growth deceleration than data revision?

RJ said...

Hi Scott,

Love your posts! The 3/10, 5/10 and 7/10 yields are now inverted. I know you said in this post you don't see any concern about recession, but if the feds keep pushing on the front end of the curve, don't you see a 2/10 inversion happening as a result?

Thanks always for sharing your ideas and insight.

davidbauer said...

Scott, just a simple, heartfelt thanks for sharing your perspectives and analysis.

Scott Grannis said...

RJ, re yield curve inversions: The fact that the Treasury yield curve is slightly inverted from 5 to 30 years is not meaningful at this time. Yes, I have noted repeatedly over many years that a yield curve inversion has preceded virtually every recession in my lifetime. BUT, more often than not a recession does not immediately follow an inversion—sometimes the curve inverts as many as several years before a recession hits. In any event, the 5-30 spread is the only current area that is inverted. I pay more attention to the 1-10 spread (currently a healthy 77 bps.

Here's the complete list of key bond market recession indicators/predictors to watch for: 1) yield curve inversion, 2) high real interest rates, 3) elevated credit spreads, 4) elevated 2-yr swap spreads. Today real interest rates are deeply negative, credit spreads are only modestly elevated, and 2-yr swap spreads are in neutral territory. The confluence of these indicators does not suggest a recession is imminent or even on the horizon.

Scott Grannis said...

davdbauer: Thank you. It's always nice to be appreciated!

RJ said...

Thanks for you comment, Scott. I realize a recession and the yield curve inversion takes time (12-18 months). I'm really not focused on the 5/30, but rather the 3/10, 5/10, and 7/10 curves that are now all inverted. It's the 2/10 that is getting close that we should keep a close eye on as one indicator. https://fred.stlouisfed.org/series/T10Y2Y/

Thanks also for you other indicators to watch for. Sure seems like high real rates are a long way off. Either rates have to really climb, or inflation has to do an about face.