Money Supply Growth Rate Continues to Decelerate

How much longer can markets stay levitated as Fed pulls liquidity?

This article first appeared on SchiffGold.

Recent Trends

According to the seasonally adjusted data, M2 expanded by $59B in March. While the money supply is expanding, this is the slowest increase since June of 2021. It’s also almost $200B less than the $238B expansion last March.

Figure 1: MoM M2 Change (Seasonally Adjusted)

The economy and stock market are used to a rapidly expanding money supply. The current fall in growth will pose trouble for the market to continue expanding. Unfortunately, the Fed now provides money supply on a major lag which means the current data is the possible culprit of the current down move in the stock market.

A look an non-seasonally adjusted money supply shows a larger growth rate this past March than the chart above; however, it’s still more than $400B less than the $571B from last March.

Figure 2: MoM M2 Change (Non-Seasonally Adjusted)

The table below shows that M2 is decelerating quite a bit at 3.3% in the latest month. This is far below the 6-month and 12-month averages (7.9% and 9.9% respectively).

When looking at the average monthly growth rate by month prior to Covid, March historically expands at 4.8%. This March is thus well behind the growth rate seen in the decade before Covid by 150 bps.

Figure 3: Average Monthly Growth Rates

The Fed only offers weekly data that is not seasonally adjusted. The chart shows how the rebound in non-seasonally adjusted money supply is quite weak compared to recent history. Since the start of the year, money supply has been expanding far less rapidly.

Figure 4: WoW M2 Change

The “Wenzel” 13-week Money Supply

The late Robert Wenzel of Economic Policy Journal used a modified calculation to track Money Supply. He used a trailing 13-week average growth rate annualized as defined in his book The Fed Flunks. He specifically used the weekly data that was not seasonally adjusted. His analogy was that in order to know what to wear outside, he wants to know the current weather, not temperatures that have been averaged throughout the year.

The objective of the 13-week average is to smooth some of the choppy data without bringing in too much history that could blind someone from seeing what’s in front of them. The 13-week average growth rate can be seen in the table below. Decelerating trends are in red and accelerating trends in green. Money Supply growth on a 13-week annualized basis was mostly accelerating for 16 weeks in a row. It has now been flat or down for 12 weeks in a row.

Growth has now reached 7.06% which is the lowest reading in more than 60 weeks.

The plot below helps show the seasonality of the Money Supply and compares the current year to previous years. It shows the current trajectory moving down quite steeply. In the last two years, this has rebounded in April, but it seems unlikely the market will see the same bounce this year. The current trajectory is lower than both 2015 and 2016.

Because M2 growth has been extremely high in recent years, the market has grown accustomed to a certain level of growth. This deceleration is clearly putting pressure on the stock market.

Figure 5: Yearly 13-week Overlay

Behind the Inflation Curve

The graph below shows YoY M2 compared to inflation and Fed Funds. As discussed before, the current trajectory is looking uncomfortably similar to the early 1970s with three major differences.

1. The money growth has been more extreme in recent years
2. Inflation is actually higher if measured the same way
3. The Fed is much further behind the curve

As shown below, inflation tends to lag increases in M2 by about 1-2 years. Notice how all the black spikes occur a few years after the large orange bars. While most forecasters are talking about peak inflation occurring now, the chart below suggests we are in the early innings. Keep in mind, inflation only reversed once the Fed brought rates up above the inflation rate.

In the most recent period, the Fed Funds is 8.4% behind inflation. This shows they are further behind the rate of inflation than ever before. In addition, the chart shows that it takes time for higher rates to bring inflation back down. The Fed does not have the luxury to wait for higher rates to work when they are so far behind the curve.

Could some inflation pressures ease now that energy has pulled back? Sure, but the majority of inflation is not due to the war in Ukraine. The inflation today is a direct result of the massive increase in money supply shown below. In March 2021, YoY M2 had increased by 24.2%. That money supply growth is creating the price increases we are seeing now.

Figure 6: YoY M2 Change with CPI and Fed Funds

Historical Perspective

The charts below are designed to put the current trends into historical perspective. The orange bars represent annualized percentage change rather than raw dollar amount. the current deceleration can be seen as the orange bars fall rapidly on the far right.

Figure 7: M2 with Growth Rate

Taking a historical look at the 13-week annualized average also shows the current predicament. This chart overlays the log return of the S&P. Mr. Wenzel proposed that large drops in Money Supply could be a sign of stock market pullbacks. The current value of 7.1% is the lowest value since September 2019.

His theory, derived from Murray Rothbard, states that when the market experiences a shrinking growth rate of Money Supply (or even negative) it can create liquidity issues in the stock market, leading to a sell off. While not a perfect predictive tool, many of the dips in Money Supply precede market dips. Specifically, the major dips in 2002 and 2008 from 10% down to 0%.

This current drop in money supply is clearly resulting in the stock market losing traction and being unable to gain momentum.

Please note the chart only shows market data through Apr 4 to align with available M2 data. This does not capture the recent sell-off.

Figure 8: 13-week M2 Annualized and S&P 500

One other consideration is the massive liquidity buildup in the system. The Fed offers Reverse Repurchase Agreements (reverse repos). Essentially this is a tool that allows financial institutions to swap cash for instruments on the Fed balance sheet.

Current Reverse Repo hit a record $1.9T on Dec 31, dwarfing the old records of ~$500B in 2016-2017. The latest rate is $1.8T. The reverse repos typically top out at quarter end before coming back down. The $1.87T on March 31 did not exceed Dec 31. This is the first time that a quarter-end did not exceed the previous quarter-end in over a year.

Figure 9: Fed Reverse Repurchase Agreements

What it means for Gold and Silver

Inflation is an expansion of the Money Supply that generally leads to higher prices. While money supply is still expanding, the rate at which it’s growing is falling. This deceleration will be enough to slow the economy and the stock market, but not enough to stop prices from rising.

This again shines light on the conundrum facing the Fed. How do they engineer a “soft-landing”? They can’t! The massive money supply growth seen in 2020 and 2021 cannot be undone without a shrinking of the money supply. Growth rate is falling, but it’s still positive.

When the stock market falls but the CPI remains elevated, the Fed is not likely to continue decreasing the money supply. It’s more likely they will come to the rescue with more liquidity. The may justify the move pointing to the strong increase in the US Dollar of late. Unfortunately, that could be the move that causes the Dollar to breakdwon, only exacserbating the inflation problem.

Gold and silver will offer an excellent hedge against the Fed’s attempts to remediate its past mistakes by only making bigger ones.

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Data Source: https://fred.stlouisfed.org/series/M2SL and also series WM2NS and RRPONTSYD. Historical data changes overtime so numbers of future articles may not match exactly. M1 is not used because the calculation was recently changed and backdated to March 2020, distorting the graph.

Data Updated: Monthly on fourth Tuesday of the month on 3-week lag

Most recent data: Apr 04, 2022

Interactive charts and graphs can always be found on the Exploring Finance dashboard: https://exploringfinance.shinyapps.io/USDebt/