Saturday, 12 April 2014

U.S. Money, Credit & Treasuries Review (as of 2 April 2014)

According to data released yesterday by the Federal Reserve, the U.S. monetary base closed at USD 3.8850 trillion for the bi-weekly period ending 2 April 2013, leaving the base USD 134 billion, or 3.6%, higher than year end 2013. Compared to the same period last year, the base increased 30.1%. This is a tremendous increase even by Japanese standards

With the Fed tapering now starting to bite combined with a higher denominator than last year, the year on year percentage increase was the lowest since the bi-weekly period ending 21 August last year. This means that even if the Fed did not taper, the growth rate in the base would continue to slow. The Fed taper therefore means the growth rate will drop even more. The monthly asset purchases will now be USD 55 billion a month starting this month. Assuming the Fed continues to buy USD 55 billion a month in assets for the rest of the year, this would result in an expansion of the base of "just" under 17% this year. With the Fed's expectation to reduce asset purchases "by a further $10 billion at each upcoming meeting absent a material change in the economic outlook" (here) the increase in the growth rate would fall below the 17% increase if the plan is stuck with. The growth rate in the base would as a result drop more than half the just under 40% expansion witnessed in 2013. 

In one way or another, this drop in the growth rate of the monetary base will have negative consequences for the stock market as interest rates could move higher and money supply will expand less than otherwise. Both are negative for not only equities, but most asset prices. It would be challenging to argue that Fed balance sheet expansion has not been a primary driver of stock market prices especially in 2013. Perhaps stock market investors is just starting to absorb this knowledge as the S&P 500 index dropped 2.65% this week. 

The M2 money supply year on year growth came in at 5.8% for the week, the lowest since the bi-weekly period ending 22 January and down from 6.2% two weeks ago. The growth rate in Bank Credit, a primary driver of money supply growth, fell from 3.0% two weeks ago to 2.9%. This is a low growth rate in a historical perspective (it has averaged 6.4% since 1985), but it is a significant increase from the trough of 1.1% hit on 25 December last year. As the Fed is now tapering, it's an absolute necessity that bank credit growth picks up to support money supply growth. Be advised that it's not my position that keeping a high money supply growth rate is the right thing to do. Regular readers of this review and EcPoFi in general will know that my commentary on the money supply is from the perspective of the Austrian Business Cycle Theory. This theory explains that booms are fueled by increases in the money supply (which again is driven by bank credit and government deficits supported by banks or the Federal Reserve) and will come to an end when the money supply growth falls. 

Continued massive budget deficits, a debt to GDP ratio of 100% and government intervention in most areas of the economy ranging from minimum wages to housing, but who cares? When turmoil sets in, being it nervous stock market investors or emerging market crisis, the money still flows to U.S. government treasuries even as money inflation is running at around 6%. During the last two weeks, the 1-year treasury yield shred 3 basis points and the 10-year one did the same. The latter is now down 30 basis since 27 December last year. Compared to a year ago, the 1-year yield is down 2 basis points while the 10-year yield is up 92 basis points resulting in the spread between the two widening by 92 basis points.

The key developments in the money supply, bank credit and treasury yields for the bi-weekly period ending 2 April 2014 (11 April for treasury yields) are summarised in the tables below. 

The U.S. Money, Credit & Treasuries Review is a report issued on a bi-weekly basis by EcPoFi. You can access all previous issues since February 2013 here.

Recommended for the keen follower of money supply developments: The Short Version of the Austrian True Money Supply.

Must read, the central banker with a different view: The Central Banker of All Central Bankers Explains The Way To Recovery.