The pace of growth in money supply is a number that’s meaningless in a vacuum. To quote a rate of expansion offers no more insight than looking a stock or bond and having no knowledge of valuations beyond. With that in mind, what can we say of the 6.6% advance (in nominal terms) over the past year in M2 money supply, based on the latest data for the week through October 29?
We can begin to search for an answer by considering the speed of the economy. For the third quarter, the government’s current estimate tells us that nominal GDP grew by an annualized 4.7%. Using those figures in combination, it’s clear that the Fed’s printing money at a significantly higher rate than economic growth.
So, what have we learned? On its face, the data suggest that money supply is rising faster than prudence suggests. But again, additional context is necessary lest we make a hasty judgment.
Let’s also add to the record that the 4.7% nominal GDP pace fell from 6.6% in Q2. For additional perspective, take note that the benchmark 10-year Treasury yield now stands at 4.23% and the Fed funds rate is 4.50%. In sum, interest rates are generally lower than the economy’s rate of growth while money supply is rising at a pace that’s substantially higher than GDP’s growth.
All of which might be considered perfectly reasonably if the goal is to juice the economy and head off a slowdown. To be fair, a slowdown for Q4 and beyond is now on everyone’s lips; only the degree seems to be in question. But once again, additional context casts a cloud of uncertainty over an otherwise obvious decision to err on the side of monetary stimulus.
Enter the humble dollar. Battered and bruised, the world’s reserve currency continues to take it on the chin these days. The U.S. Dollar Index plumbs new lows virtually on a daily basis of late, and the greenback against the euro looks even worse.
Everyone knows that capital prefers to reside in currencies where interest rates are higher rather than lower, thus the enduring possibilities of the so-called carry trade. The Fed seems inclined to dismiss such inclinations for the moment in favor of hedging against the possibility of recession. That may be wise, it may not be, depending on what happens. In particular, the question is whether a continued rout in the dollar feeds on itself and triggers economic and financial repercussions that are unexpected. No one expects the Spanish Inquisition, as the old Monty Python bit went. But that doesn’t mitigate the pain if and when it arrives.
Such is a central banker’s task in life: picking a poison and hoping for the best. But with soaring commodity prices one might wonder if the threat of recession is only part of the hazards stalking macro strategy.
“We continue to believe the greatest risk lies with the Federal Reserve orchestrating easier monetary policy to address the excesses in the financial sectors of the economy,” Edward Jong, a portfolio manager with FrontierAlt All Terrain Bond fund in Canada, told The Globe and Mail in story dated today.
The challenge is compounded by the growing pressure on the Fed for yet another rate cut. “The market is almost forcing the Fed’s hand [to cut rates],” Robert Marcus, another portfolio manager at FrontierAlt All Terrain Bond said in the G&M article. “But it’s not a slam dunk,” he added.
Indeed, the current story has no obvious ending yet. Various outcomes are still possible. The Fed could print too much money and exacerbate inflation, or perhaps it’ll add just the right amount of liquidity to keep the economy bubbling without overdoing it. Meanwhile, the dollar seems due for a technical rebound, and oil prices have probably run too high too fast, at least for the short term. Perhaps there’s a bit of respite coming, offering strategic-minded investors and central bankers alike a chance to catch their breath and reassess.
Maybe, maybe not. We don’t know and neither does any one else. We can guess, of course. Meantime, we’ll be watching the numbers. No doubt one asset class or another will fall prey to some excess or another. In fact, there are already some encouraging signs, albeit early signs that value is creeping back into some corners of the capital markets. Nothing dramatic, but at this stage of the game the mere sight of valuation trends moving in favor of buyers is a rare bird after the virtually non-stop bull markets of the past five years that have delivered the opposite.
For now, we’re watching and waiting, eager to redeploy our overweight of cash. But not quite yet, at least nothing of consequence. A nibble here and there. Stay tuned for details….