Take cover as M2 growth hits zero and monetary lags bite back

on Dec 30, 2022
  • The Federal Reserve will continue to tighten at its meeting next month.
  • Annual M2 growth in the USA was zero.
  • Household budgets will continue to be strained even as inflation eases.

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Throughout this year, the Jerome Powell-led Fed has pushed rates higher at an unprecedented pace.

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Of course, the panic among policymakers to tighten monetary policy is itself largely a product of the Fed’s prolonged easy-money policies and years of rock-bottom interest rates.

In a desperate bid to keep households afloat, there came a sugar rush of financial handouts and ultra-loose fiscal policy shortly after strict lockdowns and a total freeze on economic activity.

The turn from being helplessly stuck below target inflation to the completely alarming price surges did not take long to materialize.

Source: FRED Database

Quantitative tightening

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The tightening stance of the Fed extends to the amount of cash in circulation as well.

The famed (or now infamous) M2 indicator has continued to shrink, with monthly figures of the seasonally adjusted money supply contracting for the fourth consecutive month.

Source: SchiffGold

In an article, SchiffGOLD found,

When looking at the average monthly growth rate, before Covid, November historically expands at an annualized rate of 5.2%. This year missed by an incredible 870 bps.

Usually, the last quarter of the year sees a strong uptick in money supply which only makes this divergence from the trend more pronounced, and more painful.

Crucially, as shown in the graph below, annual M2 growth has hit zero for the first time in history.

Source: FRED Database

The lags strike back?

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Although it appears as though price pressures are beginning to bend to the will of the Fed, the price of inflation is about to get even higher.

That’s because society has yet to see the dreaded lag effect truly kick in.

Danielle DiMartino Booth, the CEO and Chief Strategist of Quill Intelligence, who has nearly a decade of experience as an advisor to the Dallas Fed, noted,

The Fed recently published a paper that showed instead of an 18-month period over which time you start to really feel the pinch of tighter monetary policy, now it’s really down to just 12 months.  

It seems that Fed economists are communicating that Q1 will see a harsh downturn and possibly the onset of a full-blown recession.

Another year, another quarter

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The Fed’s decision to hike by an additional half point in December means that the tightening game is very much on.

Come January 2023, the FOMC will go up at least another quarter of a per cent.

Market data reflect this expectation with the CME FedWatch Tool reporting about a seven to three split between the likelihood of a quarter and half-point rise, respectively.

A Republican-controlled House of Representatives will likely be unwilling to offer much in way of fiscal buffers to debt-burdened households, given the devastation wrought on the economy by the quantum of direct transfers in the past two years.

DiMartino Booth added that she doesn’t expect tax refunds and forgiveness measures to be anywhere as accommodative as they were during 2022, meaning family budgets will be highly stressed.

Ultimately, as many economists have been arguing, the soft-landing option is no longer in the realm of possibility.

If the Fed were to somehow stay its course, the economic consequences would be devastating.

Even with the effect of the monetary lags now at the Fed’s doorstep, difficult fiscal conditions becoming deeply entrenched, and the gloom around job creation particularly in lower-skilled sectors (which you can read about here), the Fed will continue to talk tough for the time being and hike by a quarter per cent in the coming weeks.


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