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Macro-Economic Update: Rates Have Been Rising But Money Supply Is Just Starting to Tighten

If you can believe it, the Fed rate today is higher than the dividend paid on most investment-grade bonds.
Macroeconomics interest rates

Co-Chair & CIO of Carbon Royalty Corp

New York Times Best Selling Author. ‘The Rise of America’ hit #1 on the Wall Street Journal & #1 on Amazon.
New York Times Best Selling Author. ‘The Rise of America’ hit #1 on the Wall Street Journal & #1 on Amazon.

Step back and watch the confusion in the heart of the U.S. monetary system.

Because while the nation remains captivated by ongoing political drama, a quiet transformation is taking place…

All concealed within the corridors of the Federal Reserve.

Notably, the U.S. Money Supply is experiencing a sustained contraction for the first time since at least 1960, with over $1 trillion being withdrawn.

These developments are signaling a shift in the fiscal landscape of a country heavily reliant on cheap debt and loose fiscal policies.

Let that sink in for a moment.

Because we’ve got a few visuals you need to see, to believe…

Money Supply: Tightening the Taps

A country that has loaded itself to the gills on cheap debt and loose fiscal policy is finally starting to see the tightening of the fiscal taps, so to speak.

But wait, there’s more…

Interest Rate Surprises

Interest rates have risen from near zero up to 5.25%. If you can believe it, this is higher than the dividend paid on most investment-grade bonds today (and more on that later).

And just this week, Fed Chair Powell indicated that two more rate hikes could be on their way.

But back to this point…

The U.S. money supply is slowly contracting and the fallout effects from that aren’t something that has been seen in real time yet in this new global economy we live in.

The chart below shows the U.S. M2 money supply (in green) which is composed of all the money in circulation, along with money in checking and savings accounts, retail investments in money market funds and term deposits under $100,000. In blue is the velocity of that M2 money supply.

The velocity of capital is the number of times one dollar is spent to buy goods and services per unit of time. It’s calculated as the ratio of Gross Domestic Product (GDP) to Money Supply.

In a sense, it represents the willingness of citizens to spend.

  • If velocity is increasing, more transactions are occurring between individuals.
  • If velocity is falling (like we have seen continuously for 25+ years), less transactions are occurring between individuals.

We can see the clear negative relationship between money supply and velocity of capital in the chart above. This is because money supply growth has outpaced GDP growth and indicates that every dollar doesn’t go as far as it used to.

Implications of Future Rate Increases

Looking ahead, it’s plausible that we see another 0.25%-0.50% rate increase over the next six months, which takes the Fed Funds target rate to 5.50%-5.75%.

The reason?

The primary driver behind these potential hikes lies in the Federal Reserve’s concerns regarding inflation.

With its preferred inflation gauge standing at 4.40%, and a 4.7% reading when excluding food and energy, the previous significant interest rate adjustments aren’t fully reflected in the economy yet.

I’ve said it before, these large interest rate increases are just beginning to work their way through the system.

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