The Fed’s interest rate hike seems to be starting to work. Not only did CPI cool down for six consecutive months in December last year, but a new data shows that the money supply in the US economy has contracted.
After surging in 2020, M2, a key measure of the money supply, has been slowing for the past two years and turned negative in December, data showed. M2 includes currency in circulation, money market fund balances and savings deposits, etc.
In December, US M2 decreased by 1.3% year-on-year, which was the lowest level since the Fed began to calculate this indicator in 1959, and it was also the first decline in M2 in all available data. The annual growth rate in November had fallen to 0.01%, well below the February 2021 peak of 27%.
Over the past year, the Fed has raised interest rates at a pace not seen since the early 1980s, playing a role in reducing the money supply and the excess savings consumers have amassed during the pandemic.
Consumers have had to dip into their savings to pay higher interest rates on everything from mortgages to car loans and credit card debt, or pay cash for big-ticket items to avoid them. The housing market is a good example. About 30 percent of homebuyers paid cash in December, the highest rate in eight years, according to real estate research firm Redfin.
Meanwhile, the U.S. household savings rate has fallen steadily, from 7% a year ago to 2.2% in October, the lowest level since 2005. This decline is exactly in line with the decline in broad money supply M2 from a peak of $13.8 trillion in March to $12.6 trillion in November.
The Fed will make an important decision next week. The market currently expects the Fed to raise interest rates by 25 basis points at next week’s FOMC meeting, representing a sharp slowdown in its historic pace of rate hikes.
Economist Milton Friedman once said: “Inflation is a monetary phenomenon whenever and wherever possible, and inflation may only be caused by a sharp increase in the quantity of money.”
The fall in M2 is indicative of a cooling US economy, and the strong pass-through of rising interest rates appears to be fueling fears of a near-term recession. The December retail sales data released by the US Department of Commerce last Wednesday was a case in point for a 0.7% year-on-year decline. And if consumer spending, which accounts for regarding two-thirds of the U.S. economy, starts to slow, that should help contain or even lower inflation.
St. Louis Fed President Bullard (James Bullard) also said this month that the sharp decline in the M2 indicator of US money supply may be good news for policymakers struggling to control high inflation.
Nathan Sheets, Citigroup’s global chief economist, also said that as M2 retreats further, it should continue to help keep inflation in check, as lower currency reserves dampen demand and reduce the “support for bank lending and other household, business and financial market transactions.” Ability to finance”.
Investment firm Merion Capital Group analyst Farr (Richard Farr) believes that investors should not take it for granted that the decline in M2 represents an economic slowdown. He said that M2 “needs to be reduced by at least another $1 trillion” for such a signal to be meaningful.
