Federal Reserve Credit Contracts Further

We last wrote in July about the beginning contraction in outstanding Fed credit, repatriation inflows, reverse repos, and commercial and industrial lending growth, and how the interplay between these drivers has affected the growth rate of the true broad US money supply TMS-2 (the details can be seen here: “The Liquidity Drain Becomes Serious” and “A Scramble for Capital”).

 

The Fed has clearly changed course under Jerome Powell – for now, anyway.

 

Our friend Michael Pollaro* recently provided us with an update on outstanding Fed credit. As there are no longer any outstanding reverse repos with domestic banks, the liquidity drain is accelerating of late, with growth in net Fed credit contracting at fairly rapid rate of 3.4% year-on-year in September, the fourth consecutive month of decline:

 

The year-on-year contraction in net Fed credit accelerates. Since there are no longer any outstanding reverse repos with domestic financial institutions, the only force counteracting the negative effect on money supply growth is inflationary bank lending.

 

Michael also sent us a chart comparing the monthly trend in total net Fed credit in the course of 2017 with the trend in 2018 to date. When “QT” started in September of 2017, outstanding Fed credit initially kept growing well into 2018, largely because reverse repos with US banks ran off faster than securities held by the Fed decreased – but that has changed quite noticeably in the meantime:

 

Fed credit in 2017 (blue bars) vs. 2018 (red bars). The downtrend becomes more pronounced.

 

Keep in mind that the reverse repos mainly served to alleviate growing delivery fails due to a shortage in certain off-the run treasury securities which banks needed as collateral. As the Fed has stopped reinvesting all proceeds from maturing treasuries and MBS, banks no longer need to borrow securities from its portfolio.

The markets evidently never “missed” the liquidity tied up in these reverse repos, not least because high quality treasury collateral serves as a kind of secondary medium of exchange in repo markets, where it supports all kinds of other transactions. With net Fed credit actually decreasing, an important threshold has been crossed. The effect on excess liquidity is more pronounced, which definitely poses a big risk for overextended financial markets.

As an aside to this, bank reserves have in the meantime declined by roughly USD one trillion from their 2014 peak, but remain far above the amounts required to support the deposit liabilities of US banks. The main effect of the decrease is that the amount of fiduciary media (uncovered money substitutes) in the system is rising, but reserves are definitely not a constraint on inflationary bank lending.

Once the temporary effect of repatriation flows on the domestic US money supply abates, bank lending growth will be the only force counteracting the effect of the Fed’s liquidity drain on the broad money supply.

 

Bank reserves are down quite a bit (and the monetary base has declined accordingly), but the main effect of this was to reduce the percentage of deposit liabilities in the banking system consisting of covered money substitutes. This increases risks for depositors somewhat, but is not a constraint on bank lending – one only has to consider the paltry amount of bank reserves that supported the credit bubble leading up to the 2008 crisis.

 

The main constraint on bank lending these days are capital requirements, which have become a great deal more stringent under Basel III. We would add to this that a number of large international banks (particularly European ones) remain very cautious with respect to credit expansion, and with good reason. As the recent upheaval in emerging markets (particularly in Turkey) and in Italian bond markets demonstrates, they continue to face considerable risks.

Not surprisingly, the economic area in which banks are most willing to lend is the US – but even US bank lending growth is paltry compared to what is considered “normal” in boom times, and may be about to falter again from a lower peak. Consider the sharp dip in commercial and industrial bank loan growth last month.

Interestingly, while consumer loan delinquencies remain fairly high, business loan delinquencies have actually declined quite noticeably over the past 18 months. Business confidence is high and lending standards have continued to ease – and yet, recently C&I loan growth is faltering anyway.

 

US commercial and industrial bank lending y/y growth rate: after rising from a low just below 1% y/y in December 2017 to 6.46% in July 2018, C&I lending growth has recently decreased again to 4.82% y/y – far below the 10%+ growth rates usually seen in boom periods.

 

US True Money Supply

Unfortunately the money supply data for September are not available yet – as of August, the US broad true money supply was still growing at roughly 4.7% y/y, but we suspect that a decline in this growth rate will be reported in September.

The y/y growth rate of the narrow aggregate M1 already decreased to 3.92% in August, one of the lowest readings of recent years. Similar low points in M1 growth were last seen in August 2008, July 2010 (in the pause between QE1 and QE2) and in February 2016.

Normally the growth rate of M1 tends to lead growth in TMS-2, but after they peaked concurrently in October/November 2016 (note: this was just an interim peak in a longer term declining trend) these roles reversed, as M1 growth proceeded to decline more slowly from there. This has changed in the meantime, as growth in M1 has recently slowed sharply, catching up with the slowdown in TMS-2 growth.

It also seems that the trend in the growth rate of the narrow money supply has lately “synced up” with the accelerating decline in assets held by the Fed. For a variety of reasons this was not always the case in recent years.

 

Fed assets in USD million (black line, left hand scale) and y/y growth in M1 (red line, rhs). Recently the trend in M1 growth has “synced up” with the slowdown in TMS-2 growth and the decline in Fed assets. M1 growth has slowed to 3.9% y/y.

 

The following chart shows the y/y growth rate of TMS-2, its 12-month moving average and the y/y growth rate in total US bank credit. The latter has actually weakened again in August, to just 3.8% y/y. It is fair to say that inflationary bank lending is currently not contributing much to money supply growth. In fact, total US bank loan growth is around two thirds lower than it was in the housing boom period between 2002-2008.

 

Year-on-year growth in TMS-2 (4.7%), the 12-month moving average of TMS-2 growth (3.7%) and year-on-year growth in total US bank credit (3.8%).

 

A major reason why TMS-2 growth is somewhat higher continues to be the Treasury’s General Account at the Fed, which reflects over-issuance of t-bills to accommodate repatriation flows. There were two such phases – the first one coincided with the introduction of new money market fund regulations, which led to MM funds moving eurodollars to the US and purchasing t-bills.

Since MM funds were primarily buying commercial paper issued by European banks, this activity led to the TED spread widening quite sharply at the time. In the meantime this has been digested and the TED spread has tightened to more normal levels again (i.e., it does not indicate any stress in the banking system).

The repatriation of cash by non-financial corporations by contrast mainly pushed up USD borrowing costs for European corporations, as Apple, Oracle and others were major buyers of CP issued by European non-bank companies. Since repatriated funds are initially deposited with money market funds before they are deployed (for stock buybacks, dividends, capex, etc.), demand for t-bills by MM funds has surged again.

Repatriation by companies is reportedly still underway, but the effect will ultimately be a “one-off”, just as the first repatriation wave by MM funds was. The large Treasury deposits with the Fed should therefore decrease again – but the money will of course remain part of the domestic money supply, as it will then show up in private bank deposits (some of it may find its way back overseas again through different channels). Incidentally, the drawdown of Treasury deposits at the Fed should slow down the QT-driven decline in bank reserves (or even reverse it temporarily).

 

Treasury deposits at the Fed – the two highlighted periods coincided with two repatriation waves. Judging from what has been published about the discussions of the Treasury’s advisory board, it appears that the Treasury accommodated these inflows by over-issuance of t-bills. The Treasury’s account at the Fed has become quite active since the “GFC”. Previously, only a tiny float of tax receipts was kept there, as the money was spent as fast as it came in (in the more distant past, the Treasury tended to hold this small float mainly in commercial bank deposits, but these amounts have become negligible).

 

Memorandum items such as the Treasury’s General Account are not included in monetary aggregates such as M1 or M2, but they clearly represent money and are therefore included in TMS-2. The Treasury will spend this money (most of the recently accumulated funds will presumably be used to redeem t-bills). By contrast, bank reserves are excluded from both TMS-2 and other monetary aggregates.

Bank reserves are as a rule not “spent” – they are either lent out in interbank markets to banks that are short of reserves (though not as long as interest paid on reserves exceeds the effective federal funds rate, but that may be on the verge of changing), or alternatively they are converted into currency if bank customers withdraw demand deposit money.

Although reserves can potentially become part of the money supply if/when they are paid out to bank customers in the form of bank notes, the concomitant decrease in deposits should at the same time lead to credit contraction. The money supply should therefore not grow – on the contrary, in a fractionally reserved system a decrease in demand deposits and reserves will tend to contract the money supply (of course this won’t necessarily be the case as long as there are large amounts of excess reserves).

 

Conclusion

Given the accelerating decline in Fed credit as “QT” continues, anemic and apparently slowing bank credit growth and a recent sharp slowdown in the growth rate of M1, we expect that the slowdown in the growth rate of TMS-2  – which was briefly interrupted after bottoming at 2.7% y/y in February – will resume shortly.

Narrow money supply growth rates in the euro area (6.5% y/y ) and China (5.1% y/y) have recently also declined to new lows for the move (we plan to discuss these developments in greater detail soon). All over the world the monetary backdrop continues to become less accommodative, which is bad news for “risk assets” such as stocks and corporate bonds.

Although pockets of weakness are in evidence here and there, most US economic indicators nevertheless continue to look strong. This supports market sentiment, but the stock market remains extremely overvalued, while profit margins are probably as high as they will ever get.

We have previously discussed the market’s mounting technical and structural problems – we believe these are a direct result of the increasingly hostile monetary backdrop (i.e., there is no longer enough excess liquidity to keep all the plates in the air).

 

Addendum: Modified Ned Davis Method Gives Partial Sell Signal

Frank Roellinger** has informed us that the Modified Ned Davis Method has given a partial sell signal at the close of October 5 with the Russell 2000 index (RUT) at 1632.11 points, i.e., it has moved from 100% long to 50% long the RUT last week.

 

Footnote:

 

*Michael Pollaro regularly publishes statistics on the “Austrian” money supply of the G4 (US, euro area, UK and Japan). He has penned a highly recommended and very useful backgrounder on the Austrian School’s monetary aggregates with numerous links to further reading material that can be accessed at Forbes.

**Frank Roellinger has invented the Modified Davies Method, which is a systematic strategy that goes both long and short the Russell 2000 Index based solely on technical signals. The method has been highly successful in recent years. For background information see “The Modified Ned Davies Method” and “Reader Question on the MNDM”)

 

Charts, tables and data by: Michael Pollaro, St. Louis Fed and Acting Man 

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • The Great Debasement - Precious Metals Supply and Demand
      Fiat Money Woes Monday was Labor Day holiday in the US. The facts are that the euro lost another 1.4%, the pound another 1.1%, and the yuan another 0.9% last week.   Assorted foreign fiat confetti against the US dollar – we have added the Argentine peso as well, as it demonstrates what can happen when things really get out of hand. [PT]   So, naturally, what is getting play is a story that Bank of England governor Mark Carney said the dollar’s influence...
  • Hong Kong - Never the Same Again
      Freedom Rock Hong Kong ranks among the freest societies in the world. Not only economically, but socially it is a very liberal place. It was marinated in British ways until 1997, much longer than Singapore and other colonies. Then China took it over as a special administered region, which according to the agreement with the UK meant that it was only nominally to be under Chinese control for the next 50 years. It was possibly the only colony in which a vast majority of citizens did not...
  • Suffering the Profanity of Plentiful Cheap Money
      A Case of Highway Robbery What if the savings in your bank account lost 55 percent of its value over the last 12 months?  Would you be somewhat peeved?  Would you transfer some of your savings to another currency?   USD-ARS, weekly. For several years the Argentine Peso has followed a certain pattern: it declines mildly, but steadily, with little volatility for long time periods, and then spikes in crash waves whenever a crisis situation comes to a head. In early 2011, it...
  • Don’t Be Another Wall Street Chump
      The Future and the Past Securities and Exchange Commission Rule 156 requires financial institutions to advise investors to not be idiots. Hence, the disclosure pages of nearly every financial instrument in the U.S. are embedded with the following admission or variant thereof:   “Past Performance Is Not Indicative of Future Results”   “Buy and hold”... “The market goes always up”... “No-one can time the market”... “Buy the dip” “With what? You...
  • A Wild Week - Precious Metals Supply and Demand
      Paying a Premium for a Lack of Default Risk The price action got pretty intense last week! The prices of the metals were up Monday, Tuesday, and Wednesday. But Thursday and Friday, there was a sharp reversal and the silver price ended the week below its close of the previous week.   The net speculative position in gold futures has become very large recently – the market was more than ripe for a shake-out. [PT]   Silver made a round trip down from $18.35 to...
  • Will the Nikkei Win the Next Olympic Games?
      Listless Nikkei On 24 July 2020 the Olympic Summer Games will begin in Tokyo, the capital of Japan. Olympic Games and Soccer World Cups are among the largest sporting events in the world.  Do you perhaps also think that these events may affect the performance of local stock markets?   Olympic Summer Games 2020 – official logo (left), and a fan-made logo (right) by designer Daren Newman [PT]   Let us examine whether and in what way such major sporting events impact...
  • The Weird Obsessions of Central Bankers, Part 3
      Inflation and “Price Stability” We still remember when sometime in the mid 1980s, the German Bundesbank proudly pointed to the fact that Germany's y/y consumer price inflation rate had declined to zero. It was considered a “mission accomplished” moment. No-one mentioned that economic nirvana would remain out of sight unless price inflation was pushed to 2% per year.   CPI, annual rate of change. During the “stagflation” period of the 1970s, Congress enacted the...
  • The Weird Obsessions of Central Bankers, Part 1
      How to Hang on to Greenland Jim Bianco, head of the eponymous research firm, handily won the internet last Thursday with the following tweet:     Jim Bianco has an excellent idea as to how Denmark might after all be able to hang on to Greenland, a territory coveted by His Eminence, POTUS GEESG Donald Trump (GEESG= God Emperor & Exceedingly Stable Genius). Evidently the mad Danes running the central bank of this Northern European socialist paradise were...
  • The Weird Obsessions of Central Bankers, Part 2
      The Negative Interest Rates Abomination Our readers are probably aware that assorted central bankers and the economic advisors orbiting them occasionally mention the “natural interest rate” (a.k.a. “originary interest rate”) in speeches and papers. It is generally assumed that it has declined, which is to say, time preferences are assumed to have decreased.   This is actually an understatement...   Although interest is generally associated with money, the...
  • Why Are People Now Selling Their Silver? Precious Metals Supply and Demand
      Big Moves in Silver Last week, the prices of the metals fell further, with gold -$18 and silver -$0.73. On May 28, the price of silver hit its nadir, of $14.30. From the last three days of May through Sep 4, the price rose to $19.65. This was a gain of $5.35, or +37%. Congratulations to everyone who bought silver on May 28 and who sold it on September 4.   The recent move in silver [PT]   To those who believe gold and silver are money (as we do) the rising price...
  • Fiat Money Cannibalization in America
      An Odd Combination of Serenity and Panic The United States, with untroubled ease, continued its approach toward catastrophe this week.  The Federal Reserve cut the federal funds rate 25 basis points, thus furthering its program of mass money debasement.  Yet, on the surface, all still remained in the superlative.   S&P 500 Index, weekly: serenely perched near all time highs, in permanently high plateau nirvana. [PT]   Stocks smiled down on investors from their...

Support Acting Man

Austrian Theory and Investment

j9TJzzN

The Review Insider

Archive

Dog Blow

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!