Following Third Largest Weekly Surge In M2, Expect Artificial Spike In Leading Economic Indicators

In the past two weeks, one of the curious development in monetary aggregates, in addition to a spike in the Adjusted Monetary Base (discussed previously here), was the $88.7 billion surge in the M2 for the week ended July 4, the third largest jump in the broadest tracked monetary aggregate in history. Some have speculated that this number may be indicative that the money multiplier has once again started working as bank reserves after 2 long years, finally start making their way into the broader market. Unfortunately as Stone McCarthy explains this is not the case at all (sorry Fed: QE is still a failure) but merely has to do with the repeal of Regulation Q (explained here) which has resulted in a surge in small tie deposits inclusive of money market deposit accounts, which have jumped by $110 billion in the past two weeks, coupled with an accelerating shift of dollar deposits back to banks domiciled in the US. In other words: regulation explains the entire move. There is, however, a kicker, and it goes to another indicator of "economic growth" - the leading economic index, which is actually driven by M2. This means that the fake surge in the M2, will result in an all too real jump in the LEI, which in turn will push the market higher as vacuum tubes interpret the data as positive for the economy as opposed to merely driven by a regulatory forced shift of money from Pile A to Pile B. Expect stocks to surge once the next LEI reading is announced as a result.

Weekly change in M2:

Stone McCarthy explains the impact of M2 on the LEI:

We have revised our projection for the growth in the June leading economic index due to an explosion in M2 growth in the last two weeks. In the week ended July 4, M2 money growth booked a $88.6 bln increase, the second largest weekly increase on record.

We now project the leading economic index to rise by 0.5% in June (earlier forecast was +0.3%) after jumping by 0.8% in May. On an annual basis, the leading index is projected to rise by 6% in June after rising by 4.3% in May.

As you might have guessed, the largest positive contribution to leading indicators in June is expected from real M2, +0.38, which would be the largest contribution since the financial crisis.

At this point, the outcome for leading indicators will likely come in way above the current consensus expectation of +0.2% for June. Since the explosion in M2 growth occurred in the most recent two weeks, unless other economists have revisited their projections for leading indicators, they may not be accounting for the spike in M2 money supply.

Since most Wall Street economists are idiots, expect one after another chatterbox (especially those out of 60 Wall) to appear on CNBC and praise the phenomenal LEI number which "validates" their thesis of a temporary soft spot, instead of admitting they once again have no idea what they are talkig about.

As to what prompted the surge in M2, here again is Stone McCarthy with the explanation:

Institutional money funds have witnessed some recent outflows, but the extent of these outflows is not alone sufficient to explain the growth of M2.

Most of the gain in M2 is attributable to 2 components. First there is the growth of the narrower monetary aggregate, M1. M1 rose by $48.1 bln in the July 4 week.

Second, we have witnessed strong growth in small time deposits inclusive of MMDAs (money market deposit accounts). Over the past 2 weeks these accounts have swelled by roundly $110 bln.

Regulation Q--Sweeps and Money Supply

The Dodd-Frank Act allows banks to pay interest on ordinary demand deposits beginning July 21. Associated with this legislation the Federal Reserve Board has repealed Regulation Q.

The undoing of Regulation Q should render sweep arrangements as relatively less attractive.

With the unwinding of Regulation Q there is simply less incentive to sweep funds from checking accounts into overnight investment vehicles. Banks can simply offer business firms non-zero interest rates on demand deposits. There will simply be a diminished incentive for firms to sustain Sweep accounts.

Against this backdrop what we may be seeing is an unwinding of sweep arrangements prior to the July 21 repeal of Reg Q. As Eurodollar deposits mature, the deposit may be coming back home to the domestic branch in the form of a demand deposit for business accounts, or as an MMDA for accounts owned by individuals.

From the Fed's H.8 release we know that there has been a dramatic sudden drop in US banks liabilities to their foreign branches. This is exactly what would happen if Eurodollar deposits were to be brought back to the balance sheet of the US branch.

And there you have it: no attempt to force more money into the market, yet another regulatory flub, and certainly not an improvement in the economy as the upcoming Leading Economic Indicators index will have you believe.


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