Tuesday, August 25, 2009

Commentary: The Fed is now quietly taking money out of the system

This is crucial. Both the bailout money and the extraordinary maneuvers of the Fed provided liquidity to the equity markets. The tinfoil hat crowd speculated that the purpose was to goose the markets enough to allow the deeply underwater banks to do equity financings/exchanges (May 19: "Bank of America raises $13.5B in offering ", July 27: "Citi completes $58B stock offering" etc, etc.). I lean toward that explanation myself, albeit sans the metallic chapeau.
Decreasing liquidity could set us up for a very rocky autumn.
From MarketWatch:

Guess what? The Federal Reserve has not only stopped depositing copious amounts of liquidity into the economy -- it now appears to be in the process of making a sizable withdrawal.

A close look at quantitative measures of monetary policy reveals a sudden change in trend. After growing at unprecedented rates for well over a year, these aggregates stopped rising several months ago and have since declined, according to data provided by the Federal Reserve Bank of St. Louis.

For example, the monetary base -- the raw material for the money supply -- has fallen at a seasonally adjusted annual rate of 8% from early April of this year through mid-August, after soaring at a 187% pace during the previous eight months.

And after ballooning from $100 billion to nearly $1 trillion between September 2008 and mid-May, adjusted reserves have since declined at a 43% clip, to just over $800 billion.

As a result, the Fed's two measures of the money supply, M2 and MZM, have begun to contract. M2 has shrunk at a 3% pace since the middle of June, while MZM, the St. Louis Fed's measure of liquid money, is down by 2% over the same period....MORE