US M2 Crashes in March, Ringing Deflationary Alarm Bells

The negative year-over-year growth of the US M2 money supply has been a notable movement in the industry in recent months. And the latest data released by the Fed on Tuesday showed that this key liquidity indicator is accelerating its collapse - recording the largest decline on record in March.

The latest data released by the Fed on Tuesday showed that the US M2 money supply (not seasonally adjusted) was $20.8 trillion in March, a sharp decline of 4.05 percent year-on-year.

This is the largest year-over-year decline since the data was first introduced in 1959, almost twice the rate of the previous month, while the indicator has also been negative year-on-year for four consecutive months.

M2 is an important indicator of the money supply, including money in circulation, money market fund balances and savings deposits. In the eyes of some currently fewer mainstream economists, the M2 money supply can provide important clues to the direction of US inflation and upcoming interest rate decisions by the central bank.

Before Tuesday's data came out, many in the industry had actually predicted that the M2 money supply might go further down in March. Morgan Stanley strategist Mike Wilson wrote earlier this month, given the recent pressure on the banking sector, M2 may "fall sharply.”

In fact, because this March M2 data, the first money supply indicator since the banking sector turmoil, so it has a key significance in itself. With the collapse of Silicon Valley Bank and Signature Bank last month, leading to a widespread sell-off in regional bank stocks, there have been questions about the health of the entire US financial system.

A major fallout from the banking crisis is the possibility of a credit crunch. Robert Sockin, a global economist at Citi, said the impact of banking-related stress will become more apparent later this year, especially in the event of a credit crunch. This will result in fewer loans being issued and M2 will continue to decline.

Time for the Fed to pull back?

Despite having anticipated a possible further pullback in M2, this poor result of a 4.05% direct year-on-year plunge in M2 money supply in March more or less still came as quite a surprise to many.

Given that the less money flowing in the economy, the less money available for banks to lend and for businesses and consumers to borrow and spend, this latest report will undoubtedly further fuel speculation of a fall in US inflation and an early recession.

According to economist Friedman's earlier view, inflation is a monetary phenomenon wherever and whenever it occurs. According to his research, the growth rate of broad money issuance is about 12-24 months ahead of the inflation rate.

The year-on-year changes in M2 growth and CPI over the past two years or so actually fit this pattern quite well. As we covered earlier this year, M2 money supply growth in the US leads CPI data by about 68 weeks: adjusted for this period, there is a fairly high degree of overlap between the two.

Vincenzo Inguscio, a volatility strategist at Nomura Holdings in London, also wrote in a report last month that "the money supply shortfall should help the Fed address inflation".

Indeed, in the view of independent economist Steven Anastasiou, the current sharp pullback in M2 may even sound the alarm for deflation. He has recently warned that if M2 falls further sharply in the future, the US will eventually experience a deflationary collapse.

In addition to affecting inflation, the US money supply contracting at the fastest rate ever may also be a very dangerous sign for the entire US economy. The inversion between the 3-month Treasury yield and the 10-year Treasury yield, a set of yield curve indicators that the Fed favours quite a bit to measure recession prospects, widened further to -167 basis points on Tuesday.