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One Last Comment on M3

Posted By Barry Ritholtz On April 17, 2006 @ 2:58 pm In Economy,Federal Reserve,Fixed Income/Interest Rates,Psychology | Comments Disabled

We started beating the M3 drum back in November 2005 [1]. It seemed to us — on the basis of the rapid increase in M3 versus M2 [2] alone — it was a worthwhile stat to keep around, and we could not understand why the Fed was so intent on cancelling M3 reporting. These perspectives were dismissed by some as paranoia.

You can imagine how pleasantly surprised we were when Raymond James’ Jeff Saut addressed that very issue this morning:

"Yet, we just don’t “get it” because as the Fed has
been raising interest rates, it has simultaneously been talking rates down by
commenting on how “contained” inflation remains. Surprisingly, concurrent with
the Fed’s financial tightening has been Mr. Bernanke’s “printing press” gone
wild with roughly $1.5 trillion additional dollars per year being added to the
country’s money supply, at least at the last M3 reading. And that caused one
savvy seer to exclaim, “Can you spell liquidity?!” Liquidity indeed, for as Ed
Hyman aptly notes, “U.S. Federal outlays in the 4Q increased to a remarkable
$2.7 trillion. That’s 21% of GDP and increasing at a 30% annual rate.”

Suspiciously, however, one month ago those M3, broad-based, money supply figures
ceased to be reported because they allegedly added little additional value to
the M2 figures. Hereto “we just don’t get it” because M3 contained the amount of
repo activity in the banking system while the M2 report does not. Repos, ladies
and gentlemen, is short for repurchase agreements, which are contracts for the
sale and future repurchase of a financial asset. Most often repos are used with
Treasury securities. We think repo activity is pretty important since it shows
the amount of “financial leverage” the Federal Reserve is attempting to
introduce into the banking and brokerage system. Indeed, we just don’t “get

Nevertheless, in this business what you see is what you get, which reminds us
of that old Annapolis “saw” – you can’t change the wind, but you can always
adjust the sails! And currently the “winds” are blowing interest rates higher.
Where this rate-rise will end is unknowable. Even the Fed has hinted that it
doesn’t know by commenting that things are “data dependent.” However, consider
this – When was the last time the Federal Reserve stopped raising interest rates
with many of the equity markets at (or near) all-time highs, base and precious
metals at multi-decade highs, oil within “spitting distance” of record highs,
and retail sales (despite a late Easter), as well as the housing figures,
stubbornly perky? Furthermore, the recent unemployment rate was at a four-year
low (4.7%), while the first quarter’s employment figures showed the strongest
non-farm payroll growth in six years. Historically, rising employment growth has
tended to lead to rising wage pressures. As the good folks at the GaveKal
organization opine, “Once again, we find ourselves asking the question, can the
Fed really stop at 5% in this environment?”

In addition to these questions, we would suggest that forgetting the
laughable “core” inflation figures (ex-food/energy), annualizing last month’s
headline CPI figure of +0.7% (core was +0.2%) yields an inflationary ramp-rate
of 8.4% (0.7% x 12). While clearly one month does not make a trend, even if we
use this week’s estimated headline CPI number of +0.4% (-0.2%E core), and
average it with last month’s (0.7% + 0.4% / 2 x 12 = 6.6%), we get an annualized
inflation rate of 6.6%. The potential inference from this is that despite the
Fed’s “tightening campaign” with Fed Funds at 4.75%, overlaid with a 6%+
inflation rate, we could still be in a negative “real” interest rate
environment. Given the possibility of still “free money” (aka negative real
rates), no wonder speculation remains rampant in the various markets."

What more can we add to that?


The 5% Solution [3]
Jeffrey Saut
Investment Strategy

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2006/04/one-last-comment-on-m3/

URLs in this post:

[1] November 2005: http://bigpicture.typepad.com/comments/2005/11/money_supply_an.html

[2] rapid increase in M3 versus M2: http://www.ritholtz.com/blog http://bigpicture.typepad.com/comments/2005/11/historical_m2_v.html

[3] The 5% Solution: http://www.raymondjames.com/inv_strat.htm

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