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Velocity and Money Supply- Inflation’s Dance Partners

Most people think the nation’s money supply is the sole cause of inflation. They fail to realize inflation has two equal dance partners. The money supply…

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Most people think the nation’s money supply is the sole cause of inflation. They fail to realize inflation has two equal dance partners. The money supply and the velocity of the money supply dance hand in hand to determine the rate of inflation.

The money supply is shrinking for the first time since at least 1960. Yet, despite the most significant decline in the money supply in sixty years, inflation remains sticky. How can that be?

Given the importance of monetary velocity and its relationship with money supply, let’s better understand velocity and ponder how it may change in the coming months.

The strong correlation between bond yields, inflation, and monetary policy gives us more reason to understand and predict velocity.

Key Takeaways

  • The Fed seriously erred in 2021, focusing too much on supply and not enough on demand.
  • What is Monetary Velocity?
  • The Fed can slow velocity, but it requires job losses and or eroding consumer confidence.
  • Forecasting the money supply and velocity leads to a complete inflation forecast.
  • Lacy Hunt of Hoisington Investment Management guides where velocity may be headed and what it means for bonds.

The Fed’s Big Error in 2021

In Mid-April 2021, the BLS reported that monthly CPI was +0.66%. That equates to a nearly 8% annualized rate or four times the Fed’s 2% target. Two weeks after that April CPI report, the Fed stated:

With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.

There was nary a concern at the Fed or on Wall Street that the recent uptick in inflation was a problem. Believing it was “transitory,” the Fed kept interest rates at zero and continued increasing their bond holdings by $120 bn a month (QE). Such dovish monetary policy would continue through the year, as shown below, despite the highest inflation in forty years.

cpi and qe fed

The word “transitory” was relentlessly spoken by Powell and other Fed members to describe an expected short burst higher in prices.

We suppose the Fed reasoned that the Pandemic-related supply chain issues would ease as the vaccine took hold. At the same time, they must have thought consumer spending from the barrage of fiscal stimulus would fade, and demand would quickly fall back toward normal levels. Therefore, normalizing supply and demand would bring prices back to pre-pandemic levels. 

The Fed was dead wrong!

Supply chain issues and inventory levels did normalize, but demand stayed strong. Demand remains strong despite the Fed hiking Fed Funds by 5% in little more than a year and reducing their Treasury and Mortgage holdings by $700 billion.

The Fed grossly failed to forecast monetary velocity.

What is Monetary Velocity?

Per the St. Louis Fed:

The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. In other words, it is the number of times one dollar is spent to buy goods and services per unit of time. If the velocity of money is increasing, then more transactions are occurring between individuals in an economy.

Most financial pundits assume it’s the money supply that drives inflation. However, velocity, measuring how often the money supply circulates through the economy, is equally important. As the graph below shows, the money supply is falling but being offset by increasing monetary velocity.

change in m2 and velocity

To grasp how the supply and velocity of money dictate prices, ask yourself how inflation would be impacted if the Fed printed a gazillion dollars tomorrow.

Is the answer the same if we instead asked, what if the Fed printed a gazillion dollars but immediately locked it up in a vault and sent it into outer space?

We can parse Fed speeches and transcripts and know they now acknowledge that velocity matters.

Slowing Velocity Requires Pain

The only way to slow velocity is to weaken the economy and reduce consumer confidence. Unfortunately, higher interest rates and QT are not helping this time. Often the most prominent factor causing consumer confidence and increasing one’s propensity to spend is a person’s employment situation.

A tight labor market, as we have, creates job security and higher wages and incentivizes workers to seek new jobs with better salaries. The graph below shows the number of job openings, and the Quits Rate soared after the pandemic but is finally moderating. Consumer confidence is falling as the labor market normalizes.

job openings and quits rate

The Fed has significant control over the money supply via its balance sheet. They indirectly control consumer and corporate confidence and demand via interest rates and narratives.

For the first time in our memory, the Fed predicted a recession. The minutes from the March 22, 2023, Fed meeting stated:

“Given their assessment of the potential economic effects of the recent banking-sector developments, the staff’s projection at the time of the March meeting included a mild recession starting later this year, with a recovery over the subsequent two years.”

For a complete understanding of the interplay between the money supply, velocity, economic activity, and inflation, we recommend reading our 2018 article Stoking the Embers of Inflation.

How Will Money Supply and Velocity Change Going Forward?

The money supply is relatively easy to forecast. The graph below shows that the change in the size of the Fed’s balance sheet has a statistically significant relationship with the money supply. The Fed expects QT to reduce the Fed’s balance sheet by $95 billion a month for the foreseeable future.

The other primary determinant is credit growth. With financial standards tightening and banks likely to lend less, along with QT, the money supply will likely continue to shrink.

fed balance sheet and money supply

And Velocity

Velocity is a function of the money supply and economic activity. To help better assess how it may change going forward, we summarize Hoisington Investment Management’s First Quarter Review. Click HERE for the entire article.  

Hoisington writes that velocity “is determined by the marginal revenue product of debt and the loan to deposit ratio (L/D).”

  • The marginal revenue product of debt, or effectiveness of debt, will undoubtedly turn lower as over $20 trillion of U.S. debt matures in the next two years and must be reissued at higher interest rates. Having to allocate more capital toward interest payments from productive investment weakens productivity, a key driver of economic growth. For equity analysts, think of this figure as the return on capital.
  • Loan growth will slow considerably in conjunction with weakening economic activity. While not mentioned in their report, the regional banking crisis further ensures that loan growth will slow.
  • As a result of both points, velocity and, therefore, inflation should turn down. Also, given the Fed’s desire to firmly squash inflation, the Fed may have limitations in its ability to lower rates or use QE to combat weaker growth. Such will only provide more impetus for inflation to fall. 

Summary

Many economic indicators point to weakening economic growth. Further, with excess pandemic-related savings vanishing and credit card debt exploding, the means to spend and keep velocity elevated are eroding.

The labor force is showing some, albeit small, signs of weakening. In addition to the JOLTs graph we shared, initial jobless claims have recently risen above the 2019 pre-pandemic average. The latest University of Michigan consumer confidence, shown below, is declining after increasing over the last 12 months. 

consumer confidence

The money supply will continue to decline. Consumer and business confidence is eroding, and loan growth is slowing rapidly. Consequently, monetary velocity will likely reverse in the coming quarters.

Unfortunately, we need the quarterly GDP data to calculate velocity, so while velocity may be declining in the real world, it could take six to eight months to see its decline.

If the money supply and velocity fall, inflation rates will decline. As a result, bonds and other interest rate-sensitive stocks and instruments will likely benefit. 

We leave you with the final sentence of Hoisington’s article:

Therefore, with the historical pattern of the financial, GDP, and price/labor cycles preceding on its well-documented path, this year’s decline in long-term Treasury bond yields is expected to continue.

The post Velocity and Money Supply- Inflation’s Dance Partners appeared first on RIA.

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February Employment Situation

By Paul Gomme and Peter Rupert The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000…

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By Paul Gomme and Peter Rupert

The establishment data from the BLS showed a 275,000 increase in payroll employment for February, outpacing the 230,000 average over the previous 12 months. The payroll data for January and December were revised down by a total of 167,000. The private sector added 223,000 new jobs, the largest gain since May of last year.

Temporary help services employment continues a steep decline after a sharp post-pandemic rise.

Average hours of work increased from 34.2 to 34.3. The increase, along with the 223,000 private employment increase led to a hefty increase in total hours of 5.6% at an annualized rate, also the largest increase since May of last year.

The establishment report, once again, beat “expectations;” the WSJ survey of economists was 198,000. Other than the downward revisions, mentioned above, another bit of negative news was a smallish increase in wage growth, from $34.52 to $34.57.

The household survey shows that the labor force increased 150,000, a drop in employment of 184,000 and an increase in the number of unemployed persons of 334,000. The labor force participation rate held steady at 62.5, the employment to population ratio decreased from 60.2 to 60.1 and the unemployment rate increased from 3.66 to 3.86. Remember that the unemployment rate is the number of unemployed relative to the labor force (the number employed plus the number unemployed). Consequently, the unemployment rate can go up if the number of unemployed rises holding fixed the labor force, or if the labor force shrinks holding the number unemployed unchanged. An increase in the unemployment rate is not necessarily a bad thing: it may reflect a strong labor market drawing “marginally attached” individuals from outside the labor force. Indeed, there was a 96,000 decline in those workers.

Earlier in the week, the BLS announced JOLTS (Job Openings and Labor Turnover Survey) data for January. There isn’t much to report here as the job openings changed little at 8.9 million, the number of hires and total separations were little changed at 5.7 million and 5.3 million, respectively.

As has been the case for the last couple of years, the number of job openings remains higher than the number of unemployed persons.

Also earlier in the week the BLS announced that productivity increased 3.2% in the 4th quarter with output rising 3.5% and hours of work rising 0.3%.

The bottom line is that the labor market continues its surprisingly (to some) strong performance, once again proving stronger than many had expected. This strength makes it difficult to justify any interest rate cuts soon, particularly given the recent inflation spike.

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Mortgage rates fall as labor market normalizes

Jobless claims show an expanding economy. We will only be in a recession once jobless claims exceed 323,000 on a four-week moving average.

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Everyone was waiting to see if this week’s jobs report would send mortgage rates higher, which is what happened last month. Instead, the 10-year yield had a muted response after the headline number beat estimates, but we have negative job revisions from previous months. The Federal Reserve’s fear of wage growth spiraling out of control hasn’t materialized for over two years now and the unemployment rate ticked up to 3.9%. For now, we can say the labor market isn’t tight anymore, but it’s also not breaking.

The key labor data line in this expansion is the weekly jobless claims report. Jobless claims show an expanding economy that has not lost jobs yet. We will only be in a recession once jobless claims exceed 323,000 on a four-week moving average.

From the Fed: In the week ended March 2, initial claims for unemployment insurance benefits were flat, at 217,000. The four-week moving average declined slightly by 750, to 212,250


Below is an explanation of how we got here with the labor market, which all started during COVID-19.

1. I wrote the COVID-19 recovery model on April 7, 2020, and retired it on Dec. 9, 2020. By that time, the upfront recovery phase was done, and I needed to model out when we would get the jobs lost back.

2. Early in the labor market recovery, when we saw weaker job reports, I doubled and tripled down on my assertion that job openings would get to 10 million in this recovery. Job openings rose as high as to 12 million and are currently over 9 million. Even with the massive miss on a job report in May 2021, I didn’t waver.

Currently, the jobs openings, quit percentage and hires data are below pre-COVID-19 levels, which means the labor market isn’t as tight as it once was, and this is why the employment cost index has been slowing data to move along the quits percentage.  

2-US_Job_Quits_Rate-1-2

3. I wrote that we should get back all the jobs lost to COVID-19 by September of 2022. At the time this would be a speedy labor market recovery, and it happened on schedule, too

Total employment data

4. This is the key one for right now: If COVID-19 hadn’t happened, we would have between 157 million and 159 million jobs today, which would have been in line with the job growth rate in February 2020. Today, we are at 157,808,000. This is important because job growth should be cooling down now. We are more in line with where the labor market should be when averaging 140K-165K monthly. So for now, the fact that we aren’t trending between 140K-165K means we still have a bit more recovery kick left before we get down to those levels. 




From BLS: Total nonfarm payroll employment rose by 275,000 in February, and the unemployment rate increased to 3.9 percent, the U.S. Bureau of Labor Statistics reported today. Job gains occurred in health care, in government, in food services and drinking places, in social assistance, and in transportation and warehousing.

Here are the jobs that were created and lost in the previous month:

IMG_5092

In this jobs report, the unemployment rate for education levels looks like this:

  • Less than a high school diploma: 6.1%
  • High school graduate and no college: 4.2%
  • Some college or associate degree: 3.1%
  • Bachelor’s degree or higher: 2.2%
IMG_5093_320f22

Today’s report has continued the trend of the labor data beating my expectations, only because I am looking for the jobs data to slow down to a level of 140K-165K, which hasn’t happened yet. I wouldn’t categorize the labor market as being tight anymore because of the quits ratio and the hires data in the job openings report. This also shows itself in the employment cost index as well. These are key data lines for the Fed and the reason we are going to see three rate cuts this year.

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Inside The Most Ridiculous Jobs Report In History: Record 1.2 Million Immigrant Jobs Added In One Month

Inside The Most Ridiculous Jobs Report In History: Record 1.2 Million Immigrant Jobs Added In One Month

Last month we though that the January…

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Inside The Most Ridiculous Jobs Report In History: Record 1.2 Million Immigrant Jobs Added In One Month

Last month we though that the January jobs report was the "most ridiculous in recent history" but, boy, were we wrong because this morning the Biden department of goalseeked propaganda (aka BLS) published the February jobs report, and holy crap was that something else. Even Goebbels would blush. 

What happened? Let's take a closer look.

On the surface, it was (almost) another blockbuster jobs report, certainly one which nobody expected, or rather just one bank out of 76 expected. Starting at the top, the BLS reported that in February the US unexpectedly added 275K jobs, with just one research analyst (from Dai-Ichi Research) expecting a higher number.

Some context: after last month's record 4-sigma beat, today's print was "only" 3 sigma higher than estimates. Needless to say, two multiple sigma beats in a row used to only happen in the USSR... and now in the US, apparently.

Before we go any further, a quick note on what last month we said was "the most ridiculous jobs report in recent history": it appears the BLS read our comments and decided to stop beclowing itself. It did that by slashing last month's ridiculous print by over a third, and revising what was originally reported as a massive 353K beat to just 229K,  a 124K revision, which was the biggest one-month negative revision in two years!

Of course, that does not mean that this month's jobs print won't be revised lower: it will be, and not just that month but every other month until the November election because that's the only tool left in the Biden admin's box: pretend the economic and jobs are strong, then revise them sharply lower the next month, something we pointed out first last summer and which has not failed to disappoint once.

To be fair, not every aspect of the jobs report was stellar (after all, the BLS had to give it some vague credibility). Take the unemployment rate, after flatlining between 3.4% and 3.8% for two years - and thus denying expectations from Sahm's Rule that a recession may have already started - in February the unemployment rate unexpectedly jumped to 3.9%, the highest since February 2022 (with Black unemployment spiking by 0.3% to 5.6%, an indicator which the Biden admin will quickly slam as widespread economic racism or something).

And then there were average hourly earnings, which after surging 0.6% MoM in January (since revised to 0.5%) and spooking markets that wage growth is so hot, the Fed will have no choice but to delay cuts, in February the number tumbled to just 0.1%, the lowest in two years...

... for one simple reason: last month's average wage surge had nothing to do with actual wages, and everything to do with the BLS estimate of hours worked (which is the denominator in the average wage calculation) which last month tumbled to just 34.1 (we were led to believe) the lowest since the covid pandemic...

... but has since been revised higher while the February print rose even more, to 34.3, hence why the latest average wage data was once again a product not of wages going up, but of how long Americans worked in any weekly period, in this case higher from 34.1 to 34.3, an increase which has a major impact on the average calculation.

While the above data points were examples of some latent weakness in the latest report, perhaps meant to give it a sheen of veracity, it was everything else in the report that was a problem starting with the BLS's latest choice of seasonal adjustments (after last month's wholesale revision), which have gone from merely laughable to full clownshow, as the following comparison between the monthly change in BLS and ADP payrolls shows. The trend is clear: the Biden admin numbers are now clearly rising even as the impartial ADP (which directly logs employment numbers at the company level and is far more accurate), shows an accelerating slowdown.

But it's more than just the Biden admin hanging its "success" on seasonal adjustments: when one digs deeper inside the jobs report, all sorts of ugly things emerge... such as the growing unprecedented divergence between the Establishment (payrolls) survey and much more accurate Household (actual employment) survey. To wit, while in January the BLS claims 275K payrolls were added, the Household survey found that the number of actually employed workers dropped for the third straight month (and 4 in the past 5), this time by 184K (from 161.152K to 160.968K).

This means that while the Payrolls series hits new all time highs every month since December 2020 (when according to the BLS the US had its last month of payrolls losses), the level of Employment has not budged in the past year. Worse, as shown in the chart below, such a gaping divergence has opened between the two series in the past 4 years, that the number of Employed workers would need to soar by 9 million (!) to catch up to what Payrolls claims is the employment situation.

There's more: shifting from a quantitative to a qualitative assessment, reveals just how ugly the composition of "new jobs" has been. Consider this: the BLS reports that in February 2024, the US had 132.9 million full-time jobs and 27.9 million part-time jobs. Well, that's great... until you look back one year and find that in February 2023 the US had 133.2 million full-time jobs, or more than it does one year later! And yes, all the job growth since then has been in part-time jobs, which have increased by 921K since February 2023 (from 27.020 million to 27.941 million).

Here is a summary of the labor composition in the past year: all the new jobs have been part-time jobs!

But wait there's even more, because now that the primary season is over and we enter the heart of election season and political talking points will be thrown around left and right, especially in the context of the immigration crisis created intentionally by the Biden administration which is hoping to import millions of new Democratic voters (maybe the US can hold the presidential election in Honduras or Guatemala, after all it is their citizens that will be illegally casting the key votes in November), what we find is that in February, the number of native-born workers tumbled again, sliding by a massive 560K to just 129.807 million. Add to this the December data, and we get a near-record 2.4 million plunge in native-born workers in just the past 3 months (only the covid crash was worse)!

The offset? A record 1.2 million foreign-born (read immigrants, both legal and illegal but mostly illegal) workers added in February!

Said otherwise, not only has all job creation in the past 6 years has been exclusively for foreign-born workers...

Source: St Louis Fed FRED Native Born and Foreign Born

... but there has been zero job-creation for native born workers since June 2018!

This is a huge issue - especially at a time of an illegal alien flood at the southwest border...

... and is about to become a huge political scandal, because once the inevitable recession finally hits, there will be millions of furious unemployed Americans demanding a more accurate explanation for what happened - i.e., the illegal immigration floodgates that were opened by the Biden admin.

Which is also why Biden's handlers will do everything in their power to insure there is no official recession before November... and why after the election is over, all economic hell will finally break loose. Until then, however, expect the jobs numbers to get even more ridiculous.

Tyler Durden Fri, 03/08/2024 - 13:30

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