Market Situation Report: CPI Outlook

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

There are many moving parts when it comes to the money supply, making it difficult to keep things concise or fully understand it. But let's try. Today's bonus chart in isolation suggests CPI will follow the M2 money supply on a lag and drop sharply over the next 18 months. M2 hasn't been this negative since the 1930s, and that period will become more relevant as we discuss this further.

In the very short term, CPI is likely to remain elevated as the ISM prices paid index rose for the 4th consecutive month, up 5.1%.

Things get more complex when looking at money aggregates. Demand deposits (checking accounts) have essentially been unchanged for 18 months. However, savings accounts have dropped by almost $2 trillion. It could be argued much of this went into retail money markets and CDs by issuing IOUs to consumers. Money market funds lend in repo or buy T-bills, taking the T-bills as collateral if lending in repo. If Janet Yellen spends that Treasury money back into the economy, we'd expect demand deposits to rise, effectively double-counting M2 to some degree.

Interestingly, if the process reverses with redemptions from money markets, the money can come from maturing Treasuries or M1 deposits paying back the money markets, which then pay back M1 depositors. Money market deposits go down, resulting in a significant M2 contraction. As mentioned, it's convoluted and double-counts the money available for goods/services or critically paying off consumer debt.

M1 is down $2.7 trillion since June 2022, yet consumer credit continues rising while bank credit is sideways, despite most M1 creation coming from banks. The debt keeps rising as money gets loaned multiple times. The danger now is the money supply aggregate dropping while debt has hit $40 trillion. Mitigating this divergence would require a higher velocity of money, which obviously slows in a recession. Should unemployment rise, we'll likely see debt come down from defaults. Then the 1930's become part of the conversation. A thought experiment for another day.

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