Money Supply Growth Rate Plummets, Interest Rates Up - The Stage Is Set For A Major Stock Market Correction

Source: Islandbreath.blogspot.no

The declines in bank lending growth is now really starting to bite into the money supply growth rate (see here for more).

According to data released last evening by the Federal Reserve, the y/y growth rate in the money supply plummeted to 6.07%, the lowest since early November 2008.

Since 2013

Since 2000

On a shorter term basis (13 week annualised percentage change), the money supply is now actually contracting. In fact, it has now been declining for four consecutive weeks. The last time this happened Lehman went bust.

Now, the economy does not react instantly to a drop in the money supply growth rate. Nonetheless, such declines are often associated with increased risk of an economic correction so the recent drops should be viewed as important warning signs.

But though the shorter term growth rates have fallen sharply in recent weeks, the longer term growth rates have been declining for years. For example, the 5-year annualised growth rate has now been falling for almost 3.5 years since peaking in October 2013.

Though the current 5-year growth rate remains relatively high at 7.7%, it is the change in the growth rate that is the more important factor (see my book for why). It has now shred 4.6 percentage points since its previous peak in October 2013, a drop of more than 37%. Yes, still less than the drops leading up to the dotcom and mortgage crises, but still large enough for investors to take note.

Meanwhile, interest rates are up. And so are stocks. With stock market prices relative to a range of fundamentals at historical highs, many stock market investors may soon find themselves stuck with big losses, especially if the downward trend in the money supply growth rate continues.

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Additional charts:

Treasury's deposits with Fed share of money supply growth rate has declined substantially and is now negative (here for more, h/t Russell Lamberti).

The longer term percentage point change in currency and demand deposits (most liquid part of the money supply) has been negative for 69 consecutive weeks - this has signaled increased risk of economic corrections a few times in the past, including the previous two busts.