The Fed’s Latest M2 Numbers Spark Inflation Concerns

The Federal Reserve (the Fed) just released money supply numbers for April, and M2 may be causing them some concerns regarding further fueling of inflation. Money supply, as measured by M2, includes the total of all currency, coins, savings deposits held by banks, and balances in retail money-market funds. This measure of easy-access money in the system is shown to be highly correlated with inflation. Previously, the M2 level had been in decline since November 2022.

M2’s Increase and its Significance

Data for April was released this week and showed an increase of 0.6% from a year ago. This rise is significant because it indicates that there is still too much money chasing too few goods and services, which could further fuel inflation. The inflationary implications, of course, may impact the Fed’s monetary policy, potentially resulting in higher rates for longer.

Interestingly, the small 0.6% gain is the first time M2 has risen over 12 months since November 2022. In fact, last April’s (2023) report was taken as a sign that the Fed was winning the war on inflation from a year earlier. This is because M2 had staged a dramatic 4.5% drop — the markets breathed a sigh of relief, expecting that the Federal Reserve’s tightening of monetary policy was doing its job of taking money out of the financial system. One year later, we’ve lost ground, and policymakers will certainly weigh this into their June 11-12 decision on rates.

Furthermore, the chart below of M2 from January 2000 – April 2020 provides a good visual of how dramatic the increase in cash and cash equivalents in the system was as the Federal Reserve began aggressively stimulating economic activity. The stimulative response was to government-led efforts related to the pandemic, as countering the pandemic was expected to have a significant negative impact on the economy (the gray lines indicate negative economic growth).

Source: Saint Louis Federal Reserve Bank

Why M2 Is an Issue

The Fed’s policy was to flood the economy with cash in 2020 as the pandemic hit. The cash came from the central bank buying bonds, which put new money into the economy, government stimulus checks raining down on consumers, and businesses being given easy access to loans and assistance. The added money this pushed into the economy showed up in M2 and acted like caffeine on the economy, stimulating sales and pushing economic growth upward.

Unfortunately, the spike in the money supply is still well above trend and is raising havoc on the cost of goods and services as it works to pull prices upward. Officials have been waiting for evidence that inflation is moving toward a 2% per-year target so they can ease interest rates. This step in the wrong direction was met by the market showing disappointment, selling off midday on Tuesday.

Key Takeaway

The recent increase in the M2 money supply is a cause for concern, as it indicates that there is still too much money available for spending and investment if inflation is expected to head to 2%. This excess liquidity and inflationary effect pose a challenge for the Federal Reserve as it seeks to control price growth. While M2 may not be the most closely followed indicator, its resurgence highlights the whack-a-mole nature of the inflation fight the Fed has been engaged in for over two years.