A Look at the Economy Ahead

Even the Fed's seasonally adjusted M2 numbers are showing a decline.

At the end of August, preliminary seasonally adjusted numbers show a 2.3 % decline in 3-month annualized M2. In other words, the Fed is not providing any money to the currents stock market run. It is purely coming from money that has been on the sidelines. Once that is completely sucked in, it is all over.

It is, however, important to realize this Fed posture will not go on forever. How long the Fed can continue this no money growth stance is the big question.

WSJ may provides some clues as it takes a look at the Fed's balance sheet and notes (htNick):

The Fed’s balance sheet expanded again in the latest week, rising to $2.072 trillion from $2.069 trillion, but the expansion highlighted the recent shift in the makeup. The increase came solely from purchases of mortgage backed securities, Treasurys and agency debt. The Fed started a program in March to ramp up such acquisitions in order to push down long-term interest rates. All of the programs set up as emergency facilities to prop up the financial system posted declines. Direct-bank lending remains at its the lowest level since the collapse of Lehman Brothers. Central-bank liquidity swaps gave back last week’s increase. The commercial paper and money market facilities also dropped again and are at their lowest levels since inception, as companies decide to take their funds out and tap investors directly as sentiment in the market improves.

The increase in the balance sheet of less than one percent (.145% to be exact) is a yawner, unless we see many more weeks of such activity. More interesting is the shift in where the Fed is pushing money. The commercial paper and money market facilities are declining as assets for the Fed, while Treasury security purchases (along side MBS buying) are increasing. In other words the private sector is losing some fear by going back into commercial paper and money markets, which puts greater pressure on the Fed to prop up government paper. The public was holding government paper and the Fed was holding commercial paper, that is switching. The real battle for the Fed starts, when the Treasury continues to issue more paper and there is no one else to buy it, and the Fed has no more commercial paper, and the like, to liquidate.

For those anxious to sound the inflation alarm, that would be the time to sound the first alarm. That type of money printing, however, may not do much for the stock market as it will be directed at Treasury security purchases. And the markets are likely at that first phase of Fed money to act as though none was going on..

Bottom line over coming months, this is what we have to look forward to:

A declining stock market

A declining economy

At some point a resumption in inflation

Continued growth of the government sector.

And the worst of all possible worlds: Stagflation.

First up, though the declining stock market.