The Fed’s tightening game is more than a one-trick pony. Quantitative Tightening (“QT”), is equally if not more important to monetary policy than the Fed Funds Rate.
The Money Supply & QT. The Fed reduces the size of its balance sheet by selling holdings or allowing holdings to mature. Both methods result in money being pulled out of circulation and delivered to the Fed. When the money supply shrinks, economic conditions tighten.
Recent history. The money supply as measured by M1 increased from $4.8 Trillion in April 2020 to $16.2 Trillion in May 2020 as fiscal and monetary policy overstimulated the U.S. economy in the face of COVID (and therefore why we have near record inflation). M1 peaked at $20.7 Trillion in March 2022 and stands at approximately $19.7 Trillion today as the Fed engages in QT.
When the money supply shrinks, asset values decline. Cash and credit becomes more expensive. The chart below plots the money supply as measured by M1 over the last 5 years against the NASDAQ Composite and the 10-year Treasury yield. So long as the money supply shrinks I would expect equity values to decline along with housing values, private company valuations, collectable cars, art, you name it.
note: M1 consists of (1) currency outside the U.S. Treasury, Federal Reserve Banks, and the vaults of depository institutions; (2) demand deposits at commercial banks (excluding those amounts held by depository institutions, the U.S. government, and foreign banks and official institutions) less cash items in the process of collection and Federal Reserve float; and (3) other liquid deposits, consisting of other checkable deposits (or OCDs, which comprise negotiable order of withdrawal, or NOW, and automatic transfer service, or ATS, accounts at depository institutions, share draft accounts at credit unions, and demand deposits at thrift institutions) and savings deposits (including money market deposit accounts). Seasonally adjusted M1 is constructed by summing currency, demand deposits, and other liquid deposits, each seasonally adjusted separately.
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