M2 Slowdown Finally Gaining Traction

The lag between monetary policy shifts and economic impact is substantial and varies. Recent actions by the Federal Reserve during the pandemic have begun to show effects, as the M2 money supply, which surged during 2020-21 due to extensive government spending and tax cuts, is now declining.

This surge contributed significantly to the inflation spike observed in 2021-22, a reality that was often overlooked in favor of alternative explanations such as supply chain disruptions. Currently, even as consumer prices showed a minor decline in June and demand indicators like retail sales appear weak, the softening economy aligns with the decrease in M2 money supply.

A modest increase in M2 since last October raises the possibility of a soft economic landing and potential Fed rate cuts. Conversely, a continued decline in M2 could heighten recession risks, while another surge could lead to renewed inflation pressures.

The growing recognition of the M2 money supply's impact on inflation is deemed crucial for investors.