The Lags are Over for Tighter Money

Recent economic reports indicate that the effects of the Federal Reserve’s monetary policy tightening in 2022-2023 are starting to materialize, with both inflation and economic growth decelerating. Consumer prices fell 0.1% in June, marking the largest monthly decline since early COVID-19, while the core CPI increased by only 0.1%, the lowest in over three years.

The housing sector shows persistent weakness, with new construction and sales declining, and existing home sales nearing their lowest levels since the 2010 housing bust. The ISM Manufacturing index dropped to 46.8 in July, signaling contraction, with production at its lowest since the COVID lockdown.

Job creation slowed significantly, with core payrolls rising just 17,000 in July and the unemployment rate increasing to 4.3%. Although M2 money supply shows a recent uptick, its growth remains below pre-COVID rates.

This suggests the Fed's tight monetary policy is effective and allows for potential rate cuts. However, analysts warn that simply lowering short-term rates is insufficient; the Fed must also prioritize money supply growth to avoid tightening inadvertently.

Historical lessons from former Fed Chair Volcker emphasize focusing on money supply over short-term rates to combat inflation effectively. The current Fed's approach has shifted away from this focus, which could pose risks if the Fed overreacts in an attempt to normalize monetary conditions, potentially leading to stagflation akin to the 1970s.

Investors should closely monitor the Fed's actions regarding money supply management to gauge potential economic impacts.