Bull Market Monetary Environment: Rising Inflation and Money Supply

With regard to recent market surge, the monetary environment presents an analytical dilemma because it is simultaneously the dominant driver of rising asset prices and also the greatest area of risk for the markets.

When considering the factors that would place the bull market in jeopardy, rising interest rates and reduced availability of credit would have to top the list. For the time being, credit remains cheap and readily available throughout the world. As a result, there continues to be tremendous monetary inflation sustaining nominal GDP growth and supporting asset prices.

M3, the broadest measure of money supply growth in the U.S., is rising at 12% per annum. Other major currencies around the world are also expanding at double-digit rates, as are various measures of global credit growth. International reserve assets held by foreign central banks are up 21% on a year-over-year basis.

As a reflection of the unbridled growth of securities-based finance in our economy, the five largest U.S. investment banks grew their balance sheets in the first quarter of 2007 at an astounding 41% annualized rate.

Outside of the financial sector, inflation continues to be broad based and has recently accelerated in labor costs, food prices, gasoline prices, and health care costs. Given widespread global inflation pressures, all of the major global central banks are either tightening official interest rates or have a bias for tightening.

We continue to view the persistent hopes and expectations of interest rate cuts from the Federal Reserve to be way off base. Meanwhile, the disconnect that has been in place for several years between market-based bond yields and inflation trends continues. Though it has been creeping up of late, the 10-year Treasury yield trades at a non-threatening level of 4.68%.

Comments

[Richie]

Mr Steinhilber,

I respectfully disagree with your position that rates are headed lower
If we are not ALREADY in recession, why do we not have any meaningful inflation given:

Deficit financing of the war (annually $300 - $400 Billion)
Massive budget deficits (always inflationary)
Massive trade deficits (that should cause importation of inflation)
Explosive money supply growth vis-a-vis GDP growth
Oil prices up 300% - 400% over the last 4 years
Historically low interest rates (from as far back as Greenspan's reign)

All of the above INDIVIDUALLY, coupled with historically very low interest rates are highly inflationary. As they co-exist simultaneously, we should be living with 10%+ inflation. But we are not. The excess liquidity is all flowing into equities (as real assets decline in value) inflating their value well beyond what earnings growth would warrant.

It seems apparent to me that this paradox can exist only if the economy were in an accelerating decline. Hence, a concurrent mountain of inflationary stimulation has no impact. It is totally negated be our on going recession. If you question my thesis, consider the following:

Base metal prices have topped out
Prescious metal prices have topped out
Virtually all other commodity prices have topped out
Oil prices have topped out
Real Estate prices have topped out
GDP growth rates have topped out
Job creations rates have topped out
The dollar is in a state of collapse
Auto Sales (volume) have topped out
Retail sales (volume) have topped out
Inflation rates have topped out
P/E ratios have topped out (years ago)
Mortgage rates have topped out
Equity extraction rates have topped out
Dividend yield growth rates have topped out
Inverted yield curve (invariably leads to recession)
Leading indicators (5 consecutive months of decline)
Public sentiment near record lows
Trucking, airline and rail revenues in decline
Help wanted in serious decline
(Kelley Services, Robt Half, Monster Worldwide)

INTEREST RATES have topped out
Next action by FED: a sizeable reduction in INTEREST RATES
Subsequent STOCK MARKET response . . . . .

[DrChaos]

One reason is simple.

War is inflationary. Always has been, always will be.