The story so far:

US and global equities have been following fluctuations in the US monetary base (i.e. currency plus bank reserves) over the last 18 months – see first chart. The most recent low in the base occurred in early May; the Dow Industrials index troughed five weeks later. The subsequent recovery in the base, however, stalled a month ago, suggesting that the rally in equities may be in the process of rolling over.

More positively, the Eurozone monetary base on an expanded definition including one-week term deposits – likely to be regarded by banks as a close substitute for reserves – has continued to rise strongly in recent weeks. The environment is reminiscent of June / July last year: the US monetary base moved sideways but the Dow rallied following a surge in the Eurozone base.

In contrast to then, however, the macroliquidity fundamentals are less favourable, with G7 real M1 growing more slowly than industrial output – see prior post. The stalling of the US monetary base in summer 2009, moreover, was clearly temporary given the Federal Reserve’s quantitative easing plans.

These various cross-currents may mean that equities continue to fluctuate in a trading range that frustrates both bulls and bears, an outcome also suggested by the “six-bear comparison” discussed in previous posts – second chart.

A more positive outlook would be signalled by Fed action to boost US monetary base. The most likely form would be a suspension of the “supplementary financing program” under which the Fed has borrowed $200 billion from the Treasury – repayment of this sum would inject an equivalent amount into bank reserves.