The relationship between the US monetary base (i.e. currency plus bank reserves) and equities identified by Andy Kessler and discussed in previous posts remains intact. The fall in the US market from a temporary rally peak in mid June followed a renewed decline in the monetary base starting about a month earlier, continuing last week – see chart.
The Eurozone monetary base, meanwhile, will have contracted significantly last week as banks repaid ECB loans – figures are released on Wednesday.
Recent US dollar weakness may partly reflect expectations that the Federal Reserve will respond to rising financial / economic risks by reinjecting reserves. One possibility is a suspension of the "supplementary financing program" (SFP) under which the Treasury has issued an additional $200 billion of Treasury bills and onlent the proceeds to the Fed. The SFP was the main reason for the contraction in the monetary base between late February and early May. A reversal would involve the central bank creating new bank reserves to repay the Treasury and, in turn, bill investors.
Caution, however, remains warranted until such a policy change is confirmed.
