The Fed’s July survey of bank loan officers supports the view here that the US economy is regaining momentum and may prove stronger than the central bank and consensus expect in late 2017 / early 2018.

The basis for this forecast is a sharp rebound in six-month growth of real (i.e. inflation-adjusted) narrow money from a low in February. Turning points in real narrow money growth have consistently led those in GDP growth in recent years – see first chart.


As previously discussed, the hypothesis here is that the fall in real narrow money growth in late 2016 / early 2017 and subsequent rebound mainly reflect the impact of reforms to money market fund regulations implemented in full in October 2016. The reforms prompted money funds to shift their portfolios out of bank deposits and financial paper into Treasury bills, resulting in a rise in banks’ funding costs in 2016 – second chart. Banks responded by reining in their balance sheet expansion, slowing money / credit growth. The net percentage of banks tightening loan standards (i.e. an average across various loan categories) rose to its highest since 2010 in July 2016 – third chart.



The adjustment of money funds’ portfolios, however, appears to have been completed by late 2016 and banks’ funding costs have normalised in 2017. Their behaviour, therefore, has turned more expansionary – the net loan tightening percentage fell further in the latest Fed survey to its lowest since 2015.

The money fund reforms acted as an effective tightening of monetary policy in 2016, resulting in the Fed having to raise rates by less than expected. The reversal of the drag this year is boosting the economy, outweighing restraint from the Fed’s three hikes since November 2016. The Fed may need to accelerate tightening to compensate.

The Fed survey loan tightening percentage, inverted, leads annual growth of real bank loans and leases, which stabilised in the second quarter  – fourth chart. The six-month change in real bank loans has recovered from -0.3% (not annualised) in February to 0.7% in June, with weekly data indicating a further rise in July.