A week ago I mentioned that following a period of six months, whereby the Fed's injections of liquidity into the banking system had flattened, the injections have started to increase again of late, probably reflecting an increase in demand for money. Data for the latest week showed a small decrease, but the main story is intact. I feel that any increase in the amount of money that the Fed puts into the financial system would reduce the odds of an interest rate cut.
As I mentioned last week, the Fed operates in an interest-rate-targeting regime, which means that if the demand for money increases at the current 5.25% fed funds rate, the Fed must supply as much money as is necessary to keep the funds rate from moving higher than 5.25%. This causes an increase in the money supply.
The monetary base, which measures the amount of reserves in the banking system, is almost constantly growing, reflecting the steady growth in the U.S. economy and the Fed's facilitation of the growth through liquidity injections. The growth of the monetary base tends to slow when the Fed raises interest rates, as is necessary in order to make the price of money (the fed funds rate) increase. This slows the economy.
The monetary base stopped growing in May, but it has increased over the past six weeks. Should the increases continue, and if the liquidity injections appear to be bolstering liquidity at a time it does not need it, the chances of a Fed rate cut would be very small.
P.S. Will you be there when Cramer makes his next move?
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Tony Crescenzi Blog Today's Key Data 12/22/2006 8:17 AM EST Here's why this morning's numbers are worth watching.
Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of The Strategic Bond Investor. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback; click here to send him an email.
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