Interbank Market News Scan: As the money supply falls, asset values fall as well…

Date Money Supply Effective Federal Funds Rate Interest on Reserve Balances Dollar Index 10-year yield

4/2022 $20651.4B 0.33% 0.4% 102.96 2.75%

5/2022 $20639.2B 0.77% 0.4% 102.14 2.90%

6/2022 $20607.9B 1.21% 1.65% 105.14 3.14%

7/2022 $20588.7B 1.68% 2.4% 106.62 2.90%

8/2022 $20479.9B 2.33% 2.4% 109.53 2.90%

9/2022 $20279.9B 2.56% 2.56% 112.12 3.52%

10/2022 $20098.1B 3.08% 3.15% 110.88 3.98%

11/2022 $19964.4B 3.78% 3.9% 104.55 3.89%

12/2022 $19821.0B 4.10% 4.4% 103.52 3.62%

1/2023 $19560.1B 4.33% 4.4% 102.92 3.53%

2/2023 $19327.8B 4.57% 4.65% 104.52 3.75%

3/2023 $18964.5B 4.65% 4.9% 102.51 3.66%

4/2023 $18629.2B 4.83% 4.9% 101.21 3.46%

Source: Board of Governors-Federal Reserve System, MarketWatch.

I am entertaining the theory that predicting foreign exchange rates requires less reliance on a theory of free markets and more reliance on the probability of a centrally planned financial system operating under the guise of free market principles. Determining where foreign exchange rates are going to go should start with an analysis of Federal Reserve System behavior. I believe the interdealer and interbank markets take their marching orders from the Fed and the U.S. Treasury.

While the banking system plays a retail and wholesale role in distributing the currency to business and consumer, it is the government and the central bank system that determine how much yield is to be extracted from taxpayer/consumers and transferred to bondholders.

Why this view? The few that control financial and natural resources are as much afraid of uncertainty as you or I. Quelling uncertainty requires a model for managing expectations and in a credit-driven political economy that means determining before-hand where interest rates and yields should end up.

Here I use the ten-year yield as a proxy for asset values. We are familiar with the concept of the inverse relationship between bond prices and yields. As yields increase, bond values fall. In the chart above we see interest rates increasing and can infer a fall in bond values over the period April 2022 to April 2023.

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The Federal Reserve’s expressed mandate is full employment and stable prices and achieves this mandate by controlling money supply. Monetarists attribute inflation to increases in money supply so we should infer a decrease in money supply as a move in the right direction. Money supply (M1) has fallen 9.8% between April 2022 and April 2023. Meanwhile, interest on reserve balances, what the fed pays banks for maintaining excess reserves in their federal reserve accounts, has increased 1,125% between April 2022 and April 2023. This increase coincides with the expected fall in bond values and decrease in money supply as banks are incentivized to keep money in their vaults versus lending the money out.

I was caught off guard by the apparent little change in the dollar index. The dollar got increasingly expensive from June 2022 through September 2022 all while yields were inching up but fell through the rest of 2022 even as yields continued to increase.

Any thoughts on the increase in yields accompanied by a fall in the DXY would be greatly appreciated. I will share more later on how the EUR/USD and the USD/JPY could be impacted later today.

Alton Drew

29 May 2023

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