U.S. Money Supply's Historic Decline: A Harbinger of Stock Market Volatility?

The U.S. money supply has recently experienced a decline not seen since the Great Depression, raising concerns about potential economic repercussions and stock market volatility. According to data from the Board of Governors of the Federal Reserve System, M2 money supply clocked in at $21.448 trillion in November 2024, down from an all-time peak of $21.723 trillion in April 2022, marking a 1.26% decrease. However, between April 2022 and October 2023, M2 money supply declined by a peak of $1.06 trillion, or 4.74%, which is the first time since the Great Depression that M2 had dipped by more than 2% on a year-over-year basis (Gerli, 2023).

Historically, sizable year-over-year drops in M2 have been a reliable indicator of economic trouble, with a flawless track record of foreshadowing economic depressions and double-digit unemployment rates (Gerli, 2023). However, it is essential to note that the fiscal and monetary policy tools available today differ greatly from those available in the past, making a depression unlikely in the modern era. Nevertheless, there is concern that a dip in M2 amid a period of above-average inflation will cause consumers to put off discretionary purchases, leading to an economic downturn that eventually weighs on corporate earnings (Bank of America Global Research, 2023).

The potential channels through which a decrease in money supply might impact stock market performance differ from those associated with an increase in money supply. A decrease in money supply can lead to higher interest rates, lower inflation, reduced credit availability, lower risk appetite, and tighter monetary policy, all of which can negatively impact stock prices. Conversely, an increase in money supply can lower interest rates, increase inflation, increase credit availability, increase risk appetite, and ease monetary policy, which can boost stock prices (Bank of America Global Research, 2023).

In response to the recent money supply decline, the Federal Reserve has reversed its quantitative tightening (QT) policy and resumed quantitative easing (QE), aiming to increase the money supply and support economic growth (Board of Governors of the Federal Reserve System, 2023). Governments have also implemented fiscal stimulus measures, such as tax cuts and increased government spending, to support economic growth. However, the effectiveness of these policies depends on various factors, including the extent of the money supply decline and the overall economic conditions.

As investors, it is crucial to stay informed about the money supply and its potential impact on the stock market. While the recent decline in U.S. money supply is cause for concern, it is essential to maintain a balanced view and allow readers to form their own conclusions. By understanding the historical context and potential channels through which money supply can impact stock market performance, investors can make more informed decisions and better navigate the volatile market landscape.