inflation?...
U.S. Bond Investors Dust Off Money-Supply Figures on Greenspan
New York, July 26 (Bloomberg) -- Money supply is back in vogue in the
bond market.
This long-out-of-fashion measure of money in the economy is back on the
list of economic indicators to watch after Federal Reserve Chairman Alan
Greenspan suggested this week that central bankers are paying closer
attention to its growth.
What's caught the attention of Greenspan and others on the Fed's
policy-making board is the 7.2 percent annual increase in one of the
most closely watched measures of money supply. That's above the maximum
target of 5 percent that Fed officials set for growth of so-called M2.
''Money supply is something to be concerned about,'' said Edgar Peters,
who helps oversee $16 billion in assets at PanAgora Asset Management in
Boston. ''Historically, its always been a leading indicator of
inflation.''
Concern about a pickup in inflation, which erodes the value of bonds'
payments, hasn't been a problem of late. The benchmark 30-year U.S.
Treasury gained about $10 per $1,000 bond this week, to yield 5.68
percent -- just above the record low of 5.56 percent reached July 7. The
bond returned 6.7 percent so far this year, when price gains and coupon
payments are included.
Yet in his semi-annual congressional testimony about the health of the
economy, Greenspan said this week that the central bank's Federal Open
Market Committee ''recognizes that monetary growth does appear to
provide some information about trends in the economy and inflation.''
Voicing the loudest concern are Jerry Jordan and William Poole,
presidents of the Federal Reserve banks in Cleveland and St. Louis, who
want to quell any signs of inflation by raising interest rates to slow
money growth. They hope that it will slow the economy and lead to a
reduction in bank lending -- one of the ways money is created.
Hawks
Jordan and Poole cast the dissenting votes in the FOMC's 10- 2 decision
on May 19 to hold the overnight bank lending rate steady at 5.5 percent,
FOMC minutes showed. ''You've got two inflation hawks that lean toward
monetary theory on the FOMC, so Greenspan has to acknowledge it,'' said
David Kotok, who manages about $400 million in assets for Cumberland
Advisors in Vineland, New Jersey.
That said, few expect the attention on money supply will sway the Fed to
raise interest rates anytime soon. Poole and Jordan ''may have attached
more importance to it, but they're really the only ones,'' said Charles
Lieberman, managing partner at Strategic Investors Management, a New
York-based hedge fund.
Focusing on money supply has been out of favor for most of this decade,
as money growth expanded rapidly through the current seven-year economic
expansion and inflation remained subdued.
That wasn't always the case. The Fed's weekly money supply figures
became the preeminent indicator to watch after former Fed Chairman Paul
Volcker said in late 1979 that he would try to control money growth to
quash inflation. ''It was hysterical; nothing went on in the bond market
from Thursday afternoon until everyone saw the numbers on Friday,'' said
Michael Hirsch, who helps run $5.6 billion in assets at Freedom Capital
Management in Boston. Hirsch was then chief investment officer for
Republic National Bank in New York.
Still Little Inflation
If money growth was above the Fed's target, the central bank would look
to counter that by raising borrowing rates. The amount of money in
circulation influences economic activity and interest rates.
There are three official measures of the money supply released by the
Fed. M1 includes all currency held by consumers and companies for
spending, money held in checking accounts and travelers checks. M2, the
most widely followed measure, adds savings and private holdings in money
market mutual funds. M3 includes M1 and M2 in addition to jumbo
certificates of deposit and other large time deposits in excess of
$100,000.
Even though these money aggregates are climbing, there hasn't been a
marked rise in inflation. As measured by the consumer price index,
inflation increased 1.7 percent in the 12 months through June. That's
down from a 2.3 percent rate in the same period a year earlier.
Demand for Dollars
Declining commodity prices, rising productivity levels and the
disinflationary effect of Asia's economic turmoil are keeping inflation
in check, analysts said. That has most investors concluding that the
growth in money isn't going to rekindle an increase in inflation any
time soon. ''We view (growing money supply) more as a consequence of
what's going on in the economy, not a catalyst,'' said Susan Hickok,
chief economist at Prudential Insurance Company of America, which
manages $370 billion in assets.
Plunging currencies in Asia and Russia increased the demand for
dollar-denominated assets worldwide, quickening the growth of money
supply, she said.
Greenspan even indicated in his congressional testimony that it's
difficult to justify changes in interest rates because of the growth in
money supply. The velocity of money, or the number of times a dollar is
actually spent to purchase goods and services in any defined period of
time, is ''difficult to predict,'' Greenspan said.
Yet investors see the renewed emphasis on money supply as a sign that
Fed officials are worried about a possible acceleration of inflation.
Long-term bond yields near historic lows, a robust employment market and
strong domestic demand are prompting a debate among Fed officials as to
whether the consequence of Asia's recession will be enough to keep the
U.S. economy from overheating.
At the least, the attention on money supply is giving investors some
comfort that Fed officials are being vigilant about inflation as they
too try to determine whether the economy's recent slowdown is just a
pause. ''Greenspan is an information machine; he looks at anything he
can to gain some insight,'' said Strategic Investors' Lieberman.
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