Liquidity requires close monitoring as Fed tightens

Sources:
Top chart: Bloomberg, U.S. Treasury Department, Federal Reserve Board, and Wells Fargo Investment Institute. Monthly data from January 1, 2006 to December 31, 2023. Budget deficit: monthly data from January 1, 2006 to November 30, 2023. Bottom chart: Bloomberg, Federal Reserve Board, and Wells Fargo Investment Institute. Monthly data from January 1, 2014 to November 30, 2023. M2 money supply = currency, demand, and small-time deposits. Fed = Federal Reserve. GDP = Gross Domestic Product.

Key Takeaways

  • Added pressure on market liquidity is set to come from a wind down of the Fed’s liquidity facility and from its policy of quantitative tightening (QT) that has reduced the size of its balance sheet and of the money supply in the past year.
  • Still-sizable money supply is combining with a recent increase in money velocity — the speed with which money circulates in financing transactions — to leave the economy exposed to inflation even as funds are drained from the financial market.