The US Money Supply Trend Continues To Forecast Disinflation

Two months ago TMC Research observed that the trend in a broad measure of US money supply (M2) continued to forecast disinflation. In this update, we revisit the forecast and reassess the current outlook. The main takeaway: M2’s trend still anticipates that pricing pressure will ease in the near term.

With the benefit of hindsight, the analysis we published on May 31 has been useful in that subsequently published economic data has strengthened the case that a disinflationary bias persists. Two months ago, the year-over-year change in the headline measure of the Consumer Price Index (CPI) posted a rise of 3.4% through April 2024 (based on revised data available today). Fast forward two months and CPI has dipped to 3.0% for the change through June.

Alternative measures of consumer inflation also show a disinflationary bias in the past two months. For example, core CPI (which excludes energy and food) has continued to ease since April. Similarly, the Cleveland Fed’s median CPI and the Atlanta Fed’s “Sticky” CPI are posting softer annual comparison since our May 31 note.

There are many factors that influence the inflation trend, but money supply is arguably a critical input. On that basis, the M2 trend still implies that inflation will ease in the near term. Advancing the 12-month changes in M2 to the year-ahead position forecasts that consumer inflation trend will dip further (see chart below).

The M2 trend tends to anticipate annual changes in CPI. Accordingly, the sharply lower money-supply change (roughly flat vs. the year-ago level) forms the basis for expecting more disinflation.

There are risks to the forecast, of course. Other factors could intervene, such as a wider Middle East war that potentially triggers a spike in oil and energy costs – key inputs to consumer prices at the headline level. Alternatively, the US economy could prove to be more resilient than expected and post surprisingly strong growth comparisons in the months ahead, which in turn would likely stabilize if not raise inflation at current levels.

But using the M2 trend as a proxy for what lies ahead continues to suggest that disinflation still has a tailwind. That outlook implies that there’s a reasonable case for expecting that the Federal Reserve will soon begin cutting interest rates as the threat of inflation continues to fade.