It’s time to start being concerned about an economic term called the monetary base. The size of the monetary base is controlled by a nation’s central bank. it consists of circulated currency and bank deposits — the most liquid form of currency. The Federal Reserve controls the monetary base through open market activities like buying and selling government bonds and by monetary policy.
The Federal Reserve raised interest rates for the ninth consecutive time in mid-December while also maintaining their policy of selling about $50 billion in securities per month. Here is a look at the four-week rate of change in Fed Reserves:
The Federal Reserve began decreasing the size of their balance sheet in December 2017 and slowly ramping up the decrease. By selling bonds, they are taking in currency which reduces the size of the monetary base.
Combine that with the increase in the Fed Funds target rate and the result is a double hit to the size of the monetary base. How much? The next graph shows the annual percent change in the monetary base:
The monetary base has been shrinking for most of 2018 and has been shrinking by more than 10% for a few weeks.
To consider the impact of this change, look at the opposite side of the graph in 2011 and 2013 when the monetary base was growing above 30% at an annual rate. Those were two very good years for the stock market and for real estate. Now, with the monetary base shrinking, it is logical to assume those two markets that had the most appreciation will now have the most depreciation.
My investment focus this year was already on the short-end of the bond market because of the flatness of the yield curve. Now it seems like avoiding equities and real estate are also a good move. I don’t think this should be a hard rule, but in this occasion, I expect some reflex in the markets.
Remember, I am not a financial advisor and I am writing this for my own thinking. Your mileage may vary. Be aware of what you do and understand why.