Trading Educators Blog
How does money supply affect trading in the markets?
There are two important components of federal market activity which affect long- term economic activity and stock and commodity values; these are interest rates and money supply. A contracting money supply was one of the factors that caused the Great Depression of the 1930's. In the early 1980's most traders focused almost totally on the money supply figures, which would cause cash bonds and T-Bill rates to react violently as soon as the M-1 and M-2 figures were released every Friday afternoon. The Fed Funds Rate and Discount Rate are the most important rates, and three consecutive increases or decreases establish a trend. When money supply decreases and interest rates increase, they tend to suppress economic growth. The Fed also buys and sells government securities, through special authorized dealers, to affect the overall money supply. Inflation becomes a problem when the CRB spot index and CRB raw industrial commodities begin to increase sharply. Stock traders will decrease holdings in interest rate sensitive stocks, like utilities, and buy cyclical stocks in the Dow Industrials, like Alcoa, or steel stocks. Expect higher interest rates to follow inflation. When interest rates move higher, T-Bonds, all T-Notes, T-Bills, and Eurodollars can be expected to feel downward pressure.Usually, but not always, rising interest rates help the dollar as long as interest rates in the U.S. are relatively higher than those in other nations. By relatively, I mean that the differential between U.S. interest rates vs. those of competing nations is somewhat out of line to the up side.