What Happens to BBB Credit Spread When the M2 Money Supply Contracts?
What happens when the money supply shrinks? Monetarist deflation fears, historical rarity, and implications for asset prices, inflation, and economic growth.
How BBB Credit Spread Responds
Scenario Background
M2 money supply includes cash, checking deposits, savings deposits, money market securities, and other near-money assets. When M2 contracts on a year-over-year basis, it means there is literally less money circulating in the economy than there was a year ago. This is extraordinarily rare, it has happened only twice since 1960: briefly in the early 1990s and more significantly in 2022-2023 after the massive COVID-era monetary expansion.
Read full scenario analysis →Historical Context
M2 contracted year-over-year only briefly in 1993-1994 (by less than 1%), which coincided with the Fed's successful soft landing and did not produce deflation. The 2022-2023 contraction was the first significant decline since the Great Depression era. During the Great Depression, M2 contracted roughly 35%, contributing to devastating deflation. In the 1970s, M2 grew rapidly, fueling the inflation decade. The strong positive correlation between M2 growth and subsequent inflation has held across d...
What to Watch For
- •M2 YoY growth turning positive again, the contraction phase is ending
- •CPI declining 12-18 months after M2 peak, monetarist lag effect working
- •Bank deposits declining, households drawing down savings, M2 mechanic
- •Fed QT ending, a major driver of M2 contraction will stop
- •Money velocity rising to offset M2 decline, the counterargument in action
Other Assets When the M2 Money Supply Contracts
Other Scenarios Affecting BBB Credit Spread
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