Monetary Base Surge Continues to Suggest a Response to Systemic Problems. As shown in the accompanying graph, Mr. Bernanke and company continue to spike the monetary base at a pace not seen since panicked efforts to avoid a systemic implosion 13-plus months ago. 

Plotted is the level of the St. Louis Fed’s Adjusted Monetary Base (seasonally adjusted), which rose to a record-high $1.96 trillion in the two weeks ended October 21st, up 4.2% from the prior two-week period. Since the near-term trough seen in the August 12th period, the monetary base has been growing at an annualized pace of 96.6%. The Fed appears to be panicking again, acting as though it has a worsening systemic problem.

The monetary base consists of currency in circulation plus bank reserves and remains the Fed’s primary tool for increasing or decreasing money supply growth.  The money supply has not responded to the surge in liquidity of the last year. This is due to the bulk of the increase in the monetary base having been in excess bank reserves, which banks are leaving on deposit with the Fed instead of lending into the normal flow of commerce. 

The pattern of weekly and monthly reporting with the still-published components of M3 money supply — specifically M2, institutional money funds and large time deposits — generally remains one of contraction. In the current circumstance, a contracting money supply is consistent with mounting liquidity issues in the banking system.  Such a contraction in money supply also would tend to throw a healthy economy into recession in the year ahead.  Of course, far from being healthy, current economic activity is bottom-bouncing in the longest and deepest economic contraction since the onset of the Great Depression.   

Fourth-Quarter GDP Contraction Should Follow Any Third-Quarter Gain. The "advance" estimate for third-quarter 2009 gross domestic product (GDP) is due for release on Thursday (October 29th). As has been discussed previously, annualized real (inflation-adjusted) quarterly growth is being touted as returning to near-average growth of around 3%.  Briefing.com reports a consensus estimate solidifying around 3.2% annualized growth, versus a 0.7% contraction in the second quarter. Such would imply a year-to-year contraction of 2.4% for the third quarter, versus a 3.8% decline in the second quarter.

The Bureau of Economic Analysis (BEA) will tend to target the consensus outlook for its first guesstimate of third-quarter GDP activity, but the reporting still is of fair risk to fall short of what appears to be an overly optimistic consensus.  Any positive quarter-to-quarter change in activity likely will reflect one-time impacts from the clunkers and the first-time homebuyers programs, and a buildup in business inventories that will face liquidation in the fourth quarter. Accordingly, fourth-quarter quarterly GDP change likely will turn negative again.

As previously discussed, at least one quarter of quarterly GDP gain has been normal during recessions of the last four decades and does not necessarily signal a recession’s end, irrespective of any happy hype out of Wall Street. With broad money supply in near-term contraction and with no relief to the structural problems impairing household liquidity, there is no economic recovery on the horizon.

In the event that BEA can keep its fourth-quarter GDP estimate in positive territory, the pattern unfolding here soon would become recognized as a double-dip recession. The worst of the U.S. economic contraction still is to come.

Still in the Week Ahead. Given the underlying reality of a weaker economy and a more serious inflation problem than expected by the financial markets, risks generally will remain for higher-than-expected inflation and weaker-than expected economic reporting in the month ahead. Such is true especially for economic reporting net of prior-period revisions.

New Orders for Durable Goods (September 2009). Market expectations are for a small monthly gain (1.0% per Briefing.com) in September durable goods orders, due for release on Wednesday, October 28th (corrected from today). Whatever the monthly change is (plus or minus) in this highly volatile series, it likely will be indistinguishable from unchanged in terms of statistical significance, while the year-to-year contraction will remain meaningful for this bottom-bouncing series.