Monetary Policy & Financial System Liquidity

Short Term Interest Rates
My indicator for the direction of short rates is currently 50% in favor of a cut to the
Fed Funds rate %. Since the Fed is running an effective ZIRP, there is certainly no
further policy action needed on this score.

Quantitative Easing and System Liquidity
My broad measure of financial system liquidity is running 5.9% yr/yr. This is the bare
minimum needed to grease the wheels of commerce. Broad liquidity growth has been
slowing recently after a nice round of acceleration. The loan book of the banking system
has been leveling off on flatlining production, factory orders and exports. Banks have
seen little need to expand the deposit base and have even backed away from increasing
balance sheet liquidity from already high levels. The large real estate portfolio of the
banking system remains basically flat with new initiations only offsetting charge offs.
The banks are also keeping a tight rein on personal credit and are losing market share to
other financial organizations. Total US business sales are up about 2% yr/yr, so we know
that internal cash flow growth is rather mild.

The weekly leading economic indicator series I follow were strongly positive in the
closing months of last year but have been more on the flat side point-to-point from Jan.
through early Jun. of 2013.

Low economic growth, very mild liquidity gains and a flattening of the banking system's
loan book are a recipe for extending the current QE program and not one for curtailing
it. In fact, even with a generous liquidity tail wind from the Fed, the US economy is
struggling to progress.

A final note. I have read many pieces about the QE programs which argue they are
inflationary, or are unmanageably large or that QE will produce genuine asset bubbles,
especially when taken in conjunction with the Fed's ZIRP. Little or no attention has been
paid to the  $3 tril. + in credit generated liquidity which was swept away in the Great
Recession and which QE has had to make up for to keep the economy afloat. Since its
prior 2008 peak, the broad base of financial liquidity has increased at only a 2%  annual
rate. QE has kept the deflation wolf away from the door.