Money Supply Rose for the First Time in More Than a Year. What That Signals for the U.S. Economy.

The money supply in the U.S. has been shrinking fast, but the latest update showed a significant change in its trajectory, offering an important clue about the outlook for inflation.

Money supply, as measured by M2, sums up the currency, coins, and savings deposits held by banks, balances in retail money-market funds, and more. Data for April released on Tuesday afternoon showed an increase of 0.6% from a year ago.

That modest gain is the first time M2 has risen from a year earlier since November 2022. Its decline—the most significant drop, of 4.5%, happened precisely one year ago—matched the narrative that the Federal Reserve’s tightening of monetary policy was doing its job of taking money out of the financial system.

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But even as M2 declined at a historic pace, the underlying thesis that the overall amount of money in the system was abnormally high never changed. The level hasn’t fallen below $20 trillion in years, and even after many months of year-over-year declines, the current level of $20.86 trillion is still way higher than before the pandemic.

That is because the Fed flooded the economy with cash as the pandemic hit. The central bank’s bond-buying program, government stimulus checks, and the extension of generous business loans, have worked to juice the economy. The recent uptick is a sign that there is still too much money chasing too few goods and services.

“Excess liquidity and savings are still likely permeating through the system,” Deutsche Bank’s global head of economics, Jim Reid, wrote on Wednesday. He welcomed the increase as a positive sign for economic growth.

Still, having unneeded money in the financial system could exacerbate inflation just as Fed officials are waiting for evidence that annual price gains are headed back to their 2% annual target before cutting interest rates. “I think the data has been very mixed…and it’s going to take longer than I had [previously] thought,” Boston Fed President Susan Collins said at a conference in Florida last week. “We’re in a period when patience really matters.”

To be sure, M2 is susceptible to revisions so investors shouldn’t read too much into the data. Strategists, including the ones at Goldman Sachs, have also called out M2 as an unreliable indicator.

People on Wall Street see usage of the so-called overnight reverse repo facility, a place where money-market funds and others park excess cash to earn short-term interest from the Fed, as a good gauge of excess liquidity in the U.S.

Presently at $459 billion, the total parked in the reverse repo facility is down sharply from its peak of $2.6 trillion about a year ago. Economists such as Michael Gapen from BofA Securities, have however noted that the total has more or less stopped falling. It has remained consistently within the $500 billion to $400 billion range since February.

Combined with the S&P 500’s 28% gain since its October low, that offers more than ample evidence to say money is still sloshing around in the system. That isn’t such a good look for the Fed.

Write to Karishma Vanjani at karishma.vanjani@dowjones.com