@onechancefreedm ↔ @JeanPierreCHE12 conversation

Despite the Fed keeping rates elevated at 5.25–5.50%, financial conditions have eased all the way back to levels we last saw when rates were near zero and the Fed was still doing quantitative easing. That’s not supposed to happen. Higher rates are meant to tighten financial conditions, making credit more expensive and slowing the economy. But in practice, the plumbing of the system is short circuiting that mechanism.

So why is this happening? A few key reasons.

First, the U.S. Treasury has front loaded a massive amount of bill issuance into short-duration maturities T-bills which are being soaked up by money market funds that are flush with cash. The RRP (reverse repo) facility has been drained since mid-2023, and that capital is being recycled into T-bills, keeping front end funding extremely liquid despite high nominal rates.

Second, the banking system still has excess reserves north of $3 trillion. That liquidity hasn’t really left. So while the Fed has stopped expanding its balance sheet, it hasn’t meaningfully drained the system either. The banking sector isn’t under significant funding pressure, which means lending capacity, while tighter than 2021 is still functioning.

Third, corporate bond spreads remain narrow, high yield issuance is quietly ramping back up, and equity markets, especially the S&P 500 have surged, lifting household wealth and easing credit access via capital markets. In short: financial conditions aren’t just about the Fed Funds Rate; they reflect market based conditions for risk taking, credit issuance, and liquidity.

Ironically, this easing of financial conditions may another reason why the Fed hasn’t cut yet. If Powell were to cut prematurely, it could further loosen conditions, risk reigniting inflation, and undermine credibility. But if the Fed keeps rates too high for too long and the underlying economy weakens beneath the surface, especially with rising delinquencies in auto loans, credit cards, and softening labor data, we could suddenly flip into hard tightening via credit events or default cycles.

So we’re in a bizarre place where the Fed’s hiking cycle is still technically in place, but the market has effectively eased around it. It’s like monetary policy is stuck in a tug of war between its formal settings (high rates) and its actual effects (easing conditions). If this divergence persists, it risks blunting the Fed’s toolkit just when it may need it most. The longer rates stay high without tightening financial conditions meaningfully, the greater the odds that when the break comes, it’s sharp, because all the buildup of leverage, positioning, and complacency didn’t adjust the way policy was designed to.

This chart is a flashing signal that the macro plumbing isn’t behaving like it used to. And that usually ends one of two ways: either a sudden policy reversal, or a market event that does the tightening the Fed couldn’t.
x.com/HappyKitty4U/s…

You’re absolutely right that we’ve been living with a bloated monetary base since COVID, trillions injected without any real economic output behind it. But where I’d push back a bit is on the idea that the solution is just rate hikes and shrinking the aggregates back to pre-COVID targets. The system we have now doesn’t really respond to those old levers the same way anymore.

Yes, M2 is still oversized, but that liquidity isn’t sitting idle. It’s been reshuffled into money market funds, short duration T-bills, and institutional plumbing that makes it look like money is tight when in reality financial conditions are loose. The Fed can hike all it wants, but unless that actually restricts credit creation or hits capital markets, it won’t slow anything down. The bubble isn’t just in the money supply, it’s in the function of how that money moves. It’s not just too much M2, it’s that the velocity is low, yet assets are inflating again.

Also, your reconstructed M3 is helpful, but I’d caution against using strict ratios like M2 must be under 55% of GDP as if that’s a hard limit. The structure of the financial system has evolved. Post 2008, and especially post 2020, balance sheet mechanics, Basel rules, and shadow liquidity have changed the way money aggregates interact with GDP. So while the risk is real and I agree that this likely ends with a sharp correction or recession, it’s not as simple as going back to Reagan-era ratios. We’re in a different kind of machine now.

In short you’re spot on that there’s a dangerous imbalance, but the system’s plumbing has changed so much that the old tools no longer drain the bubble the way they used to. That’s the real problem, Powell isn’t just fighting inflation he’s fighting a financial system that resists the very tools he’s using.