WASHINGTON -- The continuing stampede by investors into bond mutual funds is the main factor behind the anemic money supply and is not a sign of economic weakness that suggests the Federal Reserve ought to lower short-term rates, according to an analysis released yesterday by Merrill Lynch & Co.

The firm's weekly economic and financial commentary comes at a time Bush administration officials are pressuring Fed policymakers to ease credit again to ensure the recovery does not falter and send the economy into a double-dip recession.

Michael Boskin, chairman of the President's Council of Economic Advisers, said last Friday that the Fed should lower rates if growth in the money supply does not pick up "very very soon."

M2, a broad measure of the money supply, is at the bottom of the Fed's annual target range of 2.5% to 6.5%. Normally, economists say, the money supply should pick up as the economy revives and consumers and business boost demand for credit.

The report, written by Bruce Steinberg, manager of macroeconomic analysis, says the sluggish growth of the money supply is largely a technical phenomenon that reflects the move by investors to transfer assets from maturing certificates of deposit and money-market funds into bond funds where they can get higher rates of return.

M2 consists of the M1 measure of money -- currency, demand deposits, and other checkable deposits -- plus a non-transaction component that mainly involves consumer savings-type deposits. The latter category includes passbook savings accounts, small-denomination CDs, and money market funds. M2 does not include bond and income funds.

"Faced with low short-term interest rates, consumers are rolling their maturing CDs into bond mutual funds and, to some extent, into equity funds," the Merrill Lynch report concludes. "Money market funds are another source of inflows to bond and equity funds."

The report adds: "Such movements of savings have no bearing on the strength of the economy. And unless indicators of real [economic] activity begin to falter, the Fed will probably not respond to sluggish money growth."

Mutual fund managers reported this spring that investors were switching into municipal bond and other types of bond funds. Until recently, the Treasury long bond was yielding around 8.5%, while three-month T-bills have fallen to 5.75%.

According to the Investment Company Institute, the trade association for stock and bond mutual funds, net cash flow into bond and income funds reached $6.6 billion in May. That was more than double the $ 3.2 billion in May 1990. April inflows totaled $7.3 billion, up even more dramatically compared to $1.1 billion a year earlier.

"We are starting to tote up an awfully good year in terms of inflows into bond mutual funds," and said Betty Hart, a spokesman for the institute. "There's an unusually large spread between the short-term and long-term funds."

Moreover, said Ms. Hart, there is some evidence investors have been moving out of stocks into long-term bonds funds amid uncertainties over the outlook for earnings abroad and lingering questions about the durability of the U.S. recovery.

Analysts at Merrill Lynch calculated net inflows into bond mutual funds ran at a monthly rate of $7 billion in April and May, roughly double the flows into stock mutual funds during the same period.

By all accounts, investment flows into bond funds continued in June, although the Investment Company Institute will not make its monthly report available until later this week. "All indications are that they are continuing to be strong," said Ms. Hart.

The Merrill Lynch report said the "explosive growth" of bond mutual funds in recent years stems from the industry's ability to provide small investors with a variety of ways to switch their assets out of bank CDs and other instruments.

"The assets of bond mutual funds have multiplied 30 times during the past 10 years and loom much larger in relation to the consumer deposits that are part of M2," the report said. "So, unlike the situation in the not-so-distant past, inflows into mutual funds now have the capacity to distort M2 balances and appear to be doing so."

Once employment begins to grow steadily with a recovering economy, the income generated will add to consumer spending and saving and help boost money supply growth by September, the report said.

The one worry, according to the report, is that weak growth in the money supply is to some extent a by-product of weak savings rate as consumers have drawn down on their resources to maintain their living standards. The commerce Department reported yesterday that the personal saving rate, or saving as a share of disposable income, was a meager 3.5% in June.

"To the extent that low savings depressed its growth, M2 is probably signaling that the recovery will be subpar by past standards," the Merrill Lynch report concluded.

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