Chinese growth holding up, money trends stable

Posted on Thursday, October 19, 2017 at 03:27PM by Registered CommenterSimon Ward | CommentsPost a Comment

The Chinese economy has cooled since early 2017 but growth remains respectable and current monetary trends are reassuring.

Nominal GDP is a better guide to economic fluctuations in China than official real GDP growth numbers, which often show little variation. Two-quarter growth of nominal GDP, seasonally adjusted, peaked in the first quarter of 2017, falling significantly in the second and third quarters. A slowdown had been signalled by a sharp drop in six-month narrow money expansion between August 2016 and February 2017 – see first chart*.

Narrow money growth, however, has stabilised since early 2017 at a solid level by historical standards. Current growth is much stronger than in late 2014 / early 2015, when the economy was in danger of entering a deflationary recession. Aggressive monetary and fiscal policy easing averted this risk and set the stage for the late 2016 / early 2017 boomlet.

Monetary pessimists highlight weakness in broad money M2 – six- and 12-month growth of this measure recently reached new lows in data extending back to the early 1990s. As previously discussed, however, M2 has been distorted by large swings in deposit holdings of non-bank financial institutions – movements in such deposits are unlikely to provide information about near-term prospects for spending on goods and services.

An additional suppressing factor since 2015 has been a switch by households and non-financial enterprises out of time deposits into money market funds and wealth management products, which have channelled the funds back to the banks via purchases of bank bonds. Such bonds are excluded from the M2 definition.

An adjusted broad money measure excluding financial deposits and adding bank bonds has been better correlated with nominal GDP than M2 in recent years – second chart. Six-month growth of this measure is below the historical average but has recovered since June and is higher than in late 2014 / early 2015.

Broad money, therefore, is giving a less upbeat message than narrow money but does not suggest economic weakness.

The expectation here, based on the above, is that nominal GDP growth will stabilise around its recent lower level through early 2018.

One risk to an optimistic view is that policy tightening during the first half of the year has yet to be fully reflected in monetary trends. Near-term economic resilience, moreover, may sustain recent upward pressure on inflation, causing further restrictive policy moves.

*True M1 = official M1 + household demand deposits.

UK inflation boosted by belated food pick-up

Posted on Tuesday, October 17, 2017 at 12:12PM by Registered CommenterSimon Ward | CommentsPost a Comment

Today’s news of a further rise in UK consumer price inflation to 3.0% in September supports the case for the MPC to raise interest rates in November but does not provide additional hawkish information relative to the August release.

CPI inflation averaged 2.82% for the third quarter as a whole versus a projection of 2.68% in the August Inflation Report. The MPC then expected a further rise to 2.75% in the fourth quarter; current trends suggest an average of 3.0%.

CPI inflation just made it to 3.0% in September: the unrounded figure was 2.96%.

The rise from August was driven by food inflation, which jumped from 2.3% to 3.4%. A post last month noted that CPI food inflation was unusually low relative to producer output price inflation of food products, which reached 6.0% in July and remained elevated at 5.5% last month. A further rise in CPI food inflation, therefore, appears likely.

The September data collection date preceded a 12.5% increase in the British Gas standard electricity tariff on 15 September – this will lift annual inflation by a further 5-10 basis points in the fourth quarter.

Core prices are still rising at an above-target pace. The core measure monitored here excludes energy, food, alcohol, tobacco and education, and adjusts for historical VAT changes. Seasonally adjusted, core prices rose by 0.2% between August and September and at a 2.6% annualised rate in the latest three months – see chart.

As previously discussed, the claim that the inflation overshoot is entirely attributable to sterling weakness has become more difficult to sustain following data revisions showing unit labour cost growth of 2.4% in the year to the second quarter.

The view here remains that the rising inflation trend stems from a significant pick-up in money growth from 2011, with this faster expansion subsequently contributing to the fall in the exchange rate – see previous post. Annual broad money growth appears to have reached a peak in late 2016 but has usually led inflation turning points by at least two years historically, suggesting that upward pressure will persist in 2018.

Global money trends suggesting slower 2018 economic growth

Posted on Tuesday, October 17, 2017 at 10:00AM by Registered CommenterSimon Ward | CommentsPost a Comment

The IMF’s latest World Economic Outlook (WEO) – a useful summary guide to the views of the global policy-making consensus – is upbeat about economic prospects. Monetary trends, by contrast, suggest that GDP growth will slow in 2018. This is the reverse of the position a year ago, when the IMF consensus was gloomy* but money trends were signalling – correctly – that growth would surprise on the upside in 2017.

The IMF now expects its global GDP measure to grow by 3.6% in 2017, up from 3.5% in July. It forecasts a further increase to 3.7% in 2018, implying that growth next year will be the strongest since 2011.

The key forecasting indicator here is six-month growth of global real narrow money**. This appears to have fallen sharply in September, based on monetary data for countries accounting for two-thirds of the aggregate – see first chart. Six-month growth peaked most recently in June. Allowing for a typical nine-month lead, this suggests that the global economy will lose momentum around spring 2018.

The latest decline in six-month real narrow money growth follows a temporary slowdown in late 2016 / early 2017. Together, these have resulted a significant fall in year-over-year real money growth, from a peak of 9.8% in September 2016 to about 6% last month – second chart.

The monetary slowdown, as well as signalling a likely moderation of economic growth in 2018, implies a reduction in current liquidity support for markets. The gap between year-over-year real narrow money growth and industrial output expansion, monitored here as a gauge of the potential money flow into markets, has fallen to its lowest level since 2014 – second chart.

Another development suggesting reduced support for global markets is a sharp slowdown in Japanese portfolio investment overseas. On a 12-month rolling basis, Japan’s portfolio investment balance has swung from a deficit of ¥40.5 trillion or $370 billion in September 2016 to a small surplus in August 2017 – third chart. This mostly reflects a decline in Japanese purchases of foreign securities, which has coincided with a slowdown in QE since the Bank of Japan introduced its "yield curve control" policy – fourth chart

*The October 2016 WEO was entitled “Subdued demand: symptoms and remedies”.
**”Global” = G7 plus emerging E7. Real = adjusted for consumer price inflation. Narrow money = currency in circulation plus demand deposits or equivalent.

UK data wrap: more grist for MPC hawks

Posted on Tuesday, October 10, 2017 at 12:43PM by Registered CommenterSimon Ward | CommentsPost a Comment

Recent UK data releases have further boosted the probability of a November rate hike while suggesting that the accompanying Inflation Report will signal a need for additional policy tightening.

Whole-economy unit labour costs (ULC) rose by 2.4% in the year to the second quarter of 2017, far above a Bank of England staff estimate of 1.0% in the August Inflation Report. The MPC then expected ULC growth of below 2% in both 2017 and 2018, justifying its forecast of a slow return of inflation to the 2% target as import price pressures faded. A major reassessment is now required.

The overshoot in ULC growth relative to the Bank staff estimate reflects a stronger-than-expected rise in non-wage labour costs and weaker-than-expected productivity performance. Non-wage costs (i.e. “employers’ social contributions”) per employee rose by 7.1% in the year to the second quarter, apparently driven by pensions. Whole-economy output per hour, meanwhile, fell by 0.3% in the year to the second quarter versus an MPC “key judgement” of growth of just under 0.5%.

ULC growth of 2.4% in the second quarter was down from an upwardly-revised 3.5% in the first quarter. The latter number incorporated a rise in employers’ national insurance contributions from April 2016 associated with the introduction of the single-tier state pension. This increase dropped out of the year-on-year comparison in the second quarter.

Second-quarter ULC growth of 2.4% is arguably understated because it does not take account of the apprenticeship levy introduced in April. The levy is forecast by the OBR to raise £2.7 billion in 2017-18, equivalent to 0.25% of total employee compensation.

A November rate hike could, in theory, be derailed by a weak preliminary estimate of third-quarter GDP growth to be released on 25 October. August activity data released today, however, suggest that GDP will be reported to have risen by 0.3-0.4% from the second quarter, i.e. no lower than the Bank staff estimate of 0.3% at the time of the September MPC meeting.

The key release was services turnover, which receives little attention but is an input to services output, an August number for which will be reported at the same time as third-quarter GDP. August turnover along with previously-released retail sales suggest that services output more than reversed a 0.2% July fall. Incorporating industrial and construction output for August also released today, the level of GDP in August may have been 0.3-0.4% above the second-quarter level.

The ONS will have limited information about September activity when it releases the third-quarter GDP estimate, so will rely partly on statistical extrapolation. Assuming a further 0.1% monthly GDP rise in September, implied third-quarter growth would be 0.3-0.4%.

A "monetarist" perspective on current equity markets

Posted on Friday, October 6, 2017 at 09:41AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global monetary trends are signalling solid economic growth through early 2018, at least. This prospect suggests a further tightening of labour markets, which may cause central banks to accelerate plans for policy normalisation, even if inflation remains quiescent. US Treasury borrowing ahead of the reimposition of the federal debt ceiling in December, meanwhile, may have a temporary negative impact on US monetary conditions. A cautious investment stance, therefore, may be warranted, despite favourable economic trends.

Previous commentaries suggested that the global economy would lose momentum over the summer and autumn before reaccelerating in late 2017 / early 2018. This forecast is on track but the growth pull-back to date has been modest. Six-month growth of industrial output in the G7 developed economies and seven large emerging economies (the “E7”) peaked in April 2017 but remained solid through August – see first chart. The equity analysts’ earnings revisions ratio has fallen back but business surveys have stayed strong – second chart.

The basis for the forecast that economic expansion would moderate from spring 2017 was a fall in G7 plus E7 real narrow money growth between August 2016 and February 2017  – monetary trends lead the economy by about nine months on average*. Real money growth, however, recovered solidly between February and June, suggesting a restrengthening of economic momentum around end-2017. June may have marked another peak in real money growth but July / August data remained positive – first chart.

The message from monetary trends is supported by a global (i.e. G7 plus E7) leading indicator derived from the OECD’s country leading indicators, which combine a wide range of economic and financial series (but generally exclude money). The global measure, which typically leads activity by four to five months, slowed in late 2016 / early 2017 but has regained momentum over the summer, consistent with the forecast of near-term economic strength – third chart.

US real narrow money growth has rebounded strongly from weakness in early 2017, suggesting robust GDP expansion in late 2017 / early 2018 – fourth chart. The unemployment rate has stabilised at 4.3-4.4% since the spring but could fall further to 4% or below. Core inflation has declined unexpectedly but this partly reflects temporary influences, such as a large fall in mobile data charges. Fed officials are aware of a possible parallel with the 1960s, when core inflation rose sharply as the jobless rate moved through 4% – fifth chart. Policy rates may rise faster than markets currently discount, boosting the US dollar.

Chinese real narrow money growth fell in late 2016 / early 2017 but has stabilised since the spring at a level consistent with respectable economic expansion – sixth chart. Policymakers have clamped down on housing speculation, shadow financing and polluting activities but plan to support growth via infrastructure spending and targeted easing, such as a recent cut in reserve requirements for small business lending. Current monetary trends suggest that they are on track.

US real narrow money growth is now at the top of the range across major developed economies, along with Canada – seventh chart. UK expansion, meanwhile, has recovered modestly, while growth in Japan and Euroland has moderated. These trends suggest improved relative economic prospects for the US and UK and may warrant adding to equity market exposure, partly on the expectation of better currency performance.

The outperformance of emerging market equities since early 2016 was signalled by E7 real money growth crossing above the G7 level in late 2015 and remaining higher through early 2017 – eighth chart. This positive signal has now reversed, suggesting reducing EM exposure.

Globally, liquidity conditions still appear supportive for markets. Research reported previously found that major equity market declines historically were preceded by one or more of the following conditions: G7 annual real narrow money growth falling below 3%; real money growth falling below industrial output growth; and real money growth falling by 3 percentage points or more within six months. The performance relative to US dollar cash of two switching rules based on these conditions is shown in the ninth chart. The rules would have captured a significant portion of relative equity gains while limiting losses during bear markets.

The three conditions are not yet close to being triggered. G7 annual real narrow money growth of 6.3% in August, however, was down from an October 2016 peak of 8.7%, while the real money / industrial output growth gap has narrowed significantly – tenth chart. Liquidity conditions, therefore, are probably the least favourable since mid-2014 – equity markets made no progress over the subsequent two years.

A near-term concern is that the US Treasury will “overfund” the federal deficit before the debt ceiling is reimposed in December in order to replenish its cash balance at the Fed. An earlier run-down of this balance boosted the monetary base and may have contributed to the pick up in real narrow money growth since early 2017 noted earlier – final chart. A reversal of this effect could have a temporary disruptive impact on markets, particularly if accompanied by strong economic data and an associated upward revision to interest rate expectations.

*Narrow money = currency in circulation plus demand deposits and close substitutes. Broad money = narrow money plus time deposits, notice accounts, repos and bank securities. Precise definitions vary by country. Narrow money has been more reliable than broad money for forecasting purposes historically and is consequently emphasised in the analysis here. Real = inflation-adjusted. The G7 plus E7 narrow money series shown, and an E7-only series in a later chart, incorporate an adjustment to reduce a distortion from India’s demonetisation programme.

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