Japanese monetary trends suggest continued solid if unspectacular economic growth through late 2015.
GDP rose by 2.4% annualised in the first quarter versus a downwardly-revised 1.1% in the fourth quarter (previously 1.5%). The pessimistic spin is that, from the demand side, most of the growth last quarter was arithmetically due to the inventory component. This positive contribution, however, reflected a reduced rate of destocking rather than an accumulation of inventories, so is unlikely to imply a drag on future growth.
The economic recovery was signalled by monetary trends, with six-month growth of real narrow and broad money returning to a healthy level last autumn, stabilising more recently – see first chart.
Monetary trends typically precede economic activity by about six months but the lead-time was shorter in 2014, probably because real money developments were dominated by changes in the price level rather than swings in nominal growth. The six-month change in real money was pushed negative by the April 2014 sales tax hike, rebounding in October when this dropped out of the inflation calculation – second chart.
Current monetary trends suggest respectable economic expansion through late 2015 but real narrow money growth is lower in Japan than in the US and Eurozone – third chart.
The forecast here of stronger global growth during the second half of 2015 suggests that business surveys will shortly turn more upbeat. Equity analysts’ earnings revisions correlate with survey trends and are improving on schedule.
The earnings revisions ratio is the number of analyst earnings upgrades minus downgrades, expressed as a proportion of the total number of estimates. The global revisions ratio (i.e. covering the constituents of the MSCI World index) rose to its highest level since December this month, an improvement that may be echoed in Markit “flash” manufacturing purchasing managers’ surveys released on Thursday – see first chart.
Yesterday’s post noted that monetary trends in China are signalling a modest growth revival. The Chinese revisions ratio also strengthened in May – second chart.
The upturn in the global longer leading indicator calculated here – see previous post – is corroborated by an alternative indicator compiled by the New York-based Economic Cycle Research Institute (ECRI). Its website commentary states that “the long leading index has turned up, and the coincident index is starting to follow suit, with the revival being led by economies where exchange rate weakness is acting as a tailwind (Japan and the Eurozone), while being less evident in the US where dollar strength is a headwind” – see here.
The Chinese economy remained weak in April but narrow money trends suggest a modest growth pick-up during the second half of the year.
The preferred measure of economic momentum here is the six-month change in industrial output*. This fell to just 1.6%, or 3.2% annualised, in March / April – the lowest since March 2009 and compared with average growth of 10.5% per annum in the five years to end-2014.
The extent of the slowdown was not clearly signalled by the official M2 and M1 money supply measures. Six-month growth of real (i.e. inflation-adjusted) M2 fell during the second half of 2014 but remained above its level in 2011, when the economy was significantly stronger than currently. Real M1 did warn of weakness, contracting in late 2014, but similar declines in 2012 and 2013 were not followed by falls in economic growth on the recent scale – see first chart.
The patchy forecasting performance of the official M1 measure reflects a flaw in its construction. M1 is conventionally defined as currency in circulation plus demand deposits. The Chinese measure, however, includes only demand deposits of corporations. This is a major deficiency at a time when policy is attempting to promote consumption- rather than investment-led growth.
The solution adopted here was to add a PBoC series for household demand deposits to official M1 to generate a “true” M1 measure. As expected, this performs better as a forecasting indicator. In particular, real “true” M1 contracted in late 2014, correctly warning of the recent slowdown, but did not give a similar negative signal in 2012 and 2013, when growth proved more resilient – second chart.
The six-month change in real “true” M1 has been volatile in recent months but averaged 1.8% (not annualised) over January-April, versus -0.1% in the last four months of 2014. This revival should be reflected in a recovery in economic growth over the summer / autumn.
*World Bank seasonally-adjusted index.
Here’s a productivity-enhancing suggestion for students of the Bank of England’s Inflation Report. To deduce the policy message, ignore the copious verbiage and focus on a single statistic – the mean forecast for inflation in two years’ time based on unchanged policy. A number above 2.0% signals that policy tightening is required. If, in addition, the number is higher than last time, tightening is judged to be more urgent.
Both conditions were met in the latest Report. The mean two-year-ahead forecast is 2.35%, up from 2.19% in February. The MPC, therefore, has become slightly more hawkish, although Mark Carney was at pains not to disturb current market expectations of a first rate rise next spring in his press conference comments. The rise in the two-year-ahead forecast follows cuts in February and November – see first chart.
This hawkish shift, despite a downward revision to GDP growth, reflects greater pessimism about near-term supply prospects. Productivity is now projected to rise by only 0.25% this year, down from 0.75% in February.
The expectation here is that a further hawkish adjustment will occur by August as pay growth exceeds the MPC’s downwardly-revised forecast. Today’s labour market report, unseen by the Bank, showed annual growth of average weekly earnings of 1.9% in the three months to March, and 3.3% in March alone, which compares with a projection of 2.5% in the fourth quarter of 2015 (cut, strangely, from 3.5% in February). The job openings or vacancies rate continues to suggest a pick-up in pay pressures – second chart.
(A monetarist gripe: The May Report contains nine pages of analysis of potential supply but only three sentences about monetary developments. The Bank’s long tradition of ignoring money continues, despite its key role in the 2005-09 financial boom / bust.)
The recent surge in global government bond yields is consistent with the forecast here that growth and inflation will rebound in the second half of 2015, resulting in a change in direction of monetary policies.
A post in February suggested that global growth would pull back into mid-2015 before strengthening significantly in the second half. A pick-up was expected because real narrow money expansion had risen sharply in late 2014 / early 2015 and typically leads activity by six to 12 months.
An April update concluded that this scenario remained on track and, together with a likely inflation rebound, posed a risk to government bond markets. A post in March had noted that Eurozone real yields were at a similar negative level to those in the US in 2012 ahead of a major market sell-off.
Full monetary data are now available for March. Six-month growth of global real narrow money fell back from February’s 38-month high but remains well above its 2014 average – see first chart. The monetary signal, therefore, remains green.
The forecast of a stronger second half is also now receiving support from the global longer leading indicator calculated here. The indicator drifted lower into February but recovered in March and appears to have risen sharply in April, based on preliminary data – first chart.
Another market development consistent with the forecast growth rebound is recent outperformance of stocks in “cyclical” industries relative to “non-cyclicals”. The relative performance of cyclicals correlates with G7 manufacturing purchasing managers’ new orders, which recovered slightly in April – second chart.
Will second-half economic strength carry over into 2016? As noted, real narrow money growth slipped in March and may fall further as inflation rebounds, unless nominal trends accelerate. The suggestion is that the coming economic pick-up will prove to be another false dawn. Markets, however, have probably yet to adjust fully to the near-term positive momentum change. Bond yields may have further to rise.