Many market participants monitor the OECD’s composite leading indicators for guidance on near-term economic prospects. October numbers to be released on 8 December are likely to be strong, providing further support for the forecast here – based on monetary trends – of a developing global economic boomlet.
The OECD presents its leading indicators in detrended form, meaning that a stable reading signals future economic growth in line with the estimated longer-run trend. As of September, its G7 leading indicator was falling gently, while indicators for China, India, Brazil and Russia were rising. The OECD interpreted these developments as signalling “stable growth momentum in the OECD area with growth gaining momentum in major emerging economies”.
The OECD’s calculations were replicated here in order to produce an October estimate of its G7 leading indicator, based on partial data*. The indicator appears to have risen strongly last month, while revisions may show that it has been increasing since June – see chart. Rather than “stable growth momentum”, therefore, the new data may signal above-trend and accelerating economic expansion.
Key drivers of the October increase and upward revision to earlier data include recent stronger business / consumer surveys, large increases in US housing starts and durable orders in October and financial market developments, i.e. rising stock markets and steepening yield curves.
*For example, additional data points are available for five of the seven components of the US leading indicator. Note that the October indicator readings take into account November data on the components, where available (e.g. US consumer sentiment).
The Chancellor delivered a somewhat racy Autumn Statement, belying his reputation as a fiscal hawk. Faced with a significant rise in projected borrowing due to a shortfall in tax receipts and lowered OBR growth forecasts, Mr Hammond nevertheless chose to announce “giveaways” amounting to 0.4% of GDP per annum by 2020-21. He also introduced surprisingly unambitious new fiscal rules that appear to give him scope to add up to a further 1.2% of GDP to the deficit in 2020-21, should he decide that the economy requires additional stimulus.
The centrepiece of the Statement, and the destination for most of the additional borrowing, is the new National Productivity Investment Fund, which will spend rising amounts on housing, transport, telecoms and R&D, reaching £7 billion by 2021-22, or 0.3% of GDP. Welfare measures absorb a further £2 billion in that year, reflecting the Government’s decision to backtrack on changes to personal independence payments and a small giveaway on universal credit. Tax changes were modest, with a rise in insurance premium tax and additional avoidance measures raising slightly more than the cost of freezing fuel duty for a sixth year.
The new fiscal mandate requires the government to reduce the structural or cyclically-adjusted deficit to below 2% of GDP by 2020-21 – significantly weaker than the previous requirement of an actual budget surplus in 2019-20 and beyond. The mandate is easily met on the OBR’s forecasts, showing a structural shortfall of 0.8% of GDP in 2020-21. The new supplementary target is for net debt to fall as a percentage of GDP in 2020-21 and is equally unlikely to constrain the Chancellor’s future room for manoeuvre, not least because an unwinding of the Bank of England’s term funding scheme is projected to cut the net debt ratio by 1.4 percentage points in that year.
The key judgement underlying today’s package was made by the OBR rather than the Chancellor – a forecast that the economy will grow by an average 1.9% per annum in the five years to 2020-21, only 0.2 percentage points below its Budget projection, despite Brexit. The OBR arguably gave Mr Hammond an easy ride on his first outing; it may well prove less accommodating in future assessments.
The consensus view is that the outlook for the UK public finances has deteriorated significantly since the Brexit vote. Rising nominal GDP growth, however, is supporting central government receipts, suggesting only a modest overshoot of the Office for Budget Responsibility’s March forecast of net borrowing of £55.5 billion in 2016-17. The OBR’s new fiscal forecasts in tomorrow’s Autumn Statement may be too pessimistic if they assume that nominal GDP will slow in 2017 and beyond.
October public finance numbers released today were better than expected, showing cumulative borrowing in the first seven months of 2016-17 £5.6 billion lower than in the same period of 2015-16. A continuation of this rate of improvement over the remaining five months would imply full-year borrowing of about £66 billion – above the £55.5 billion OBR forecast but below a consensus projection of £70.4 billion (according to the Treasury’s monthly survey of forecasters).
The rate of improvement, however, may pick up over the remainder of 2016-17. Central government taxes and national insurance contributions rose by 4.2% over April-October from a year before, below the OBR’s March forecast of a 5.5% increase in 2016-17 as a whole. This divergence may narrow or close as taxes / NICs benefit from recent faster nominal GDP expansion.
Annual growth of nominal GDP bottomed in the third quarter of 2015 and is likely to have risen further last quarter – data will be released on Friday. Taxes / NICs are starting to reflect this pick-up, with annual growth increasing to 4.7% in the three months to October – see first chart.
The OBR in March projected that nominal GDP growth would rise from 3.6% in 2016-17 to 4.0% in 2017-18, remaining around this level over the subsequent three years. If it follows the consensus (as it usually does), these numbers may be cut to 3.0-3.5% in the Autumn Statement. Monetary trends, however, support the March forecast or even faster growth in 2017-18 – see second chart and previous post. The OBR, therefore, may be overly pessimistic about prospects for receipts and, by extension, borrowing in tomorrow’s update.
Services turnover numbers for September suggest that output in the industries covered rose significantly from August, in turn raising the possibility that the official estimate of GDP growth in the third quarter will be raised from 0.5% to 0.6% – revised data will be released on 25 November. (Caveat: translating the turnover data into a forecast for output is not straightforward – see previous post.)
The current estimate of 0.5% GDP growth assumes that services output rose by 0.2% in September. The turnover survey covers nearly 60% of the sector and suggests an increase of at least 0.5% for this group. Unless output in the rest of the sector – dominated by government activities – fell, the 0.2% official growth assumption looks too low. A rise of 0.4% would probably be sufficient to trigger an upward revision to third-quarter growth.
Such an increase would also imply that the September level of GDP was 0.2% above the third-quarter average, implying solid growth “carry-over” into the fourth quarter. The 1.9% October rise in retail sales reported yesterday, meanwhile, will contribute +0.1 of a percentage point to the change in GDP in that month. Current evidence, therefore, appears consistent with GDP growth remaining at around 0.5% in the fourth quarter – contrary to the consensus forecast of a slowdown.
The Fed’s indifference to monetary trends contributed to it making two policy mistakes over the past 12 months. Is it about to make another?
The Fed hiked by 25 basis points in December 2015 and guided markets to prepare for four further quarter-point moves during 2016. Its hawkishness was in conflict with narrow money trends: six-month growth of real M1A* had fallen to a five-year low in October 2015, signalling that the economy would be weak over the winter and during the first half of 2016 – see chart. GDP growth averaged just 1.0% annualised in the fourth, first and second quarters. The Fed was forced to backtrack.
The second mistake was its failure to resume rate-hiking in summer 2016. Real narrow money growth had rebounded strongly from late 2015, suggesting a return to above-trend GDP expansion in late 2016 / early 2017. GDP rose at a 2.9% annualised pace in the third quarter, with similar growth expected in the current quarter (the Atlanta Fed’s “nowcast” model projects 3.6%). A summer hike would have put the Fed slightly “ahead of the curve” and might have prevented or tempered the recent sharp rise in inflation expectations and Treasury yields.
Fed Chair Yellen’s comments yesterday suggest that the central bank has turned hawkish again. Markets now discount a 91% probability of a December hike and a greater-than-50% likelihood of at least one further quarter-point increase by June 2017, according to the CME.
In contrast to late 2015 and summer 2016, narrow money trends do not argue strongly that the Fed is on the wrong track. Six-month growth of real narrow money has fallen back since August but remained respectable in October, suggesting solid economic expansion through spring 2017, at least. A further slowdown, however, would be concerning. Investors should monitor monetary trends and ignore Fed communications to assess policy prospects for later in 2017.
*M1A = currency in circulation plus demand deposits. Real = deflated by consumer prices.