Narrow money trends in emerging economies continue to support optimism about near-term economic prospects. Inflation, meanwhile, is falling, giving a direct boost to real money growth and creating scope for central bank policy easing.
Six-month growth of real (i.e. consumer price-deflated) narrow money in the “E7” large emerging economies rose sharply in mid-2015, signalling an economic pick-up in the first half of 2016, allowing for the normal six to 12 month lead. Consistent with this forecast, industrial output growth rebounded in February and March – see first chart.
Prior economic weakness and recent currency stabilisation, meanwhile, have resulted in a marked reduction in inflationary pressures. E7 annual “core” consumer price inflation peaked in June 2015 and dropped to a 23-month low in March. Headline inflation is also now falling, despite strong food price rises and a waning benefit from lower energy prices – second chart.
E7 inflation trends contrast with G7 developments: G7 core inflation is at a 47-month high and the headline rate is likely to move up sharply to equal or exceed it by late 2016, assuming that commodity prices remain at current levels – third chart.
Falling E7 inflation and currency reversals have relieved upward pressure on interest rates in some countries and opened the door to cuts in others. Among the E7, Brazil, India and Russia may cut rates soon.
China, however, is unlikely to ease further, reflecting recent better economic data and rising concern about renewed housing market speculation. Annual new house price inflation rose to 4.9% in March, a 22-month high, and the historical relationship with narrow money growth suggests a further increase through late 2016, barring an official clamp-down – fourth chart.
Lower inflation and stable or easier monetary policies are likely to sustain solid E7 real narrow money growth, which remained higher than G7 growth in March – fifth chart. The E7 / G7 gap, however, could narrow or close over coming months as real money growth normalises from its recent buoyant pace in China and recovers in the US and Japan – sixth chart.
Chinese economic reports today confirm a recovery predicted by monetary trends, which continue to give a positive signal, though are no longer strengthening.
Headline activity data matched or beat consensus expectations but may have been flattered by calendar effects. Annual growth of nominal GDP rebounded from 6.0% in the fourth quarter, the lowest since 1999, to 7.1% in the first quarter. A turnaround had been suggested by a strong acceleration of narrow money, as measured by the “true M1” aggregate* calculated here, from mid-2015 – see first chart. The increase, however, was probably boosted by an extra calendar day due to the leap year.
Annual growth of industrial output rose from 5.4% in January / February to 6.8% in March, well above a 5.9% consensus prediction. A previous post argued that the late timing of the Chinese New Year depressed January / February growth relative to the underlying trend and was likely to deliver a compensating overshoot in March. This suggests a partial relapse in April data, which will give a better indication of the extent of trend improvement.
Annual growth of fixed asset investment rose to 11.1% in March, the highest since June 2015. The pick-up, however, has been entirely government-led, with the annual increase in private investment sliding further to 4.7% last month – second chart. Strong growth of corporate narrow money suggests that private spending will revive soon.
Money and credit expansion remained solid in March. The detail necessary to calculate true M1 is not yet available but annual growth in the official M1 measure surged further to 22.1%, the highest since 2010. This partly reflected a favourable base effect, so a reversal is likely in April. Annual M2 growth was little changed at 13.4% – third chart.
Pessismists argue that an economic recovery has been achieved only by engineering another credit splurge. Annual growth of the stock of “total social financing” (TSF) (i.e. bank loans and other domestic fund-raising by households and non-financial enterprises) has risen from a low of 12.0% in June 2015 to 13.4% in March but remains well below the average in recent years – third chart**. Faster expansion of narrow money than credit is normally a positive signal for the economy and markets.
The economic forecasting approach here focuses on six-month growth of real (i.e. inflation-adjusted) narrow money. Based on the official M1 data, this remained strong in March but has moved sideways since late 2015, suggesting a stabilisation of economic growth at a higher level in the second half of 2016 – fourth chart.
*True M1 = currency in circulation plus demand / temporary deposits of corporations and households. The official M1 measure omits household deposits.
**Growth of a broader aggregate including local government bonds is stronger but also below its recent average. Domestic credit measures have been inflated by corporations switching away from external borrowing.
Japanese monetary trends suggest that the economy will recover from recent stagnation.
Narrow money M1 rose by 1.8% in February / March combined, representing the largest two-month gain since March / April 2011, following the Tohoku earthquake and tsunami. Six-month growth of real (i.e. inflation-adjusted) M1 in March was the highest since September – see first chart.
The pick-up reflects the Bank of Japan’s 29 January decision to cut the marginal interest rate on bank reserves to -0.1%. The 1.8% increase in M1 in February / March is identical to an increase in Eurozone M1 in July / August 2014 after the ECB cut its overnight deposit rate to -0.1% in June. Eurozone M1 acceleration was sustained and was followed by stronger economic growth from late 2014 (when the IMF was warning of a 40% risk of a recession).
Japanese six-month real narrow money growth is currently still at the low end of the range across major economies, suggesting better economic prospects elsewhere – second chart.
Broad money M3 has yet to confirm the more positive signal from M1, growing by 0.2% per month in February and March, in line with the average over the prior 12 months. Six-month growth of real M3 eased further in March – first chart.
M3 has been comically impervious to the BoJ’s QE blitz. Annual growth of 2.6% in March was identical to the rate in April 2013 when incoming Governor Kuroda fired his “quantitative and qualitative easing” (QQE) bazooka. In monetary terms, his missile was defused by a combination of commercial bank sales of JGBs, a balance-of-payments outflow and lack of private sector credit demand.
The third chart below shows that a rise in the contribution to annual broad money growth since early 2013 of expanding BoJ credit to the government has been outweighed by a faster contraction of commercial bank lending. Posts in 2013 (e.g. here) argued against claims that QE would boost broad money growth significantly but the scepticism did not extend to expecting zero impact.
QQE did contribute to a massive undershoot of the yen. Economic pessimists argue that the currency’s rebound will deliver a further blow to a struggling economy. The rise to date, however, has reversed less than a third of the fall in the effective rate since 2012, while a recovery in global trade during 2016 may outweigh any negative competitiveness effect on export performance.
The Atlanta Federal Reserve estimates that US GDP growth fell to 0.1% annualised in the first quarter, reflecting drags from (in order of magnitude) reduced inventory accumulation, a wider trade deficit and lower business investment. This would imply growth in the fourth and first quarters combined of only 0.7%, or 0.35% before annualisation.
The weakness of the economy in the last two quarters was predicted by a sharp fall in six-month growth of real (i.e. inflation-adjusted) narrow money between February and October 2015, i.e. points 8 and 9 in the first chart below. As the chart shows, turning points in six-month real money growth have consistently preceded those in two-quarter GDP expansion in recent years, usually by between six and 12 months.
Real narrow money growth has revived since October 2015, suggesting that that a recovery in GDP expansion will begin between April and October 2016. Labour market data, however, may soften near term in lagged response to GDP weakness. The employment indices of the Institute for Supply Management purchasing managers’ surveys are consistent with this scenario – second chart.
The forecast that GDP momentum is at or close to a low is supported by the OECD’s US composite leading indicator. The OECD presents its leading indicators in “ratio to trend” format, i.e. a rise (fall) indicates that the economy is growing above (below) trend. The US indicator continued to decline in February but at a slower pace, consistent with below-trend but rising GDP growth.
An alternative approach, preferred here, is to monitor the rate of change of the indicator before detrending. The one- and six-month changes are clearly signalling an approaching upturn in economic momentum – third chart
The indicator’s components are: housing starts, consumer sentiment, average weekly hours, durable orders, the ISM manufacturing purchasing managers’ index (PMI), the yield curve and stock prices. The PMI, stocks and weekly hours contributed to the recent recovery.
Neither monetary trends nor the leading indicator yet suggest a strong economic pick-up. There is a risk that real money growth will fall back as higher energy prices lift inflation.
The recovery in the US indicator follows a pick-up in its Chinese counterpart – fourth chart. The twin improvement is consistent with the central scenario here of a recovery in global economic growth during 2016 – see Friday's post.
Global economic growth was depressed over the past 18 months by the disruptive effects of the crash in oil prices and successive slowdowns in China and the US. These drags are fading, while global money and credit trends remain solid. The combination of recovering economic activity with plentiful liquidity argues for a positive bias towards equity markets but there are risks stemming from poor productivity performance, an associated rise in “core” inflation and possible further policy missteps.
Economists expected the 2014-15 oil price collapse to boost global growth as increased disposable income and spending of energy consumers offset cut-backs by producers. This neglected the scale of overinvestment in energy extraction during the period of high prices and the consequent potential for a capex bust. US consumers, meanwhile, saved much of the windfall from lower energy bills, perhaps reflecting lingering post-crisis caution and an expectation of higher interest rates.
Energy capex cuts are probably nearing an end, while the US personal saving ratio may be at or close to a peak. The oil market is returning to balance, suggesting a stabilisation or recovery of prices. Following a sharp increase in 2014-15 that triggered the price collapse, global oil supply growth is slowing and may soon converge with rising demand expansion – see first chart.
China’s economic slowdown was a major drag on global growth in 2015. It had been predicted by monetary trends: the six-month rate of change of real (i.e. inflation-adjusted) narrow* money, as measured by “true” M1, turned negative at the end of 2014 – second chart. Following policy easing during the first half of 2015, however, real money growth rebounded strongly, suggesting an economic recovery in 2016. This appears to be playing out, with the housing market strengthening, profits recovering and business confidence rising.
The Chinese slowdown was followed by a loss of US economic momentum in late 2015 and early 2016. This had also been foreshadowed by monetary trends, with real narrow money slowing sharply between February and October 2015 – third chart. Real money growth remains modest but has recovered in early 2016, consistent with the economy regaining some momentum during the second half.
The US economic slowdown has pushed back interest rate rises, relieved upward pressure on the US dollar and contributed to a rally in commodity prices – in line with the central scenario proposed in our previous commentary. Worries about higher US interest rates may remain in abeyance during the second quarter as recent low GDP growth feeds through to softer labour market data. Recovering monetary expansion suggests that upward pressure on rates will return later in 2016, however.
European economic growth has been stable and respectable, questioning downbeat commentary on the region. Eurozone GDP rose by 1.6% in the year to the fourth quarter of 2015, with domestic demand up by 2.2% – the fastest annual growth since 2007. This performance should be assessed against “potential” economic expansion estimated by the EU Commission, IMF and OECD at only 1.0-1.2%. Above-potential growth has been reflected in a steady decline in unemployment.
UK economic solidity has also received insufficient recognition. GDP growth in the fourth quarter was the highest in the G7 and the indications for the first quarter are positive. Real narrow money growth in the Eurozone and UK remains stable and stronger than in the US and Japan, suggesting upside risk to consensus GDP forecasts.
Our “global” real money and bank lending growth measures, covering the G7 developed economies and seven large emerging economies (the “E7”), have remained range-bound at historically-respectable rates – fourth chart. Real money growth continues to run well above economic expansion, a condition normally associated with rising asset prices. The resilience, in aggregate, of equity, bond and property markets despite recent economic difficulties is consistent with a supportive liquidity backdrop.
The recovery in equity markets later in the first quarter may partly discount a near-term firming of global economic growth and an extension of the US interest rate pause. The combination, however, of plentiful liquidity with positive economic news from China / Europe and a cooler US labour market over the spring / summer may allow the rally to extend.
The assessment here is cautiously rather than fully optimistic, for several reasons. First, global productivity trends remain dismal. Productivity stagnation has supported growth of employment and consumer spending but at the expense of rising unit labour costs and a squeeze on profit margins. Labour markets, moreover, may now have tightened sufficiently to trigger an acceleration of wages.
Secondly, and relatedly, G7 “core” inflation is firming, threatening a sharp rise in headline rates later in 2016 as favourable energy and food price effects unwind. The annual increase in G7 consumer prices excluding food and energy was 1.6% in February, a four-year high – fifth chart. An inflation snap-back could raise concerns that G7 monetary policies are excessively loose, leading to a disruptive rise in bond yields.
Rising inflation, it should be emphasised, is an issue for developed rather than emerging economies. E7 core pressures are moderating in response to weak activity and currency stabilisation, opening the door to monetary policy easing – sixth chart.
A third concern is that ECB and Bank of Japan experimentation with negative interest rates will have a net contractionary impact, for example by damaging banks’ profitability and capacity to expand or prompting households to save more to achieve asset growth targets. Monetary trends have weakened in Denmark and Switzerland, where rates first became significantly negative. As noted, Eurozone narrow money growth is strong but the numbers have yet to reflect the full impact of December / March rate cuts.
Current real narrow money trends argue for a bias to overweight the Eurozone and the UK while underweighting Japan and the US in a developed markets equity portfolio – second chart. UK relative equity market performance has been depressed by a rise in the risk premium on sterling assets due to the forthcoming June “Brexit” referendum on the country’s EU membership. A rebound is likely in the event of a “remain” decision; “exit” would trigger wider market turbulence, probably involving generalised European underperformance.
In other developed markets, real narrow money is growing respectably in Canada and Sweden but has slowed sharply in Australia and is contracting in Switzerland, suggesting underweighting Swiss equities.
The outperformance of emerging equity markets during the first quarter followed a cross-over of six-month real narrow money growth in the E7 above the G7 level in late 2015 – seventh chart; as noted in the previous commentary, the sign of the E7 / G7 gap has had a positive association with the sign of emerging market relative returns historically. The real money growth gap remains favourable for emerging equities, while a Chinese economic recovery, lower E7 core inflation and a delayed rise in US interest rates may also be supportive.
*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.