The US unemployment rate fell to 4.7% in February but remains above a low of 4.6% reached in November 2016. The judgement here is that it may stabilise or edge higher, for three reasons.
First, the jobless rate is inversely correlated with the job openings or vacancies rate, which has retreated from a peak in April 2016 – see first chart. Companies are reluctant to lay off workers – reflected in a low level of weekly initial unemployment claims – but the decline in the openings rate suggests that they are not stepping up recruitment. This may partly reflect uncertainty about healthcare and tax reforms.
Secondly, the labour force participation rate – the percentage of the civilian population in or seeking work – has stopped falling. It may even be embarking on a modest upward trend – second chart. The combination of population growth and a rising participation rate may allow moderate employment expansion to be maintained without a further reduction in unemployment.
Thirdly, growth of labour demand is coincident with or lags GDP expansion – third chart. As previously discussed, real narrow money trends suggest a GDP slowdown into the summer – fourth chart. Recent elevated unit labour cost growth adds to the risk that companies will curb recruitment if economic expansion moderates.
The OECD’s leading indicators are giving tentative confirmation of the forecast here, based on real narrow money trends, that global economic momentum will peak in spring 2017 and slow into the autumn.
The OECD this week released January data for its country leading indicators. Note that the January estimates of the trends in the components incorporate February data where available – so the indicators already reflect strong February business survey results, for example. The country information is combined and transformed here to create a global (i.e. G7 plus E7) leading indicator of industrial output. Six-month growth of this indicator continued to rise in January but the one-month increase fell back – see first chart.
As previously discussed, global six-month real narrow money growth peaked in August 2016, suggesting a peak in industrial output expansion around May 2017, allowing for an average nine-month lead. Six-month growth of the leading indicator may have peaked in January, based on the fall in one-month momentum. It typically leads by four to five months, so this would suggest a peak in economic momentum in May-June, consistent with the monetary signal.
The prospect of a summer economic slowdown, coupled with the Fed’s recent hawkish shift, may imply stronger headwinds for equity markets and other risk assets. Any setback, however, could prove to be modest and temporary if investors believe that the economy will retain reasonable momentum and / or reaccelerate in late 2017.
Such a scenario cannot be ruled out based on current monetary data. Global six-month real narrow money growth, while well down from last summer, remains at a respectable level by historical standards, after adjusting for an excessively negative signal from Indian M1 due to the demonetisation programme – second chart. The recent fall has partly reflected a sharp rise in six-month consumer price inflation, which is likely to moderate if commodity prices stabilise at their current level. In the US, February narrow money numbers may have been depressed by a delayed send-out of income tax refunds, reflecting legal changes: refunds last month were $25 billion lower than in February 2016, equivalent to 0.9% of the narrow money stock measure tracked here – third chart.
Chancellor Hammond was constrained by Office for Budget Responsibility (OBR) forecasts showing little carry-over of this year’s borrowing undershoot into future years. With no “back of the sofa” money to spend, Mr Hammond opted to raise taxes to plug the funding gap for social care and pay for additional business rates relief and higher spending on education / training. He did so by hiking national insurance contributions for the self-employed and – unexpectedly – slashing the recently-introduced dividend allowance.
The net effect of all government decisions – including the boost to spending from the recent cut in the personal injury discount rate – is to raise borrowing by £3.1 billion in 2017-18, with the amount falling in the subsequent two years and turning into a reduction of £1.0 billion in 2020-21. These numbers are rounding errors – £3.1 billion is equivalent to 0.15% of forecast nominal GDP in 2017-18.
Mr Hammond’s caution may partly reflect a desire to delay major initiatives until the new Autumn Budget. He may have greater room for manoeuvre by then, since borrowing may continue to undershoot the OBR’s forecast. A key assumption is that nominal GDP growth will fall from an estimated 4.2% in 2016-17 to 3.3% in 2017-18, contributing to a slower increase in tax receipts. However, nominal GDP rose by an annual 4.9% in the fourth quarter of 2016 and monetary trends suggest continued solid expansion in 2017 – see chart.
The new OBR numbers show an odd-looking profile for cyclically-adjusted net borrowing, which now rises from 2.6% of GDP in 2016-17 to 2.9% of GDP in 2017-18 before dropping sharply to 1.9% in 2018-19. The suggestion is that fiscal policy will be expansionary this year but will turn significantly contractionary next year, when the Brexit uncertainty drag on growth may reach a peak. This profile looks implausible: solid nominal GDP growth may result in stronger tax receipts and lower borrowing in 2017-18, while the Chancellor may choose to deliver a significant fiscal stimulus this autumn to cushion the Brexit effect.
The US Institute for Supply Management (ISM) manufacturing new orders index – widely followed as an indicator of US / global industrial activity – reached its equal highest level since 2009 in February. This is consistent with the suggestion from global narrow money trends that economic momentum will rise to a peak in spring 2017 before slowing into the second half of the year. The ISM orders index is expected here to fall back over coming months.
Narrow money trends provide a significantly longer lead on future economic activity than the ISM survey. The first chart shows the ISM new orders index and six-month global real narrow money growth pushed forward six months. The strong February ISM reading matches a peak in real money growth in August 2016. Based on this relationship, the ISM orders index may have reached a peak in February and is likely to decline into mid-year.
Three other considerations suggest that ISM strength will fade. First, the February orders surge partly reflected increased inventory building, which is likely to prove temporary. The ISM inventories index rose to its highest level since 2015 last month.
Secondly, consumer spending on goods has slowed, suggesting insufficient final demand to maintain the current pace of orders expansion. Three-month growth of retail sales volume fell to 0.6%, or 2.5% annualised, in January – second chart – while February auto sales were lacklustre. Demand for capital goods is recovering but probably not enough to offset this softness.
Thirdly, ISM strength has not been confirmed by East Asian business surveys, which usually act as a bellwether of global trends. The Federation of Korean Industries February survey, indeed, reported a marked weakening of business expectations, although this may be partly attributable to political and corporate scandals – third chart.
The pattern of recent years has been that periodic slowdowns in the global economy have swiftly led to additional monetary policy stimulus, limiting and eventually reversing any damage to equities and other risk assets. Major central banks, however, may take a tougher line this year, reflecting low unemployment rates, high headline and rising core inflation, and a growing “populist” backlash against low / negative rates and neverending QE.
UK monetary trends correctly predicted recent economic strength but are now signalling a second-half slowdown. The earlier buoyancy, however, is likely to sustain upward pressure on inflation into 2018, suggesting a difficult “stagflationary” backdrop for the MPC and markets.
The big story in last week’s fourth-quarter GDP report was not the expected upward revision in quarterly output growth from 0.6% to 0.7% but rather a sharp increase in nominal GDP expansion – annual growth rose to 4.9%, the fastest since 2014 and up from just 2.1% a year earlier. This strength has been driven by an acceleration in the GDP deflator, which rose by 2.8% in the year to the fourth quarter, the largest annual gain since 2008 – see first chart. This ought to be ringing alarm bells at the Bank of England, since the GDP deflator is a broad measure of domestically-generated inflation and is not directly affected by changes in import costs.
Nominal GDP numbers, admittedly, are often revised significantly but the suggested strength is consistent with recent higher-than-forecast tax receipts and undershooting public sector borrowing.
Faster nominal GDP expansion was predicted by an acceleration of narrow and broad money – measured by non-financial M1 and non-financial M4 – in 2015-16. Annual growth of the two measures has moderated since September 2016 but remains solid by post-crisis standards, at 9.2% and 5.5% respectively in January – second chart. Allowing for the usual six to 12 month lead, this suggests that nominal GDP growth will rise further in the first half of 2017 and remain elevated into year-end, and probably beyond.
The question, then, is how nominal GDP growth will divide between output expansion and inflation. The preferred monetary measure here for forecasting fluctuations in economic activity is the six-month rate of change of real (i.e. consumer-price-deflated) narrow money. This measure peaked in June 2016 and has fallen sharply since October, to its lowest since 2012, reflecting a pick-up in six-month CPI inflation as well as lower nominal money expansion – third chart. This slowdown suggests that two-quarter output momentum is at or close to a peak and will decline during the second half of 2017. Real narrow money, however, is not yet signalling outright economic weakness – the six-month change is still far from turning negative, as it did before the 2011-12 “double dip” scare.
Household and corporate (PNFC) narrow money trends are informative about prospects for consumer spending and business investment respectively. Six-month growth rates of real household and PNFC M1 were similar in January – fourth chart. Both have moderated recently but have yet to signal significant spending weakness.
The suggestion that nominal GDP expansion will remain firm while output growth will moderate implies further upward pressure on GDP deflator inflation. Such strength would undermine the MPC’s claim that rising CPI inflation is entirely explicable by sterling weakness and commodity price gains, with no impact from domestic capacity pressures or “second-round” effects.
How would the MPC respond? The market judges that the Committee will have a strong aversion to raising rates during the Brexit negotiation process, almost irrespective of inflation or currency developments. Even Governor Carney, however, may believe that policy credibility has been stretched to its limit; he may, in any case, be running out of new excuses to defend the MPC’s ultra-loose stance.