A post in September noted that US narrow money growth had fallen sharply and was signalling a loss of economic momentum in early 2015, allowing for the usual lag. US economic news has mostly disappointed recently, reflected in a significant negative reading of the Citigroup US data surprise index, while the Atlanta Fed’s “nowcast” model suggests GDP growth in the first quarter of only 1.2% annualised.
The slowdown predicted by monetary trends has been magnified by cuts in oil and gas extraction-related investment and employment. New advertisements for extraction jobs and related high-education occupations plunged by 42% and 38% respectively between November and January, according to the Conference Board.
Some commentators claim that economic weakness will be sustained through 2015, with familiar voices even suggesting that a recession is looming. This is not the message from the latest monetary trends.
As discussed in a post in January, six-month growth of US real (i.e. inflation-adjusted) narrow money recovered at end-2014, reflecting an energy-driven fall in consumer prices. The revival continued in January and available weekly data for February suggest a further large gain, this time driven by stronger nominal expansion – see chart*.
Broader money measures have also reaccelerated. Based on the weekly data, six-month growth of real M2 probably rose to 4.0% in February, or 8.1% annualised – the highest since December 2011.
Monetary trends, therefore, suggest that current economic weakness will extend into the second quarter but growth will bounce back strongly in the second half of 2015.
Previous posts (e.g. here) noted that 10 of the 11 US recessions since World War Two were preceded by a contraction of real narrow money, the exception being 1953-54 downturn, which may have been caused by fiscal tightening as defence spending was slashed after the Korean War. A 2015 recession remains unlikely, with the latest monetary trends suggesting a receding risk.
*The February estimate is based on the average level of narrow money through 23 February and an assumed 0.4% monthly increase in consumer prices.
G7 annual consumer price inflation fell to 0.2% in January, the lowest since October 2009, but the “core” rate excluding food and energy was unchanged at 1.6% – see first chart. Stable core inflation suggests that deflation worries are overblown.
The G7 headline and core rates are currently subject to a small upward distortion from last April's Japanese sales tax hike. Without this, core inflation would be 1.4% – close to its average of 1.5% since 2005.
The second chart shows the headline / core inflation gap and the annual rate of change of commodity prices, as measured by the IMF’s all-items index. The headline / core gap is probably at or close to a bottom, assuming no further fall in commodity prices.
Core inflation is likely to be supported by increasingly tight labour markets and associated upward pressure on wages and unit labour costs. As previously discussed, job openings rates (i.e. vacancies expressed as a percentage of filled and unfilled jobs) are at or above their 2000s cyclical highs in the US, Japan, Germany and the UK. Wage growth is firming in all four economies, while productivity trends remain weak.
In Japan, annual growth in scheduled earnings (i.e. excluding overtime and bonuses) at firms with 30 or more employees rose to 1.3% in January, a 15-year high – third chart. With the job openings rate up again, and profits buoyant, workers are in a strong position to push for further wage gains in the spring “shunto”.
UK monetary trends remain consistent with solid economic growth. Broad money was held back in January by a transfer of funds out of bank deposits into the new National Savings pensioner bonds. Narrow money was less affected by this shift and continues to expand strongly, though is now lagging the equivalent Eurozone measure.
The Bank of England’s favoured broad money measure – M4 excluding holdings of “intermediate other financial corporations”, or M4ex – rose by 0.1% in January but was depressed by a record £6.6 billion monthly inflow to National Savings, reflecting strong demand for 65+ pensioner bonds. This largely explains a £10 billion withdrawal from household interest-bearing deposits. National Savings inflows were in a £400-700 million range in the prior six months, suggesting a £6 billion impact from the new bonds, equivalent to 0.3% of M4ex.
Chancellor George Osborne last month announced that the bonds would remain on sale until 15 May, with take-up now expected to reach £15 billion, or 0.8% of M4ex.
Narrow money M1 – comprising physical cash and sight deposits – appears to have been little affected by the bond sales, rising by a solid 0.8% in January.
The forecasting approach here focuses on six-month growth of real (i.e. inflation-adjusted) “non-financial” M1 and M4, covering holdings of households and private non-financial firms (i.e. excluding all financial corporations). Both measures are still giving a positive message for economic prospects – see first chart.
Corporate M4 holdings are growing particularly strongly – encouraging since corporate liquidity is better correlated with future economic growth than household M4.
Real money trends, however, are now stronger in the Eurozone than the UK, suggesting that the period of UK economic outperformance since 2011 is ending – second chart.
Increased competition from National Savings probably contributed to a small uptick in the average interest rate on household bank deposits in January. Deposit and, to a lesser extent, lending rates trended lower over 2013-14, delivering a stealth loosening of monetary policy – third chart. This boost is now fading.
Strong Eurozone January monetary statistics support the optimistic view here of economic prospects while casting doubt on the wisdom of next month’s launch of sovereign QE.
Narrow money M1 surged by 1.7% last month, with the broader M3 measure up by a solid 0.7%. Six-month growth rates rose to 5.8% for M1 and 2.6% for M3 (11.8% and 5.3% annualised) – the fastest since November 2009 and December 2008 respectively.
Real growth was further boosted by a larger six-month decline in consumer prices, mainly reflecting lower energy costs – see first chart.
Six-month real M1 growth rose to 6.7%, or 13.7%, a level matched or exceeded in only two years since 1980 – 1999 and 2009. Industrial output and GDP subsequently rose strongly in both cases – second chart.
As well as signalling an economic pick-up, the current wide gap between real money and output growth suggests unusually favourable liquidity conditions for markets. Sovereign QE threatens to throw fuel on the flames, leading to destabilising asset price bubbles / busts.
M1, and to a lesser extent M3, have been boosted by the ECB’s rate cuts, which have reduced the opportunity cost of holding money. This does not reduce the significance of monetary strength for economic prospects. Faster money growth confirms that economic agents are responding to lower rates and are likely to increase spending on goods and services and investment in financial markets.
The country breakdown of overnight deposits, which dominate M1, shows strength across the big four economies. Six-month growth of real deposits surged in Italy and France last month and remains buoyant in Spain, with Germany lagging but solid – third chart.
In other news today, German unemployment on an internationally-standardised definition fell to a new post-reunification low of 4.7% in January, far below current US / UK levels, while the job openings (vacancies) rate reached another record. Growing labour shortages should maintain upward pressure on wages – a regional branch of the IG Metall engineering union this week secured a 3.4% rise from 1 April despite weak consumer prices.
The MSCI World index of developed equity markets this week reached a new record in US dollar terms. The local currency version of the index had surpassed its previous high in early February. The continued strength of equity markets is consistent with the assessment here of a favourable global liquidity backdrop.
According to the “monetarist” forecasting approach, real money – i.e. the money stock divided by prices, or M / P – leads the economy, while “excess” money – i.e. real money divided by output, or M / (P*Y) – leads financial markets. The latter idea suggests that equity markets will do well when real money is growing faster than output.
The first chart shows annual growth rates of G7 industrial output and real narrow money since 1970. Shaded areas mark periods when real money was growing faster than output, i.e. excess money was rising. The monetarist approach implies that equities should have performed more strongly during these periods.
This was the case. From the start of 1970 to the end of 2014, the MSCI World US dollar index returned a cumulative 314% more than US dollar cash (i.e. three-month eurodollar deposits). Investing in equities only when G7 excess money gave a positive signal would have boosted the excess return to 913%. By implication, equities underperformed cash on average during non-shaded periods.
The second chart compares the cumulative return relative to cash of buying-and-holding equities and a switching portfolio based on G7 excess money*. The maximum relative return drawdown of the switching portfolio in the historical data is 18% versus 56% for equities.
The annual growth rates of G7 real narrow money and industrial output were 7.3% and 1.7% respectively in November, the gap having widened since end-2013. A correction in markets is possible at any time but the liquidity backdrop remains supportive.
*The switching rule incorporates lagged as well as current excess money.