China update: mixed monetary / leading indicator signals

Posted on Friday, August 10, 2018 at 09:41AM by Registered CommenterSimon Ward | CommentsPost a Comment

The OECD this week released June data for its composite leading indicators. As expected, the G7 measure fell further, with the US component as well as the Japanese / European indicators now signalling below-trend economic growth – see first chart*. Even the OECD concedes that its indicators “are pointing tentatively to easing growth momentum”, contradicting the claim in the organisation’s May Economic Outlook that “global GDP growth is set to strengthen further in 2018-19”.

The OECD’s leading indicators are used here as a cross-check of the message from monetary trends, although the lead time of the indicators is shorter - usually four to five months versus around nine months for money. The fall in the G7 indicator is consistent with an earlier slowdown in G7 real narrow money, growth of which remains weak. As previously discussed, however, the OECD’s Chinese leading indicator has been giving a more positive message recently than narrow money trends. This divergence widened further in June, with the indicator suggesting that economic growth will pick up during the second half of 2018 – second chart.

Three possible explanations for the conflicting Chinese monetary / leading indicator signals are:

1) Surging use of mobile payments is boosting monetary velocity, i.e. current low narrow money growth does not imply weak economic prospects.

2) The leading indicator has become unreliable because of rapid structural economic change.

3) The leading indicator, unusually, has turned ahead of narrow money, i.e. growth of the latter will strengthen over coming months, confirming an improving economic outlook.

Explanation 2) is currently favoured here, suggesting retaining a cautious view of economic prospects, while recognising that uncertainty is higher than normal.

On 1), the argument is that the rapid adoption of mobile payments technology has been associated with a fall in households’ desired holdings of currency and demand deposits, i.e. each unit of narrow money now supports a higher level of economic activity.

Such a velocity shift, however, would be expected to play out over several years and is unlikely to explain a collapse in annual narrow money** growth from 22% in August 2016 to 6% in June 2018.

The fall in money demand, moreover, would be expected to be focused on currency holdings of households. Currency, however, accounts for only 9% of narrow money and its annual growth has been relatively stable – the narrow money slowdown has been driven by demand deposits. Deposits of non-financial enterprises, meanwhile, have slowed by more than those of households.

Explanation 2) is based on the idea that the components of the OECD’s Chinese leading indicator were suitable for an earlier stage of the country’s development but do not capture the shift away from investment- and export-led growth towards consumer spending.

The six components of the indicator are: steel production, motor vehicle production, building completions, production of chemical fertilisers, the export orders balance from the PBoC’s quarterly 5000 enterprise survey and stock market turnover. The weighting of hard production data is higher than for other OECD country indicators, while there is no gauge of consumer behaviour.

To assess whether the recent upturn in the leading indicator reflects its unusual composition, an alternative indicator was constructed attempting to mirror the components of the OECD’s US leading indicator. A reasonable Chinese equivalent measure was judged to be available for six of the seven US components, the exception being average weekly hours worked in manufacturing – see table.

The third chart compares the performance of the official and alternative indicators. The alternative version appears better aligned with economic developments in recent years: it rose strongly from end-2015 ahead of a pick-up in growth in late 2016 / early 2017 and has been signalling trend or slightly below-trend expansion more recently.

The alternative leading indicator is giving a more positive message for economic prospects than narrow money trends but the divergence is much less pronounced than for the official indicator.

Explanation 3) for the conflicting monetary / leading indicator signals is that the usual timing relationship between the two has reversed. On this view, monetary trends should improve soon to confirm the stronger message from the leading indicator. As previously discussed, recent interest rate falls suggest a recovery in narrow money growth but the timing and magnitude are uncertain – fourth chart.

As noted, explanation 2) is currently favoured here, but 3) is preferred to 1). This assessment will be revised as necessary in light of incoming monetary and leading indicator data – starting with July money numbers scheduled to be released in the coming week.

*The indicators are expressed in trend-adjusted form, i.e. a rise signals above-trend economic growth.
**Narrow money = true M1 = currency plus demand deposits of households, non-financial enterprises and government organisations.

UK Inflation Report: monetary muddle

Posted on Friday, August 3, 2018 at 12:11PM by Registered CommenterSimon Ward | CommentsPost a Comment

Hallelujah! The August Inflation Report included a box discussing recent monetary developments. The analysis, however, is flawed.

The box appears to have been included to counter the criticism made here and by others that a rate rise was inappropriate because monetary trends have weakened. As the Report notes, “(t)welve-month growth in broad money slowed to 3½% in 2018 Q2, having been above 7% in 2016 H2”.

So why is this of no concern? The Report concedes that “money growth may provide a signal for recent and future trends in activity and inflation”. However, “developments can … also reflect other factors that have limited implications for spending prospects, which appears to have been the case at present”.

The key “other factor” operating at present, it is claimed, is a reduction in households’ precautionary demand to hold money. The Report argues that broad money growth was boosted in 2016 by households switching out of investment funds into liquid assets, with this switch attributed to “heightened uncertainty around the referendum”. The slowdown in household and overall broad money growth more recently “appears in part to reflect some of that precautionary demand subsiding, as investment fund holdings have risen”.

There are several problems with this argument. It is not at all clear why households should be less uncertain about Brexit now than in 2016. The Report does not offer any corroborating evidence of a fall in the precautionary demand for money, apart from the rise in investment fund holdings.

A reduction in household uncertainty, moreover, would be expected to be associated with a positive reassessment of income prospects and spending plans, leading to a rise in the transactions demand for money. This could, in theory, offset or outweigh the fall in precautionary money demand.

Empirically, the argument in the Report implies that an expanded monetary / savings aggregate incorporating investment funds would have displayed stable growth in recent years, with no slowdown recently. This, surprisingly, was not explored, but is not the case.

The chart compares annual growth rates of narrow (M1) and broad (M4) non-financial* money measures and an expanded aggregate including National Savings products, foreign currency deposits and retail flows into UK-registered unit trusts and OEICs (“non-financial M4++”). Growth of the expanded aggregate fluctuated in a relatively narrow range over 2015-17 but has fallen significantly this year, reaching a six-year low of 3.7% in June.

Inflows to retail investment funds have slowed sharply in recent months – they totalled £4.7 billion in the second quarter compared with £12.1 billion a year earlier (IMA data). On the argument of the Report, this reduction should be boosting household money growth.

The view here remains that money trends are weak because spending plans are subdued, depressing the transactions demand for money. Yesterday’s rate increase, while expected, risks exacerbating this weakness.

*Covering holdings of households and private non-financial corporations but excluding those of financial corporations.

OECD leading indicator preview: further weakness

Posted on Tuesday, July 31, 2018 at 04:03PM by Registered CommenterSimon Ward | CommentsPost a Comment

The central expectation here, based on monetary trends, is that global economic momentum will continue to weaken into the fourth quarter of 2018 before reviving slightly into early 2019 – see previous post. The OECD’s composite leading indicators, which in most cases exclude money, are giving stronger support for the forecast of a near-term further economic slowdown.

The OECD will release June data for its indicators on 8 August but most of the component information is already available, allowing an independent calculation. The G7 indicator is estimated to have fallen further in June, with revisions likely to magnify the scale / speed of the decline from a January 2018 peak – see first chart. The indicator is expressed in trend-adjusted form, i.e. the recent fall implies below-trend economic growth.

The decline in the G7 indicator was initially driven by European countries and Japan, with the US indicator continuing to rise. This raised the possibility that non-US weakness would prove temporary as US acceleration boosted global demand – the consensus view when economic data started to disappoint in early 2018.

Monetary trends, however, suggested that convergence would occur by the US losing momentum rather than a pick-up in the rest of the G7. The latest leading indicator estimates are consistent with this expectation, with the US indicator also now falling and no let-up in the declines in Europe / Japan – second chart.

The third chart shows a “global” indicator that combines data for the G7 and seven large emerging economies (the “E7”) while “adding back” an estimate of trend industrial output growth. Six-month growth of this indicator peaked in December 2017 ahead of a March 2018 peak in G7 plus E7 six-month output expansion. It continued to decline in June, consistent with a further loss of output momentum through the third quarter, as suggested by monetary trends.


Based on the monetary forecast that economic momentum will bottom in the fourth quarter, one- and six-month changes in the G7 plus E7 leading indicator may stabilise during the third quarter.

No monetary case for UK rate hike

Posted on Monday, July 30, 2018 at 04:01PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK monetary trends are showing signs of recovery but remain weak, arguing against the rate hike that the Monetary Policy Committee is expected to deliver this week.

As usual, the focus here is on “non-financial” broad (M4) and narrow (M1) monetary aggregates, comprising money holdings of households and private non-financial businesses. The Bank of England’s M4ex measure additionally includes money held by non-bank financial corporations (excluding intermediaries) but such holdings are volatile and uninformative about future spending on goods and services*.

Annual non-financial M4 growth was 3.1% in June, which compares with a recent low of 3.0% in April and a peak of 6.8% in September 2016. Annual non-financial M1 growth fell further to 4.4% in June, a six-year low and down from 10.1% in September 2016 – see first chart.

As the chart shows, the collapse in money growth since 2016 has been reflected in a significant slowdown in nominal GDP, annual expansion of which is currently estimated by the Office for National Statistics to have fallen to only 2.7% in the first quarter of 2018.

Three-month growth of the two aggregates recovered during the second quarter, suggesting a stabilisation or modest revival in the annual rates of expansion – second chart. A significant pick-up, however, would be required to warrant concern that monetary conditions are too loose for achievement of the inflation target over the medium term.

Current monetary trends, indeed, argue that an inflation undershoot is more likely. The velocity of non-financial M4 – i.e. the ratio of nominal GDP to the aggregate – has fallen at an average rate of 0.7% per annum (pa) since end-2009, compared with a reduction of 3.0% pa over the prior decade. Assuming a continued decline of 0.7% pa, current annual growth of non-financial M4 of 3.1% in June, if sustained, would result in a 2.4% pa rate of increase of nominal GDP. This would imply an inflation undershoot unless potential economic expansion is well below 1% pa.

The MPC has a long tradition of ignoring monetary trends and continues to make serial policy mistakes as a result. It failed to lean against monetary buoyancy in the mid-2000s, prolonging and magnifying the credit bubble. It was slow to launch QE after the bubble burst and monetary trends stagnated.

After an initial recovery, money growth fell back in 2010 but the Bank of England proceeded to wind down the special liquidity scheme, which had provided significant support for bank balance sheet expansion, thereby exacerbating monetary weakness and contributing to the 2011-12 economic slowdown and double-dip scare.

The most recent mistake was to cut rates and launch additional QE in August 2016 despite strong money growth, which signalled that the economy was likely to continue to expand despite the negative shock of the EU referendum result. This unnecessary policy easing magnified sterling weakness and associated upward pressure on import prices and inflation.

The MPC now appears poised to make the opposite mistake. Three-month growth of the money measures fell sharply immediately after the November 2017 rate hike – second chart. A similar response to an August 2018 increase could result in annual rates of expansion declining to dangerously low levels. Why run this risk? The MPC should skip policy action this week and make a November rate increase conditional on a further recovery in monetary trends.

*M4ex is giving a similar message to the non-financial monetary aggregates currently.

Euroland money trends steady, Italy / Greece stronger

Posted on Wednesday, July 25, 2018 at 03:03PM by Registered CommenterSimon Ward | CommentsPost a Comment

The “surprise” weakening of Euroland economic growth in the first half of 2018 was foreshadowed by a monetary slowdown in late 2017. Monetary trends have stabilised since early 2018, suggesting that economic expansion will continue at around its recent pace through early 2019 – GDP may rise at a 1.25-1.5% annualised rate, below ECB and consensus forecasts of 1.75-2.0%. Country narrow money details show weakness in France, surprising resilience in Italy and growing strength in Greece.

As usual, the focus here is on non-financial monetary aggregates, comprising holdings of households and non-financial corporations (NFCs). Non-financial M1 and non-financial M3 rose by 0.3% and 0.4% respectively between May and June. Annual growth of non-financial M1 edged down to 7.3% but remained above a March low of 7.2%. Annual non-financial M3 growth rose to 4.0%, a five-month high and up from 3.4% in March – see first chart.

Six-month growth rates of the aggregates expressed in real terms (i.e. deflated by consumer prices) recovered further to their highest levels since November. They remain, however, lower than over 2015-17 and similar to 2013-14, when GDP growth was running at about 1.5% per annum* – second chart.

Country-level narrow money trends suggest a relatively pessimistic outlook for the French economy: six-month growth of real non-financial M1 deposits fell to a five-year low in June – third chart

Recent weakness, moreover, reflects a stagnation in corporate real money holdings, which appears at odds with hopes that President Macron’s economic reforms would boost business confidence and expansion plans – fourth chart.

Growth of real non-financial M1 deposits in Italy, by contrast, rebounded strongly in June, suggesting that confidence and spending intentions are holding up despite the risk of a government / EU showdown over fiscal policy and an associated widening of the Italian / German yield spread.

Greek real non-financial M1 growth, meanwhile, reached its highest level since 2016, with corporate holdings surging – fifth chart. The strength in 2015-16 was artificial – it reflected a boost to overnight deposits from maturing time deposits but money was trapped in the banking system by cash withdrawal limits and capital controls. These have been relaxed significantly in 2018, while broad as well as narrow money has accelerated.

*Annualised rise of 1.4% between second quarter of 2013 and fourth quarter of 2014.