Having warned of recent economic weakness, US narrow money trends are now signalling a revival of growth during the second half of 2016, suggesting renewed upward pressure on interest rates and, possibly, the US dollar.
As previously discussed, turning points in six-month real (i.e. inflation-adjusted) narrow money growth have consistently led turning points in two-quarter GDP expansion in recent years – see first chart. Real money growth bottomed in October 2015 and had shown a modest revival through March. Weekly data through 11 April suggest a marked acceleration this month. (The final data point in the chart assumes no further change over the remainder of April and a 0.2% monthly rise in consumer prices.)
Narrow money is a much more reliable leading indicator of the economy than broader aggregates. Six-month growth of real M2, however, has also revived recently. A broader measure including institutional money funds and large time deposits remains subdued but is expanding in real terms at close to its average pace in recent years – second chart.
The narrow money signal is provisional. The recent pick-up needs to be confirmed by full April data. There is a risk that six-month growth will fall back in May, reflecting a large monthly increase in November 2015.
Monetary trends, it should be emphasised, typically lead the economy by between six and 12 months. The central expectation here is that activity will remain soft for several more months, mirroring narrow money weakness last autumn. Consistent with this, the Federal Reserve Bank of New York’s “nowcasting” model currently predicts GDP growth of only 1.2% at an annualised rate in the second quarter, after 0.8% in the first.
The labour market, moreover, is likely to lag any GDP rebound. Employment / unemployment data may soften during the current quarter. While low weekly jobless claims indicate that firms remain reluctant to lay off workers, business survey evidence and the Conference Board’s online help-wanted tally point to a slowdown in hiring – third chart.
Markets, therefore, could enjoy several more months of improving global economic news and a neutral Fed before needing to grapple with a scenario of uncomfortably strong US growth in late 2016.
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 earlier timing of the Chinese New Year in 2016 versus 2015 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.