Monetary trends and the latest Federal Reserve bank loan officer survey are signalling slower US economic expansion in the first half of 2014. This would confound, again, Keynesian forecasters, including the IMF, who expect growth to strengthen as “fiscal drag” lessens*.
The monetary measure emphasised here is six-month growth of real narrow money, i.e. currency plus demand deposits deflated by consumer prices. This has displayed increased amplitude in recent years but peaks and troughs continue to lead turning points in industrial output expansion, with an average lead since 2008 of 11 months – see first chart. Real money growth peaked in December 2012 and fell significantly during the first half of 2013, suggesting a loss of economic momentum from late 2013.
The latest Fed loan officer survey, meanwhile, reports that a net -4% of banks tightened credit standards on loans to small firms in the three months to January. This is still an expansionary reading by historical standards but compares with a low of -23% in May 2013. The credit tightening balance is an inverse short-term leading indicator so this rise also suggests a growth peak in late 2013 – second chart.
The survey, in addition, confirms other evidence of a faltering housing recovery, with the net percentage reporting stronger mortgage demand** plunging to -37%, the lowest since 2008. The mortgage demand balance correlates with home sales: the fall in transactions late last year may extend in early 2014 – third chart.
Real money trends and the lending survey, it should be emphasised, remain consistent with respectable economic growth. Economic news, in other words, may disappoint the optimists without being weak enough to prompt the Fed to stop “tapering”.
*US GDP grew by 1.9% between 2012 and 2013 and by 2.7% in the year to the fourth quarter despite a fall in the “structural” fiscal deficit of 2.3% of GDP in 2013, according to the IMF. The deficit is projected to decline by 0.8% of GDP in 2014.
**All residential mortgages until Q1 2007; average of prime and non-traditional balances after.
The sharp fall in the US Institute for Supply Management (ISM) manufacturing new orders index in January is consistent with the long-standing view here that global industrial growth would peak at end-2013 and moderate in the first half of 2014. Other G7 purchasing managers’ surveys were upbeat last month but the US often leads the cycle and the ISM decline more than offset strength elsewhere – see first chart.
A growth peak was expected because of a slowdown in global real narrow money expansion from spring 2013 – monetary trends lead activity by about six months, according to the Friedmanite rule. The money numbers, however, have yet to signal economic weakness – see previous post.
The shift from acceleration to slowdown should be confirmed by the global longer leading indicator calculated here from OECD country leading indicator data – a December update will be available on Monday 10 February. The global measure appears to have peaked in September – see here – and has led recent growth turning points by an average 4-5 months.
The global leading indicator comprises G7 and emerging E7 components. An attempt to replicate the OECD’s country calculations suggests that the G7 series fell significantly in December* – second chart. Indeed, the G7 indicator may have dropped to its long-run average – crosses beneath this average have been associated with weak equity markets historically, as explained here.
*This replication is experimental and has not yet been extended to the E7 component.
The acceleration phase is over but monetary trends suggest that UK economic growth will remain solid through summer 2014.
The forecasting approach here focuses on the six-month rate of change of real narrow money, as measured by non-financial M1 deflated by consumer prices. This turned positive in late 2011, about six months before the economy began to show signs of life – see chart. Real money expansion continued to rise strongly during 2012, peaking in early 2013, since when it has eased slightly. GDP growth, accordingly, stabilised in late 2013 and may run at a slightly lower but still strong pace during the first half of 2014.
Current official data show GDP rising at a 3.0% annualised rate during the second half of 2014 (i.e. between the second and fourth quarters) but this is likely to be revised up, possibly to 3.5-4.0% – see Tuesday’s post. Based on the minor slowdown in real money expansion, GDP growth could run at about 3% during the first half of 2014. Weak productivity trends suggest that potential output is rising by less than 2% per annum, so 3% actual expansion would imply significant additional pressure on supply capacity, with attendant inflationary risks.
The message from narrow money is supported by the broader M4 measure. Real non-financial M4 growth also picked up in 2011-12, stabilising since early 2013. The current level remains low by recent historical standards but has been sufficient to support rapid economic expansion because the velocity of circulation has risen, as negative real interest rates have reduced the savings demand to hold money.
To repeat, the fundamental drivers of economic resurgence have been a reversal of the 2010-11 inflation spike and falling bank funding costs since mid-2012 due to Eurozone financial stabilisation and the funding for lending scheme. Falling inflation has lifted real money growth while lower deposit interest rates have encouraged consumers and firms to spend monetary savings, reflected in the switch from M4 into M1 and rising M4 velocity.
Faster economic growth is not, in other words, due to QE, reduced fiscal drag or a credit-driven consumer splurge. The latter hypothesis is particularly fanciful – lending to individuals rose by just 1.3% in the 12 months to December, implying that the household debt to income ratio continues its trend decline. The “creditist” argument that no economic improvement was possible without a prior pick-up in bank lending has been comprehensively demolished by recent events yet commentators continue to pore over credit tea leaves while ignoring the money supply.
Eurozone monetary trends are judged here to be consistent with a continued economic recovery during the first half of 2014. December numbers, however, were mildly disappointing – further weakness in January would suggest slower growth later in 2014.
The headline money / credit measures continue to diverge, allowing entrenched bears and bulls to cite “evidence” in favour of their respective positions. In real terms (i.e. adjusted for consumer prices), broad money M3 was unchanged in the six months to December, while lending to the private sector was down by 1.6% (not annualised). Narrow money M1*, however, rose by a respectable 2.4%.
The statistical evidence is that real M1 significantly outperforms M3 as a leading indicator, while credit lags the cycle. Real M1, indeed, has a flawless forecasting record over the last decade, clearly signalling well in advance the 2008 recession, 2009-10 rebound, 2011-12 “EMU crisis” relapse and current recovery. M3 missed the former two while lending has had little relationship (even lagging) with short-term economic fluctuations – see first chart.
ECB research confirms that the signal from M1 can be improved slightly by stripping out financial sector holdings, which are volatile and of little consequence for short-run economic prospects. Real non-financial M1 rose by 3.2% in the six months to December versus 2.4% for headline M1. Its growth has been broadly stable since spring 2013 at a level historically consistent with moderate economic expansion – second chart.
While the six-month increase remains healthy, real non-financial M1 fell in December alone. This could be an early signal of a second-half economic slowdown, although monthly numbers are often volatile around year-end.
Further insight is provided by country-level narrow money trends**. Real growth in the core and peripheral groupings*** was similar in the six months to December, suggesting no major divergence in economic prospects – third chart. Among the large economies, narrow money trends are solid in Germany and Spain, with France and Italy lagging and renewed Dutch weakness hinting that recent economic improvement in that country will prove temporary – fourth chart.
*M1 comprises notes / coin and overnight deposits.
**Country data are available for overnight deposits but not notes / coin.
***Core = Austria, Belgium, France, Germany, Luxembourg, Netherlands; periphery = Greece, Ireland, Italy, Portugal, Spain.
GDP is provisionally estimated to have grown by 0.7% in the fourth quarter of 2013 and by 1.9% for the year as a whole. These numbers are likely to be revised higher. Quarterly GDP changes between the fourth quarter of 2012 and the second quarter of 2013 have already been raised by 0.2 percentage points per quarter. If current third and fourth quarter numbers – 0.8% and 0.7% respectively – are increased by the same amount, 2013 growth will rise to 2.0%.
Excluding North Sea oil and gas production, GDP expansion last year was 2.0% and will probably be raised to about 2.25% later in 2014 as revisions come through.
GDP in the fourth quarter was still 1.3% below peak, reached in the first quarter of 2008. The non-North Sea shortfall is smaller, however, at 0.3%. Monthly output data and official estimates indicate that GDP in December was 0.4% above the quarterly average – see chart. This, in turn, implies that the non-North Sea measure regained its peak level at end-2013, even before allowing for revisions.