Economic base case: spreading slowdown & wage squeeze on profits

Posted on Wednesday, September 12, 2018 at 03:06PM by Registered CommenterSimon Ward | CommentsPost a Comment

A post in January suggested that financial markets would face challenges in 2018 from a spring slowdown in the global economy and a pick-up in wage pressures in lagged response to labour market tightening.

The economic slowdown occurred on schedule: six-month growth of industrial output in the G7 and seven large emerging economies fell sharply between April and June, though recovered in July*. The loss of momentum, however, occurred outside the US and was focused on Euroland in particular – see first chart.

Measures of core wage growth, meanwhile, have firmed – second chart. Unemployment rates have fallen further this year while headline consumer price inflation has risen, suggesting that the uptrend in pay growth will extend into 2019.

Market prospects depend importantly on how current US / rest of the world economic divergence is resolved. Monetary and leading indicator evidence argues that a softening of US momentum is more likely than a reacceleration in the rest of the world.

The six-month change in US real narrow money appears to have recovered in August but remains very weak – third chart**. Second-quarter financial accounts released next week will provide information on sectoral monetary trends, which could affect the assessment of economic prospects here.

As expected, the OECD's US leading indicator fell further in July; a decline implies below-trend GDP growth, with trend currently estimated at 2.3% per annum – fourth chart.

Narrow money developments outside the US, meanwhile, have yet to suggest a reversal of recent economic weakness. Six-month growth of Chinese real narrow money, indeed, appears to have fallen further in August despite a shift to less restrictive policies since April – third chart***.

A second key issue for markets is whether faster labour cost growth feeds through to core consumer price inflation, forcing monetary policies to shift hawkishly relative to current plans, or else squeezes profit margins. The bias here is in favour of the latter scenario.

Firms may struggle to pass on cost increases against a backdrop of slowing demand and restrictive monetary conditions. Measures of business operating profits outside the US have already lost momentum as wage bills have risen faster than nominal GDP – fifth chart. 

Incipient profits weakness is consistent with the global business investment cycle being at or near a peak – see previous post.

The imposition of tariffs and associated supply chain disruption pose an upside risk to the view that core inflation will not rise significantly further. Supply pressures are reflected in the low level of the global manufacturing PMI supplier deliveries index (lower = longer delivery times). Swings in this index have shown an inverted leading relationship with movements in G7 core consumer price inflation – sixth chart. The index, however, has recovered slightly since June; a renewed fall would warrant concern that core inflation is still some way from a peak.

*Output growth was marginally above six-month real narrow money growth in July, so the first equities / cash switching rule discussed in a previous post will move to cash at end-September, barring data revisions.
**M1A divided by consumer prices. August estimate based on weekly monetary data through 27 August and assumed 0.2% rise in consumer prices.
***True M1 = official M1 plus household demand deposits. August partly estimated.

An example of the misuse of economic statistics

Posted on Wednesday, September 5, 2018 at 09:59AM by Registered CommenterSimon Ward | CommentsPost a Comment

A colleague was sent the first chart below, which shows that US after-tax corporate profits peaked six quarters before the onset of the 2008-09 recession and 15 quarters before the 2000-01 recession. With profits reaching a new record in the second quarter of 2018, according to data released last week, the suggestion is that any recession is unlikely before late 2019 at the earliest.

Why does this chart represent a misuse of statistics? An immediate question is why it covers only two recessions. The second chart extends the sample period back to 1985 to encompass the 1990-91 recession. Profits peaked in the quarter immediately preceding the start of that recession. Allowing for a one-quarter reporting lag, there would have been no recession warning from a fall in profits.

The chart, moreover, uses the current vintage of profits data. Profits numbers are frequently revised heavily, making it important to check that real-time data showed a similar profile. The third chart adds real-time profits* as reported in the month immediately preceding the start of the 2008-09 and 2000-01 recessions (i.e. December 2007 and March 2001).

Unlike the current vintage data, real-time profits had not fallen when the 2008-09 recession began and had declined for only one quarter before the 2000-01 recession.

Contrary to the suggestion of the creator of the chart, the new high in profits reported for the second quarter offers no reassurance that a recession is distant.

*Source: St Louis Fed ALFRED database.

Monetary / leading indicator signals still negative

Posted on Tuesday, September 4, 2018 at 10:33AM by Registered CommenterSimon Ward | CommentsPost a Comment

Near-complete July monetary data confirm an estimate in a previous post that six-month growth of real (i.e. inflation-adjusted) narrow money growth in the G7 economies and seven large emerging economies fell to its lowest level since February – see first chart. The “big picture” is that real money growth declined significantly between June 2017 and February 2018 and has since moved sideways, remaining below its range over September 2008-November 2017. Allowing for a typical nine-month lead, this suggests that six-month industrial output growth will fall further into late 2018 and stay weak into early 2019.

The OECD’s composite leading indicators continue to confirm the downbeat message from narrow money trends. The OECD is scheduled to release a July update of its indicators on 10 September but most of the component information is already available, allowing an independent calculation. The G7 indicator is estimated to have fallen further in July, with a decline signalling future below-trend GDP growth – second chart. Weakness remains broad-based geographically; the July data, in particular, should confirm that the US indicator is now in a downtrend – third chart.

There were notable falls in six-month real narrow money growth in July in the US, Euroland, Canada, Switzerland and Sweden – fourth and fifth charts. The UK bucked the trend but the recent recovery may not survive the unwise August rate hike. Australia remains at the bottom of the range among developed economies, suggesting downward pressure on interest rates. Also of interest is a sharp contraction in Hong Kong domestic-currency real M1 reflecting recent pressure on the currency peg – sixth chart.

It has been suggested that trends in broad money, unlikely narrow money, signal a “Goldilocks” scenario of moderate global economic growth with subdued inflation. Six-month growth of G7 plus E7 real broad money, however, also eased in July and is below its average in recent years – first chart. Broad money, in any case, has been an unreliable indicator – it did not signal the 2008-09 recession in advance and wrongly suggested a “double-dip” in 2010-11. Real broad money growth did pick-up in 2015-16 ahead of the 2016-17 economic “boomlet” but this partly reflected a slowdown in inflation, while narrow money accelerated much more impressively.

It is possible that broad money growth is being supported currently by an incipient rise in risk aversion in financial markets and an associated increase in the precautionary demand for money, which is more likely to be in broad form (i.e. time deposits, notice accounts, bank bonds etc.) – such an effect may also help to explain why broad money trends remained solid in the initial stages of the 2008-09 financial crisis and recession.

The July monetary data confirm that annual growth of G7 real narrow money moved further below 3% and has now also fallen by more than 3 percentage points over six months. The second of the equities-cash switching rules described in a previous post, therefore, remained in cash at end-August.

The first rule is based on the difference between G7 plus E7 six-month real narrow money growth and industrial output growth, which remained positive in June – the latest available month of full industrial output data. Accordingly, this rule stayed in equities at end-August. Partial data for July, however, suggest that output growth recovered slightly; with real narrow money growth falling, the gap between the two may have closed, in which case the first rule would switch to cash at end-September.

Are UK monetary clouds lifting?

Posted on Thursday, August 30, 2018 at 12:15PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK monetary growth recovered further in July but could fall back in the wake of this month’s rate hike. August data should be awaited before upgrading economic expectations.

Six-month growth of real (i.e. inflation-adjusted) narrow money, as measured by non-financial M1, rose to its highest level since November 2017 in July, though remains below its range over the prior five years (i.e. back to August 2012). Real broad money – non-financial M4 – has also reaccelerated, following significant weakness earlier in 2018 – first chart.

The rise in six-month real narrow money momentum in July contrasts with falls in the US and Euroland. UK growth remains lower than in Euroland but the gap is the smallest since October 2016 – second chart.

“Local” UK shares – as measured by the FTSE local UK index, which includes companies generating 70% or more of sales from the UK / Europe, the Middle East and Africa – have underperformed other markets significantly in currency-adjusted terms so far in 2018, undershooting even emerging markets – third chart. Improving absolute and relative monetary trends suggest that the case for underweighting UK shares is weakening.

The caveat, of course, is the unfortunate August rate hike, which risks aborting the monetary recovery. Six-month growth of narrow and broad money fell sharply immediately after the November rate increase.

The recovery in real money growth, in addition, has been partly due to a slowdown in six-month consumer price inflation – fourth chart. This could reverse in the wake of recent sterling weakness – the effective exchange rate fell by 2.6% between April and July.

A cautious view of UK economic / market prospects, therefore, will be maintained here, at least pending August monetary data released at end-September.

Sectoral data show that the recent rise in six-month real narrow money growth has reflected increases in both the household sector and private non-financial corporate (PNFC) components – fifth chart. The latter improvement, in particular, is surprising, suggesting that businesses are not yet scaling back expansion plans in response to the supposed increased risk of a “no deal” Brexit.

Euroland money trends suggesting sub-consensus GDP growth

Posted on Wednesday, August 29, 2018 at 09:23AM by Registered CommenterSimon Ward | CommentsPost a Comment

Euro area July money numbers were disappointing, suggesting that GDP growth will stick at its recent slower pace – contrary to consensus hopes that first-half weakening represented a temporary “soft patch”.

As usual, the focus here is on non-financial monetary aggregates, comprising holdings of households and non-financial corporations (NFCs)*. Six-month growth rates of real (i.e. inflation-adjusted) non-financial M1 and non-financial M3 fell in July and are back near lows reached in April and May respectively – see first chart.

Both real money growth measures declined significantly between June 2017 and April / May, correctly signalling the “surprise” weakening of GDP expansion in the first half of 2018. The sideways move since April / May suggests that economic growth will continue at around its recent pace through the first quarter of 2019 – GDP may rise at a 1.25-1.5% annualised rate, below ECB and consensus forecasts of 1.75-2.0%.

The fall in six-month real non-financial M1 growth in July reflected notably weaker expansion of non-financial corporate deposits – second chart. This may signal a scaling-back of business expansion plans in response to uncertainties around US trade policy, Brexit, the ending of QE and Italy / EU relations.

Curbed business expansion would be expected to feed back into consumer spending via reduced hiring and slower expansion of worker incomes. Corporate real M1 holdings display a stronger correlation with future GDP expansion than household holdings, according to ECB research.

The third chart shows six-month growth rates of real non-financial M1 deposits in the "big four” economies. The Euro area slowdown over the past year has been driven by France and Spain, suggesting a greater loss of economic momentum in those two countries – already evident in French GDP data for the first half.

Italian real deposit growth has been volatile but weakened sharply in July. Monetary trends led the Italian / German yield spread around the 2011-13 recession but have lagged the spread recently; with the latter widening further, the monetary slowdown may be sustained – fourth chart.

*The headline M1 / M3 aggregates also include financial sector money holdings, which are more volatile and display a lower correlation with future GDP expansion, according to ECB research.