US money trends suggesting stable inflation

Posted on Tuesday, November 13, 2018 at 09:38AM by Registered CommenterSimon Ward | CommentsPost a Comment

A post in September 2017 argued that the Fed would become more hawkish as the unemployment rate moved below 4%, partly reflecting concern about a replay of the 1960s, when inflation rose sharply after this level was crossed. A key difference, however, from the 1960s is that broad money trends remain subdued, which may be helping to contain inflation expectations. With the economy expected to slow over coming quarters, an inflation break-out is deemed here to be unlikely.

The earlier post suggested that solid economic growth and 1960s redux concerns would cause the Fed to hike rates by more than the consensus expected in 2018. At the time, the median projection for the three-month Treasury bill rate in the third quarter of 2018 was 1.7%, according to the Philadelphia Fed survey of forecasters. The outturn was 2.1%, with the rate currently at 2.4%.

The first and second charts illustrate the similarity of inflation / unemployment trends in the first half of the 1960s and in recent years. Core inflation remained in a narrow range below 2% despite a multi-year decline in the jobless rate. After the latter moved below 4% in February 1966, however, core inflation surged to more than 3% within a year. In econo-speak, the Phillips curve was flat at unemployment rates above 4% but steepened sharply once this level was crossed.

The unemployment rate fell below 4% in April 2018. While core inflation has firmed, this partly reflects the dropping-out of last year’s large cut in wireless phone charges and a break-out of the range of recent years has yet to occur – September’s 2.0% reading was below a post-recession peak of 2.1% in 2012.

One possible explanation for the difference is that monetary trends have been much weaker than in the 1960s. The third and fourth charts superimpose annual broad money growth, as measured by non-financial M3, derived from data in the Fed’s quarterly financial accounts. Money growth was robust – 8% plus – for several years ahead of the 1966 inflation break-out. It has averaged 5.0% since 2012, recently falling below this level.

High money growth in the 1960s may have contributed to inflation expectations becoming “unanchored”, resulting in a wage / price spiral. Direct measures of inflation expectations, unfortunately, are unavailable for the period but economists’ inflation forecasts rose sharply in 1965-66, which could be indicative of a broader shift  – the median one-year ahead projection for CPI inflation increased by 1 percentage point between June 1965 and June 1966, the largest change over 12 months since 1954, according to the Livingston survey (which has a longer history than the Philadelphia Fed survey).

Consumer and market inflation expectations have remained stable recently, as have economists’ forecasts – fifth chart.

Broad money growth fell sharply in 1966, foreshadowing a significant economic slowdown in 1967, which arrested the decline in the unemployment rate and stabilised core inflation temporarily – third chart. Recent weaker money trends – narrow as well as broad – suggest a similar scenario for 2019. The window for a break-out in core inflation, therefore, may be closing. A sustained rise remains plausible over the medium term, assuming that a weaker economy in 2019 leads to easier Fed policy and an associated rebound in money growth.

Global leading indicators signalling further slowdown

Posted on Tuesday, November 6, 2018 at 09:51AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global monetary trends suggest that industrial output momentum will fall further into late 2018, stabilising at a weak level in early 2019 – see previous post. Shorter-term leading indicators are consistent with the forecast of a continued slowdown but have yet to signal a stabilisation.

The forecasting approach here seeks confirmation for monetary signals from a global leading indicator based on the OECD’s country leading indicators*. This indicator typically leads industrial output by four to five months at momentum turning points, compared with about nine months for monetary trends.

The OECD will release September data for its leading indicators on 12 November but most of the component information is already available, allowing an independent calculation.

The OECD presents its indicators in trend-adjusted form, so a rise (fall) signals above (below) trend economic growth. The G7 leading indicator is estimated to have declined further in September, i.e. it continues to suggest sub-par expansion – see first chart.

The rate of decline of the indicator, moreover, has been increasing, consistent with a widening growth shortfall relative to trend.

The global leading indicator calculated here combines data for the G7 and seven large emerging economies and is designed to predict the direction of economic momentum, rather than whether growth is above or below trend. Six- and one-month rates of change of the indicator continued to decline in September, suggesting a further fall in output momentum into early 2019 – second chart.

Assuming that the monetary forecast of a stabilisation of economic momentum in early 2019 is correct, the indicator rates of change should be at or near a low. Until this is confirmed, or monetary trends rebound, a negative view of prospects remains warranted.

*The global leading indicator incorporates the alternative Chinese leading indicator described in a previous post, rather than the OECD’s version.

Brexit-focused MPC ignoring weak money trends

Posted on Thursday, November 1, 2018 at 02:04PM by Registered CommenterSimon Ward | CommentsPost a Comment

Brexit uncertainty may at least have prevented the Bank of England from making another policy mistake.

Today’s MPC communications suggest that, absent the Brexit cloud overhanging economic prospects, the Committee would have hiked rates again to counter perceived inflationary risks from a tight labour market. Weak money trends, however, argue that policy settings are already restrictive and the next move may have to be to ease not tighten.

Annual growth rates of four different money measures fell further in September, to the lowest levels since 2012 – see first chart*. Consumer price inflation has also declined this year but by much less, so real money growth has slowed significantly.

The second chart compares annual growth of nominal GDP with that of the four money measures. The monetary slowdown since 2016 has been reflected in a slide in nominal GDP growth, ignoring a small recovery in the second quarter of 2018 (which could be revised away). With money trends still weakening, nominal GDP growth may move down further towards 2% in early 2019. The MPC needs to achieve average growth of about 3.5% per annum to meet the 2% inflation target, assuming potential output expansion of about 1.5% pa.

The monetary slowdown partly reflects policy tightening – the November 2017 / August 2018 rate hikes, closure of the term funding scheme in February 2018 and instructions to banks to conserve capital because of Brexit risk. In addition, Brexit uncertainty and slower-than-expected global growth have dampened business / consumer confidence and spending plans, resulting in a reduction in credit demand and lower desired holdings of transactions money.

Facing possibly significant Brexit-related volatility over coming months, the MPC could do worse than steer policy on the basis of monetary trends. That means eschewing any consideration of another rate hike until money growth recovers, and moving to an easing bias if trends continue to weaken.

*Non-financial = held by the household sector and private non-financial corporations. M1 = narrow money = sterling notes / coin and sight deposits. M4 = broad money = M1 plus sterling time deposits, repos and bank securities of up to five years’ original maturity. M4++ = non-official expanded measure = M4 plus foreign currency deposits, national savings and retail sales of unit trusts and OEICs. M4ex = Bank of England’s preferred broad money measure = non-financial M4 plus M4 holdings of financial corporations, excluding intermediaries.

Global monetary update: no recession signal

Posted on Wednesday, October 31, 2018 at 05:53PM by Registered CommenterSimon Ward | CommentsPost a Comment

Global narrow money trends continue to signal a weak economic outlook but have not deteriorated further since early 2018 – a recession warning, in other words, has yet to be issued.

Six-month growth of global (i.e. G7 plus E7) real narrow money moderated in September but, in broad brush terms, has moved sideways since reaching a low in February, remaining below its range over 2009-17. Allowing for an average nine-month lead, the suggestion is that six-month industrial output momentum will bottom out in late 2018 and stabilise at a weak level in early 2019 – see first chart. 

The expected economic slowdown is on track – G7 plus E7 six-month industrial output growth is estimated to have declined to a 26-month low in September, based on data accounting for two-thirds of the aggregate.

Narrow money trends have stabilised across the major economies: the six-month change in real narrow money is above its minimum over the last year in all the G7 plus E7 economies except Mexico and Korea. Real narrow money growth is relatively firm in Japan and Euroland and weak in the US (and China), casting doubt on the sustainability of recent US economic / equity market outperformance – second chart.

While the stabilisation of G7 plus E7 real narrow money growth is reassuring, trends have deteriorated further in smaller Far East economies suffering a triple squeeze from US rate hikes, China’s slowdown and tariff wars – third and fourth charts. These economies are too small to have a significant direct impact on global activity but associated financial stresses could contribute to an extension of the current “risk-off” move in markets, with negative feedback to monetary trends / economic prospects in the major economies.

     The two "monetarist" rules followed here for switching between global equities and US dollar cash recommended cash at end-September. The first rule, which prefers equities if G7 plus E7 six-month real narrow money growth is above industrial output growth, will move back into equities at end-October, since a positive gap was restored in August and appears to have been maintained in September – first chart.

As an aside, G7 plus E7 annual real narrow money growth remained below industrial output growth in August and, probably, September. A switching rule using annual growth rates would also have outperformed buy-and-hold significantly historically but by less than the rule based on six-month changes.

The second rule prefers equities if G7-only annual real narrow money growth is above 3.0%, its pre-GFC long-run average. Growth recovered in September but did not exceed this threshold, so this rule will remain in cash during November – fifth chart.

Profits taking strain of rising wage growth

Posted on Friday, October 26, 2018 at 10:56AM by Registered CommenterSimon Ward | CommentsPost a Comment

Recent inflation news is consistent with the view here that rising wage cost growth is having a greater impact on profit margins than core price trends.

G7 headline and core (i.e. ex. food / energy and large tax changes) consumer price inflation eased for a second month in September. The core rate remains near the top of its post-crisis range but the recent July peak only matched a 2012 high, when labour markets and wage pressures were much weaker – see first chart.

The headline / core gap probably peaked in July and is likely to fall further into early 2019, assuming that commodity prices remain at their current level – second chart.

The judgement here has been that firms would struggle to push through price increases against a backdrop of restrictive monetary conditions and slowing economic momentum.

The third chart compares annual growth rates of nominal GDP and narrow money for the G7 plus E7 grouping. Nominal GDP expansion probably peaked in the second quarter of 2018, the latest data point, with money trends signalling a sustained slowdown. Assuming stable or more likely rising wage growth, lower expansion of aggregate nominal income implies a slowdown or outright weakness in profits and / or employment. Profits should take the strain first, leading to subsequent employment cut-backs.