Euroland money data better but still signalling slowdown

Posted on Wednesday, February 28, 2018 at 03:26PM by Registered CommenterSimon Ward | CommentsPost a Comment

Euroland monetary growth recovered modestly in January but a slowdown since mid-2017 continues to suggest a loss of economic momentum through late 2018. The OECD’s Euroland leading index is confirming a prospective downshift in economic growth.

As usual, the monetary analysis here focuses on non-financial M1 / M3, the forecasting performance of which is superior to the headline M1 / M3 measures*.

Non-financial M1 rose by a solid 1.1% between December and January, with non-financial M3 up by 0.6%. Six-month growth of the two aggregates reversed a decline in December but remains lower than during the first half of 2017 – see first chart.

The recovery in six-month nominal growth, moreover, was roughly matched by a further rise in six-month consumer price inflation, so real money expansion was little changed, having reached its lowest since 2014 in December – second chart.

The ECB publishes a country breakdown of overnight deposits, which account for more than 80% of M1. This breakdown suggests that the slowdown in Euroland real narrow money since mid-2017 has been driven by France and Spain – third chart. Better French economic data since the election of President Macron may have been coincidental and temporary, while the Catalonia political crisis may be dragging on Spanish prospects.

German real overnight deposit growth has fallen by less but from a lower level. Strong German GDP growth during the second half of 2017 relied on net exports – domestic demand rose by only 0.25% per quarter. Italian real deposit growth has been relatively stable recently.

The OECD’s Euroland composite leading index, which typically lags monetary trends by several months (and excludes money measures), confirms softer economic prospects. The normalised version of the index is estimated to have declined in January, the first fall since August 2016, with a further reduction projected for February – fourth chart**. The normalised index is designed to predict GDP relative to trend, so the shift from rising to stable / falling suggests that recent strong growth will give way to trend or slightly below-trend expansion.

The turnaround in the index mainly reflects a recent cooling of business and consumer surveys, along with weaker stock market performance.

*Non-financial = covering holdings of households (HHs) and non-financial corporations (NFCs), i.e. excluding financial sector money.
**The OECD is scheduled to release a January reading on 8 March but most of the component information is available, allowing an independent calculation.

Euroland economic news softening on schedule

Posted on Wednesday, February 21, 2018 at 11:59AM by Registered CommenterSimon Ward | CommentsPost a Comment

Previous posts (e.g. here) argued that the Euroland economy would slow from around spring 2018. Weaker February PMI results are consistent with this forecast. As usual at economic momentum peaks, the consensus is likely to emphasise the still-strong level of survey indicators, playing down the change of direction. Money trends, by contrast, suggest a further significant cooling over coming months.

Six-month growth of real narrow money, as measured by non-financial M1 deflated by consumer prices, peaked most recently in June 2017, falling in December to its lowest level since 2014. Allowing for a typical nine-month lead, this signals a likely decline in economic momentum from around March 2018 through September, at least. Two-quarter GDP growth, in fact, may have peaked in the third quarter of 2017, although recent data have tended to be revised upwards – see first chart.

Business surveys lead activity by up to three months, implying that they should reflect monetary trends six months or so later. The second chart shows the manufacturing PMI and output expectations from the EU Commission manufacturing survey, along with six-month real narrow money growth lagged by six months.  The survey indicators appear to have peaked on schedule in December, with the February decline in the PMI likely to be echoed by next week’s EU Commission survey. The relationship suggests a further fall in the PMI towards the 50 level by mid-2018.

Why have monetary trends weakened despite ECB President Draghi’s best efforts to delay policy “normalisation”? The view here is that narrow money is demand-determined and influenced importantly by spending intentions, explaining its leading relationship with activity. Sectoral figures show that money holdings of both households and corporations have slowed. Spending intentions may have been dampened by a combination of higher inflation, firmer long-term yields, euro strength, incipient global cooling, Brexit worries and concern that some governments will face financing difficulties as the ECB’s QE backstop is withdrawn.

Will global money trends stabilise soon?

Posted on Tuesday, February 20, 2018 at 10:30AM by Registered CommenterSimon Ward | CommentsPost a Comment

The global real money measure tracked here appears to have slowed further in January, reinforcing the expectation of a significant loss of economic momentum later in 2018.

The US, China, Japan, Brazil and India have released January monetary data, together accounting for two-thirds of our G7 plus E7 aggregate. Assuming unchanged money growth in other countries, and incorporating near-complete inflation data, six-month expansion of G7 plus E7 real narrow money is estimated to have reached another nine-year low – see first chart.

With six-month industrial output growth expected to have been little changed from December, real narrow money expansion is likely to have fallen short of output growth for a second month, suggesting unfavourable prospects for equity markets – see previous post.

The fall in real narrow money growth since mid-2017 reflects both lower nominal expansion and a pick-up in six-month consumer price inflation – second chart.

Money trends suggest significant downside risk to consensus economic growth expectations but are still far from signalling a recession – every global downturn since the 1960s (at least) was preceded by a contraction of real narrow money. The expectation here is that global real money growth will stabilise or recover slightly over coming months, for two reasons.

First, six-month consumer price inflation may have reached a near-term peak in January, assuming that commodity prices stabilise at their current level – third chart.

Secondly, US narrow money growth may revive into mid-2018 as tax cuts lift disposable incomes and spending intentions. Stronger US monetary data may offset weaker trends elsewhere.

We examined the behaviour of US narrow money growth around three previous major tax cuts, signed into law by Presidents Johnson (1964), Carter (1978) and Reagan (1981). These were the top three initiatives since 1950 ranked by impact on existing revenues, according to a Treasury study, involving losses of 1.6%, 0.8% and 2.9% of GDP respectively. For comparison, the Tax Cuts and Jobs Act of 2017 is projected to cut revenues by 1.1% of GDP*. The three prior reductions occurred against a backdrop of rising interest rates, as now.

Surprisingly, there was a consistent pattern across the three episodes: six-month narrow money growth declined before and just after legislation was passed but then rose for 5-6 months, subsequently falling back again – fourth chart.

This pattern could reflect uncertainty about the success and details of legislation holding back spending and activity pending its passage. In addition, some beneficiaries of tax cuts may lack liquid resources or access to credit, delaying the boost to their spending until reductions flow through to disposable incomes.

The recent monetary slowdown fits the historical pattern and the suggestion is that narrow money growth will recover temporarily in Q2 and Q3 2018.

Such a revival could warrant a more positive view of US economic prospects for late 2018 / early 2019 but would not alter the forecast of a near-term slowdown. Global prospects, of course, will also hinge on developments in China, where money trends suggest an increasing risk of a “hard landing” unless the authorities reverse policy restriction soon – see previous post.

*All figures refer to static impact over four years, except 1964, which refers to full impact in single year.

Chinese money trends flashing danger

Posted on Wednesday, February 14, 2018 at 11:25AM by Registered CommenterSimon Ward | CommentsPost a Comment

Chinese data for January / February can be distorted by New Year timing effects. With this caveat, January money numbers appear notably weak, reinforcing the expectation here of a significant economic slowdown later in 2018.

A negative view of the data may seem odd given that annual growth rates of M1 and M2 rose between December and January – from 11.8% to 15.0% and from 8.2% to 8.6% respectively. The official measures, however, are flawed: M1 excludes household demand deposits*, which are relevant for assessing consumer spending prospects, while M2 has been distorted in recent years by large fluctuations in deposit holdings of financial institutions – such deposits appear to be uncorrelated with future spending / activity.

The analysis here, therefore, focuses on “true M1” – official M1 plus household demand deposits – and M2 excluding financial deposits. Annual growth rates of these measures, in contrast to the official M1 / M2 aggregates, continued to slide in January, reaching their lowest levels since mid-2015 – see first chart.

The preferred measure here for forecasting purposes is the six-month rate of change of real true M1 (i.e. deflated by consumer prices, seasonally adjusted). This fell sharply between August 2016 and January 2017 but then stabilised through September 2017 at a respectable historical level – second chart. This stabilisation was the basis for the view here that the Chinese economy would retain solid momentum through early 2018 – contrary to pessimistic forecasts from followers of the “credit impulse”, among others.

The six-month growth rate, however, resumed its decline in the fourth quarter of 2017 and fell significantly further in January. Allowing for a typical nine-month lead, this suggests economic weakness starting around mid-2018.

Demand deposits within true M1 comprise holdings of households, non-financial enterprises and government departments / organisations. The latter can be excluded to create a “private” variant of the aggregate. This measure has slowed even more sharply – second chart.

Chinese narrow money trends tend to lead house prices, industrial profits and producer prices, in that order – third chart. The monetary slowdown was reflected in a moderation of house price inflation during 2017; profits growth and producer price inflation have turned down more recently – third chart. These trends are likely to extend. Weaker economic data and easing inflationary pressures may prompt a partial reversal of recent policy tightening in mid-2018.

*Such deposits are large – equivalent to 46% of the stock of official M1 – and appear to be inversely correlated with currency in circulation and corporate demand deposits around the New Year.

UK MPC hawkish shift at odds with money trends

Posted on Tuesday, February 13, 2018 at 02:22PM by Registered CommenterSimon Ward | CommentsPost a Comment

Last week’s UK Inflation Report signalled that the MPC intends to raise rates again in May if the economy evolves in line with its forecast. Monetary trends suggest that the Committee should proceed with caution.

The MPC’s new-found hawkishness partly reflects its repeated underestimation of inflation outturns. January consumer price inflation remained at 3.0%, in line with the latest Bank staff estimate but well above a projection of 2.6% for the first quarter of 2018 in the November Inflation Report. The MPC expects inflation to fall back to 2.4% by the fourth quarter of 2018. It may continue to be disappointed – on plausible assumptions, the forecast for late 2018 here is 2.6-2.7%.

Current and near-term high inflation, however, is a consequence of past policy laxity relative to monetary and economic conditions. Belated remedial action risks compounding the error.

The February Inflation Report, as usual, contained no monetary analysis. The MPC’s difficulties, on the view here, stem from its neglect of monetary trends. A key mistake was to ease policy in August 2016 when money growth was high and rising. Annual expansion of the Bank’s broad M4ex aggregate was 5.9% in June 2016 (available to the MPC in August), the highest since 2008, with the narrow non-financial M1 measure growing by 9.2% – see chart.

Monetary trends, that is, signalled that the economy did not require post-EU-referendum support. The MPC’s easing decision magnified the fall in sterling associated with the referendum result, thereby contributing to the current inflation overshoot.

Annual money growth, however, peaked in late 2016 and trended lower during 2017. December numbers released in late January – the first to reflect a full month at the higher level of Bank rate – showed a further significant step down. Annual expansion of non-financial broad and narrow money is the lowest since 2012. The monetary slowdown has been reflected in a moderation of nominal GDP growth.

Monetary trends are not weak enough to suggest imminent economic danger and / or an eventual inflation undershoot. They question, however, the urgency of policy tightening. The MPC, on the view here, should wait for a stabilisation or recovery in money growth before hiking again.