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.

Is the liquidity backdrop for markets now negative?

Posted on Thursday, February 8, 2018 at 09:50AM by Registered CommenterSimon Ward | CommentsPost a Comment

The consensus narrative is that recent equity market declines reflect worries that rising inflation will force central banks to accelerate policy tightening. An alternative possibility is that global monetary conditions are already restrictive and will act as a drag on the economy and markets even if policies are unchanged.

Market prospects, on the view here, are related to the difference – if any – between actual growth in the stock of money and the rate of expansion warranted by (nominal) economic expansion. “Excess” money growth will usually be associated with an increase in demand for financial assets and higher prices of those assets (assuming unchanged supply). Conversely, low money growth relative to economic needs will usually signal weak demand for assets and stagnant or falling markets.

Divergences between actual and required money growth may be reflected in a general trend in asset prices or a sharp movement in a particular market, depending on the economic backdrop, popular investment themes and valuations, among other factors.

The level of money growth required to support economic expansion, of course, cannot be measured directly. A simple approach is to assume that the economic demand for money rises in line with output and prices of goods and services. The sign of the gap between money growth and the sum of output growth and inflation will then be a gauge of whether monetary conditions are positive or negative for asset prices.

Such an approach would have been helpful for assessing global equity market prospects historically. We examined the relationship between the monthly excess return on the MSCI World index in US dollars relative to US dollar cash and the sign of the gap between the six-month rates of change of G7 real narrow money (using consumer prices as the deflator) and industrial output. The mean excess return on equities over cash between December 1969 and December 2017 (48 years) was 3.6% per annum (pa). The mean excess return in months following a positive signal from the real  money / output growth gap was 10.2% pa*. By contrast, equities suffered a mean net loss of 4.8% pa in months following a negative signal.

The chart compares the cumulative return relative to US dollar cash of the MSCI World index and a strategy that switches between equities and cash depending on the sign of the real money / output growth gap**. The strategy would have captured much of the rise in equities while limiting drawdowns***.

The gap between G7 six-month real narrow money growth and industrial output growth was positive between January 2011 and November 2017 but appears to have fallen below zero in December, based on full monetary / price data and partial information on industrial output.

Incorporating China and other large emerging economies does not alter the current signal: G7 plus emerging E7 six-month real narrow money growth also appears to have crossed beneath industrial output growth in December.

Real broad money growth – either G7 or G7 plus E7 – is also now below industrial output growth.

A cautious investment stance may remain warranted until the real money growth / output growth gap reverses back into positive territory.

*The analysis allowed for a two-month reporting lag for monetary / economic data.
**The strategy also requires the six-month change in real narrow money to be positive in order to hold equities.
***The strategy suffered a significant loss during the 2000-02 bear market because it switched back into equities prematurely. Equity market valuations were still historically high when the buy signal was issued.

Global leading indicator confirming monetary warning signal

Posted on Monday, February 5, 2018 at 04:02PM by Registered CommenterSimon Ward | CommentsPost a Comment

Incoming evidence is consistent with the view here that the global economy will slow significantly later in 2018.

As suggested by earlier partial data, six-month growth of real narrow money in the G7 and seven large emerging economies fell to its lowest level since 2009 in December. Real broad money growth also weakened further. The most recent peak in real money growth occurred in June / July 2017, suggesting a decline in six-month industrial output growth starting around March / April 2018, allowing for the average nine-month historical lead – see first chart.

A peak in economic momentum around the end of the first quarter is now also being signalled by a shorter-term G7 plus E7 leading indicator based on the OECD’s country composite leading indicators (which do not generally include money measures). This indicator usually leads by between three and five months and its six-month growth edged down in December. One-month growth has fallen for three consecutive months – second chart.

The assessment here is that economic strength in early 2018 partly reflects the final stage of the upswing in the US / global stockbuilding cycle, which is judged to have bottomed in early 2016 and usually tops out after about two years. The US ratio of inventories to final sales of goods and buildings continued to fall sharply in the fourth quarter of 2017, with demand boosted by recovery spending in hurricane-affected areas – third chart. This suggests a high level of stockbuilding in early 2018 as firms seek to restore the ratio to a normal level. The level of GDP growth depends on the change in stockbuilding, so a moderation of the latter later in 2018 would imply a drag on economic momentum.

Consistent with this interpretation, the ISM manufacturing inventories index rose sharply in January, while the Atlanta Fed’s GDPNow model currently projects that an increase in stockbuilding will boost first-quarter GDP growth by 1.25% at an annualised rate.

If the scenario of a second-quarter slowdown is correct, global business surveys should be at or near a peak. The US ISM manufacturing new orders index fell slightly in January, as did new orders components of manufacturing PMI surveys in China (NBS and Markit) and Euroland / the UK (Markit). The lagged relationship with global real narrow money growth suggests a significant decline in the ISM measure by mid-2018 – fourth chart.

Slowing economic momentum would be expected to be associated with a reversal of recent outperformance of cyclical equity market sectors, defined by MSCI to include materials, industrials, consumer discretionary, financials and IT. Cyclical sectors are historically expensive relative to defensive sectors, defined as energy, consumer staples, health care, telecommunications and utilities: the ratio of the price to book of the MSCI World cyclical sectors index to that of the defensive sectors index is at its highest level since 2000 – fifth chart.

Global money trends still weakening

Posted on Friday, January 26, 2018 at 03:52PM by Registered CommenterSimon Ward | CommentsPost a Comment

Global policy-makers are trumpeting “synchronised” economic growth. They should, instead, be worrying about synchronised monetary weakness, which is ringing alarm bells about economic prospects for later in 2018.

Euroland money numbers for December released today were soft. Six-month growth of real narrow money – defined as non-financial M1 deflated by consumer prices – fell further to its lowest level since 2014. Real broad money growth also declined sharply – see first chart.

The real money slowdown reflects both lower nominal monetary expansion and a rise in six-month inflation. Six-month growth of nominal narrow money was also the lowest since 2014 last month – second chart.

Six-month real narrow money growth also fell further in December in the US, China and Japan. Our “global” measure covering the G7 and seven large emerging economies appears to have reached the bottom of its range since 2009 – third chart*. 

Global six-month real narrow money growth peaked most recently in June / July 2017 and has led turning points in industrial output growth by nine months on average in recent years (and over the longer term). This suggests a loss of economic momentum in the second quarter of 2018 extending well into the second half.

Weaker global monetary trends reflect significant US and Chinese policy tightening since late 2016. QE tapering by the ECB and BoJ, meanwhile, has slowed capital outflows and boosted the euro and yen – earlier currency falls played a key role in generating current Euroland / Japanese economic “strength”.

Will US tax cuts head off or mitigate a loss of global economic momentum? A significant stimulatory impact would probably be signalled by a rebound in US narrow money growth in early 2018. A negative view will be maintained here barring such a reversal.

*December monetary figures are available for countries accounting for 83% of the G7 plus E7 aggregate.