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G7 yield curve echoing monetary slowdown signal

Posted on Thursday, April 12, 2018 at 10:47AM by Registered CommenterSimon Ward | Comments5 Comments

The assessment here that the global economy has entered a slowdown phase likely to last through late 2018 (at least) rests primarily on weaker monetary trends since mid-2017. The slope of the G7 yield curve – another longer leading indicator with a respectable historical record – is consistent with the monetary message.

G7 six-month real narrow money growth has displayed a significant positive correlation historically with the slope of the yield curve, defined as a GDP-weighted average of 10-year government yields minus three-month money rates – see chart. The correlation is maximised by applying a two-month lag on real money growth, i.e. money growth appears to move slightly ahead of the yield curve.

While the yield curve slope often gives a similar forecasting message to narrow money trends, the judgement here is that money signals are more reliable.

The yield curve has given some notable false signals historically, e.g. it inverted in 1986 and 1998 but no recession ensued over the following two years. Real narrow money trends did not suggest economic weakness on these occasions.

The yield curve, moreover, can be distorted by central bank efforts to control it through QE and forward guidance. Real narrow money growth picked up strongly between mid-2015 and mid-2016, correctly signalling global economic acceleration in late 2016 / 2017. The yield curve, by contrast, flattened over this period, possibly partly reflecting an increased G7 flow of QE following the start of the ECB’s programme in March 2015. The QE pick-up, indeed, may have both boosted money growth while distorting the yield curve signal.

A further consideration is that real narrow money appears to work better as a forecasting indicator than the yield curve slope in emerging economies. This may partly reflect financial market underdevelopment – the performance of the yield curve may improve as markets deepen and mature. A money-based global forecasting measure, therefore, is likely to outperform one based on interest rates.

Real narrow money trends and the yield curve slope are giving a similar message currently. The monetary slowdown has been accompanied by a flattening curve. Real money continues to grow and the curve has not inverted, so no recession signal has yet been given.

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Reader Comments (5)

Very insightful, as always, and very much appreciated!

Has there been any occasion in the past where the YC was inverted and real narrow money growth was negative but no recession occurred?

And has any recession occurred without the signal of both the inverted YC and negative real narrow money growth?

Many thanks!

April 13, 2018 | Unregistered CommenterJan Leroy

Superb analysis again, Simon - always very edifying to read, thank you!
I have a query: if you look at the UK on its own in the same terms (real narrow money and 3m-10y yield curve) and over the same period, do you get similar recession signals/outcomes?
Thanks again,
Tony B

April 13, 2018 | Unregistered CommenterTony

Thanks Jan, Tony.

There have been seven US recessions since 1965, according to the NBER.

There is no official arbiter of G7 / global recessions. In my judgement, six of the seven US recessions “went global”, the exception being the 1969-70 recession. Annual G7 GDP growth bottomed at 3.1% in the fourth quarter of 1970 – much higher than in the other six US recessions.

These six recessions were all preceded by both a contraction of G7 real narrow money on a six-month rate-of-change basis and an inversion of the G7 yield curve (as defined in the post).

There were no cases over this period of both these conditions being fulfilled but no recession ensuing within two years. Before the early 1990s recession, however, there was a brief period when real money growth resumed and the yield curve disinverted before negative signals were again given – the recession followed the second “double negative”.

The correlation between six-month real narrow money growth and the slope of the yield curve in the UK is much weaker than for the G7 in aggregate. The yield curve has inverted four times since the mid 1970s without a recession ensuing within two years. The six-month change in real narrow money remained positive during these episodes. Real narrow (and broad) money, however, gave a false recession signal by contracting in 2010-11 – the two-quarter change in gross value added, excluding oil and gas extraction, fell to 0.1% in the fourth quarter of 2011 but did not turn negative.

April 24, 2018 | Registered CommenterSimon Ward

Many thanks for your response - excellent, as always.
Is it fair to say, then, that for the UK the necessary and sufficient condition for economy-wide recession is BOTH an inverted yield curve AND contracting real narrow money supply? The money supply's only 'false' signal, in 2010-11, was not accompanied by a curve inversion...
Alternatively, that 2010-11 period did see UK property prices only managing to move sideways (actually falling in real terms), according to ONS data. A different asset class impacted by negative money?

April 24, 2018 | Unregistered CommenterTony

Thanks for your further comments, Tony. The combination of contracting real narrow money and an inverted yield curve preceded the four UK recessions since the 1970s, with no false signals. There are, however, international examples of a contraction in real narrow money being followed by a recession despite a positively-sloped curve (e.g. the US in 1937-38, Euroland in 2011-12). As you point out, while the UK avoided a recession in 2011-12, economic conditions were recession-like in many respects.

April 30, 2018 | Registered CommenterSimon Ward

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