UK inflation resilience consistent with past monetary strength

Posted on Wednesday, September 19, 2018 at 12:55PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK consumer price inflation rebounded to 2.7% in August, well above a consensus estimate of 2.4% and suggesting an overshoot of the 2.48% forecast for the third quarter in the August Inflation Report. Core as well as headline inflation pushed higher – see first chart*. Hikes in household energy bills may contribute to the headline rate remaining at around 2.5% in the fourth quarter, rather than falling to 2.29%, as predicted in the Report.

Does this news vindicate the MPC’s August rate hike and even suggest a need for further near-term policy tightening?

Not according to the analysis here. Inflation resilience is judged to be a reflection of monetary strength in 2016, taking into account the historical two-year-plus lead from monetary trends to core retail / consumer prices, documented in a post in May 2016. Annual growth rates of broad and narrow money – as measured by non-financial M4 / M1 – peaked in September 2016, falling to the lowest levels since 2011-12 in the second quarter of 2018. Inflation, therefore, should subside in 2019-20, barring significant sterling weakness or a commodity price shock.

MPC hawks are concerned about upward pressure on earnings and unit labour cost growth but profit margins rather than prices are likely to take the strain against a backdrop of restrictive monetary conditions and weak economic expansion. A margin squeeze, indeed, is already under way: annual growth of employee compensation has been above that of nominal GDP over the last three quarters, resulting in corporate gross operating profits stagnating – second chart.

Monetary trends need to strengthen to justify further policy tightening. As previously discussed, the numbers through July were showing signs of recovery but this may have been aborted by the August rate hike – the next data release is on 1 October. The August inflation jump, meanwhile, will act as a drag on real money growth and, by extension, economic prospects.

*Core = excluding energy, food, alcohol, tobacco and education, and adjusted for VAT changes.

Chinese money trends still weakening - policy easing too little / late?

Posted on Monday, September 17, 2018 at 03:08PM by Registered CommenterSimon Ward | CommentsPost a Comment

Chinese August money numbers were surprisingly weak, suggesting that the economy will continue to lose momentum into early 2019, despite a recent shift towards policy easing.

Annual growth of narrow money – as measured by true M1* – fell to 4.3% in August and is approaching levels reached in late 2014 / early 2015, ahead of the 2015-16 hard landing scare. Nominal GDP expansion has been following narrow money growth lower and may weaken significantly further by early 2019 – see first chart.

Shorter-term money growth rates also eased: six-month expansion fell to 1.1%, or 2.3% at an annualised rate, again the lowest since 2015. Real-terms growth – relative to consumer prices – is approaching zero.

Recent falls in interest rates suggest a revival in money trends but the timing and magnitude are uncertain – second chart. Even if growth were to pick up from September, a recovery in economic momentum would be unlikely before spring 2019.

Historically, monetary policy loosenings have involved relaxation of quantitative controls on credit creation as well as lower rates. The clampdown on shadow banking activity, however, continues, with weakness in this sector offsetting a recent slightly faster pace of bank lending growth: annual expansion of total social financing fell further to 9.5%** in August, a record low in data extending back to 2004.
Without accompanying credit loosening, PBoC liquidity injections and lower rates may have a delayed and muted impact on monetary trends and, by extension, economic activity.

The narrow money slowdown has been broadly based across its components – currency in circulation and corporate / household demand deposits. Deposit growth of non-financial enterprise is particularly weak – only an annual 0.4% in August.

Annual growth of broad money has been stable in recent months but at a weak level by historical standards. Headline M2 expansion has been supported by a rapid rise in financial sector deposits; the non-financial M2 measure preferred here rose by only 7.3% year-on-year in August – third chart.

Optimists expect infrastructure spending to boost the economy later in 2018 but state-led fixed asset investment continued to fall year-on-year in August – fourth chart. Private investment growth remained solid but slowing enterprise money trends suggest weakening prospects.

Housing activity has been stronger than expected here so far in 2018 but annual sales growth fell back in August and may be signalling a peak in price inflation – fifth chart. Recent rapid price gains have probably contributed to the authorities’ reluctance to lift credit restraints.

The monetary signal of a further economic slowdown is supported by the latest reading of an alternative composite leading indicator discussed in a previous post. To recap, the OECD’s composite leading indicator may no longer be reliable given structural shifts in the Chinese economy. The alternative indicator attempts to replicate the components of the OECD’s US leading indicator, with the aim of achieving broader economic coverage. The alternative indicator moved sideways in 2017 / early 2018 but has fallen significantly since March, suggesting below-trend economic expansion – sixth chart.

Five of the six components of the alternative leading indicator have weakened recently, the exception being the slope of the yield curve. The latest reading was dragged down by weakness in domestic orders and future income confidence in the PBoC’s third-quarter business and consumer surveys respectively, released over the weekend.
*True M1 = official M1 plus household demand deposits. Official M1 = currency in circulation plus demand deposits of non-financial enterprises and government organisations.
**Old basis. 10.1% on new basis including asset-backed securities and loan write-offs. New basis unavailable before 2017.

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.