The forecast here that global growth will pick up into 2017 rests importantly on an assumed recovery in business spending. Firms are expected to turn more expansionary partly in response to a recent revival in profits.
The first chart shows annual rates of change of S&P 500 reported earnings*, incorporating a bottom-up Capital IQ consensus estimate for the third quarter, and Chinese industrial profits, as reported by the National Bureau of Statistics. Chinese profits resumed growth in early 2016 and are rising at their fastest pace since 2013. US earnings seem to be following.
The second chart shows the IBES consensus estimate for MSCI World 12-month-forward earnings per share (EPS) in US dollars, along with the “revisions ratio” – the number of analyst upgrades in the latest five weeks minus downgrades, expressed as a proportion of the total number of estimates (and seasonally adjusted). The forward EPS estimate has been trending higher since early 2016, while the revisions ratio is the strongest since 2014.
*Total index earnings not earnings per share.
UK consumer price inflation is expected here to rise above 3% during 2017, exceeding Monetary Policy Committee (MPC) and consensus forecasts. The MPC is likely to try to avoid tightening policy in response, arguing that it intends to “look through” the increase, an approach it claims was successful in 2008 and 2011, when CPI inflation reached over 5% before falling back. Monetary growth, however, is much stronger than in those years, suggesting that the coming inflation rise will represent a permanent upward shift rather than a “temporary blip”. In reality, key MPC officials may now be covertly in favour of aiming for a sustained overshoot of the inflation target, a policy recently embraced explicitly by the Japanese monetary authorities.
A post in May presented long-term evidence showing that all major swings in “core” inflation (i.e. excluding food / energy costs, tax effects etc) since World War 2 were preceded by a significant change in monetary growth, typically by between two and three years. Annual broad money growth, as measured by non-financial M4, has been trending higher since 2011, reaching 6.6% in August, the fastest since 2008. Monetary forces, therefore, will be pushing up on inflation in 2017 and 2018 – see first chart*.
The rise in core inflation to date has been delayed and muted by the lagged impact of exchange rate strength over 2013-15. The currency effect, of course, is about to become a powerful tailwind. Manufactured import prices rose by 7.3% in the year to August and annual growth is likely to reach 10-15% by early 2017, barring a significant recovery in sterling. Import price changes appear to have their maximum impact on core CPI inflation after about a year, suggesting strong upward pressure from late 2016 – second chart.
Core CPI inflation, therefore, is expected here to rise from 1.2% in August to about 2.5% by late 2017. Headline CPI inflation, meanwhile, is likely to be pushed significantly above the core rate by rising energy and food prices due to sterling weakness and stronger global commodity costs. Based on current sterling commodity prices, the headline-core inflation gap may increase to over 1 percentage point by mid-2017 – third chart. Combined with a strengthening core trend, this would probably be sufficient to lift the headline rate above 3%.
The CPI inflation surges in 2008 and 2011 proved temporary partly because they occurred against a backdrop of weak and falling monetary growth – the annual increase in non-financial M4 bottomed at 2.0% in 2009 and 1.5% in 2011. Recent strong growth has yet to peak, suggesting that core CPI inflation will remain under upward pressure until late 2018, at least. The coming inflation overshoot, therefore, is likely to be sustained, unless global commodity prices turn down afresh or sterling stages an improbable large recovery.
*Core CPI = CPI excluding energy, food, alcohol, tobacco and education, and adjusted for VAT changes.
The assessment here is that the global economy has been gaining momentum since mid-year and growth over the next six to 12 months will be significantly stronger than expected by policy-makers and the consensus. This series of short posts will highlight incoming evidence that supports, or refutes, this view.
The OECD yesterday released August data for its country leading indicators, allowing calculation of the composite G7 plus emerging E7 leading indicator tracked here. Six-month growth of the latter rose further – see first chart. Both G7 and E7 components contributed to the increase – second chart.
The rise in leading indicator growth from a low in December 2015 follows a pick-up in G7 plus E7 six-month real narrow money expansion from a bottom in August 2015. The further increase in real money growth to a seven-year high in August 2016 suggests that the indicator will continue to gain momentum.
Brexit-supporting economists argue that the referendum result hastened a fall in the pound that was inevitable and will ultimately prove beneficial. Such claims are dubious.
The Brexit supporters cite the large current account deficit – equivalent to 5.9% of GDP in the second quarter of 2016 – as evidence that the pound was significantly overvalued. The trade deficit in goods and services, however, was 2.6% of GDP in the second quarter, close to its average of 2.4% between 2000 and 2015. It has been trendless in recent years despite relatively strong UK domestic demand growth – see first chart.
Business survey evidence refutes the claim that the pre-referendum level of the exchange rate was limiting export performance. The percentage of CBI industrial firms citing pricing as a constraint on exports stood at 49% in April, below a 2000-15 average of 54%. The long-term average (since 1972) of this series is 58% – second chart.
The rise in the current account shortfall has been driven by a move from surplus to deficit in the investment income balance. This move, however, has reflected a change in the form of the return received on foreign assets from income to capital gain. The cumulative capital gain on the net international investment position in recent years has exceeded not only the income deficit but also the overall current account shortfall. The net investment position (i.e. external assets minus liabilities) stood at -5.1% of GDP at the end of the first quarter (before the referendum) versus a 2000-15 average of -8.8% – third chart.
An alternative view is that the fall in the pound was not inevitable but has been the result of international investors revising down their assessment of the equilibrium value of the exchange rate in response to 1) the UK opting for inferior trading arrangements with its largest export market and 2) post-referendum monetary and fiscal loosening. The MPC bears significant responsibility – cutting rates and launching more QE when broad money is growing at a double-digit pace* is a recipe for a weak currency.
Monetary trends were signalling a rise in inflation in 2017 well before the Brexit vote. Sterling’s slide will accelerate the pick-up as import prices surge – fourth chart. CPI and RPI inflation are expected here to rise above 3% and 4% respectively during the course of next year. Will Brexiters comfortable with the pound’s decline also defend these increases as inevitable and necessary?
*M4ex rose at an annualised rate of 11.3% in the four months to August.
Incoming monetary and economic news is consistent with the central view here that US / global growth is gaining momentum and will prove stronger than policy-makers and the consensus expect over the next six to 12 months. This view implies that: 1) the Fed was wrong to defer raising rates in September (just as it was wrong to hike in December 2015 when monetary trends were signalling economic weakness); and 2) pressure for additional monetary policy relaxation in other major countries will ease, possibly benefiting investments that have suffered from moves towards low / negative rates (e.g. financial stocks).
Global narrow money strength is the key reason for economic optimism. Full monetary statistics for August confirm that six-month growth of real (i.e. inflation-adjusted) narrow money in the G7 economies and seven large emerging economies (the “E7”) rose to its highest level since 2009, ahead of a sustained period of solid economic expansion. Real broad money growth has also firmed – see first chart.
The rise in real narrow money growth began in the E7 – with China a key driver – but has spread to the G7 more recently, reflecting increases in the US and Japan. The E7-G7 differential turned positive in late 2015 ahead of this year’s outperformance of emerging market assets; the gap has narrowed but has yet to reverse sign, suggesting retaining overweight EM positions – second chart.
The positive signal from global monetary trends has been confirmed by a pick-up in a non-monetary composite leading indicator for the G7 plus E7 economies derived from OECD country leading indicator data. An August reading of this indicator will be available next week but calculations here suggest that the G7 component has continued to gain momentum – third chart.
Country-level data over the past week provide further evidence that the global economy is lifting:
1) The new orders index of the US ISM manufacturing survey rebounded strongly in September after an August slump. The latter decline seems to have been a “Brexit echo” of the sharp fall in the corresponding UK survey index in July, which has since been more than reversed – fourth chart.
2) Japanese industrial output rose by a stronger-than-expected 1.5% in August, with METI’s survey of manufacturers projecting further gains of 2.2% and 1.2% in September and October. The latest Tankan business survey, meanwhile, reported a further rise in labour shortages, suggesting that recent upward pressure on real wages will be sustained – fifth chart.
3) Chinese producer prices continue to firm, with the input price index of the NBS manufacturing survey rising to 57.5 in September, marking the eighth month comfortably above the 50 level – sixth chart. The return of pricing power is a key reason for the recent surge in industrial profits, which promises a recovery in business investment over coming quarters – see previous post.
4) The German Ifo manufacturing survey reported the strongest business expectations for 18 months, suggesting a swift reversal of July industrial output weakness, which appears to have been mainly due to holiday timing effects – seventh chart.
5) UK services output rose by 0.4% in July, in line with the projection in a previous post, after an upwardly-revised 0.3% June gain. GDP now looks on course to rise by at least 0.4% in the third quarter following a bumper 0.7% second-quarter increase – a huge embarrassment for analysts who claimed that the economy was flatlining before the Brexit vote and would contract in response to the shock result.