Chinese industrial activity regained momentum over the summer and early autumn but monetary and survey evidence suggests a slowdown into 2014.
Annual industrial output growth edged up from 10.2% to 10.3% in October, while six-month expansion is estimated here to have reached its highest level since July 2012 – see first chart. This revival is consistent with respectable real money supply trends in early 2013 and a rise in the new orders component of the official manufacturing purchasing managers’ survey in the spring and summer.
Six-month real narrow money (M1) growth, however, has fallen sharply since mid-year, reflecting both slower nominal expansion and a food-driven rise in inflation. Allowing for the typical half-year lead, this suggests that the economy will lose momentum around end-2013. A fall in the PMI new orders index in September / October may represent early confirmation of this scenario.
Broad money and credit trends have also softened: real six-month growth in the broad “total social financing” credit measure is estimated to have fallen to its lowest since November 2011 last month – second chart. Real M1 / M2, meanwhile, is expanding more slowly than industrial activity, implying an unfavourable liquidity backdrop for financial markets.
These trends are probably in line with policy goals – the inflation up-tick and bubbling house prices argue against the authorities providing early relief.
The US unemployment rate rose from 7.2% to 7.3% between September and October but would have declined but for the government shutdown, which resulted in both federal and private-sector employees being temporarily laid off and therefore included in the unemployment total.
Temporary layoffs rose from 1,087,000 in September, accounting for 0.70 percentage points of the 7.2% unemployment rate, to 1,535,000, equivalent to 0.99 pp, in October. This suggests that the jobless rate would have been 0.29 pp lower in the absence of the shutdown, or 7.0% rather than 7.3%.
The continued underlying improvement is revealed by the unemployment rate excluding temporary layoffs, which dropped another 0.25 pp to 6.3%, a five-year low – see chart.
The November employment report to be released early next month will be critical but the odds of a December Fed “taper” have shortened.
The ECB cut its main refinancing rate yesterday supposedly in response to weaker-than-expected inflation news. Current inflation trends, however, reflect monetary policy about two years earlier. The ECB pursued a disastrous policy in 2011, raising rates in April and July even though Eurozone real narrow money M1 was contracting. The consequent recession is the main reason for the recent inflation decline.
ECB policy, however, changed dramatically following Mr Draghi’s installation as President in November 2011. Rate cuts and a series of initiatives to relieve pressure on liquidity-short banks and lower funding costs generally resulted in a strong revival in monetary growth in late 2012 and 2013, laying the foundation for the current economic recovery. Monetary trends have faltered recently – see previous post – but remain consistent with economic expansion and do not support deflation worries.
Importantly, recent lower inflation has not been accompanied by a weakening of consumer and business price expectations – in contrast to the inflation drop associated with the 2008-09 “great recession”. The net percentage of consumers expecting prices to rise at a faster pace over the next 12 months is close to its long-term average and has firmed slightly recently – see chart. This firming is consistent with the change from deflationary to reflationary monetary policy that started two years ago.
Yesterday’s cut in the refinancing rate will have little impact on monetary conditions because short-term market rates were below the new level – the introduction of a negative deposit rate would have been much more significant. President Draghi stated that the ECB is not concerned about deflation, consistent with the assessment above. This raises the question of why it chose to act at all. The probable aim was to cool unwelcome euro strength – the trade-weighted exchange rate has risen by nearly 8% over the last 12 months. It would be surprising if such modest action proved effective and the ECB’s efforts may be thwarted by the Federal Reserve, which remains strongly committed to a weak dollar and may reinforce its commitment to its “low for long” interest rate policy over coming months, as well as delaying “tapering”.
Four MPC members would be voting to raise Bank rate this week if the Committee were responding to incoming news in the same way as in the past, according to the “MPC-ometer” model followed here.
The MPC-ometer is designed to forecast the “average interest rate vote” of Committee members based on a small number of economic and financial inputs relevant for assessing the outlook for growth and inflation. Estimated in 2006, the model proved useful for predicting interest rate changes in the late 2000s; it also signalled the expansions of QE in 2011 and 2012*.
The model reading for November is +10 basis points (bp), suggesting four votes for a 25 bp Bank rate rise and five for no change**. The reading has risen from a recent low of -9 bp in May, when the MPC was contemplating further easing – three members voted to expand QE every month between February and June.
The further increase in the model reading this month from +5 bp in October reflects robust third-quarter GDP expansion, additional strength in purchasing managers’ surveys, higher consumer inflation expectations and a buoyant stock market.
The judgement here is that the MPC has already fallen “behind the curve” by failing to respond to compelling evidence of monetary excess, such as a surge in annual M1 growth into double-digits. The fact that the MPC-ometer has yet to signal a tightening move is not at odds with this view, since the Committee has kept policy too loose on average historically.
The current position, of course, is unprecedented because the MPC has locked itself into a straitjacket in the form of its “forward guidance” framework. This guarantees that necessary policy restraint will occur even later than in previous cycles, in turn implying another significant inflation overshoot in 2014-15, with subsequent negative consequences for economic growth.
*The model was modified in 2009 to incorporate QE, with the relevant parameter implying that £75 billion of gilt-buying is the policy equivalent of a quarter-point rate cut.
**Such an outcome would imply an average interest rate vote of 11 bp, i.e. four-ninths of 25.
The OECD’s leading indicator indices are widely monitored and influence investor perceptions of the state of the global economy. September data to be released next week* may signal a loss of growth momentum; this could cause investors to become more cautious about equity market prospects.
The OECD’s indices are presented in “normalised” form so that a stable reading indicates economic growth at trend. The key G7 index has been rising since late 2012, suggesting future above-trend expansion – the OECD claims that its indicators lead by six to nine months. However, an attempt here to replicate the OECD’s calculations yields an estimate that the G7 indicator stabilised in September – see first chart. If confirmed, this would raise doubts about the current consensus view that global growth will be significantly stronger in 2014 than 2013.
The estimated stabilisation of the G7 indicator in September reflects weakness in the US component – second chart. The latter may be picking up a transitory negative impact from the recent government shutdown and uncertainty about whether the debt ceiling would be raised. This suggests waiting for an October reading released in early December before concluding that US / global growth prospects are deteriorating.
The OECD indices are used here to construct short and longer-term leading indicators of G7 industrial output growth. If the September OECD estimate proves correct, both indicators will decline notably, with the longer-term measure crossing below its historical average – third chart**. Such a crossover would cause the investment rule described in a previous post to switch from equities to cash.
*Tuesday 12 November.
**The last indicator readings in the chart are estimates.