The hike is effectively 20 rather than 25 basis points because market rates will track the increase in the overnight reverse repo rate from 0.05% to 0.25%. The Committee signalled confidence in the economic outlook by voting unanimously while maintaining median forecasts of a 1 percentage point rise in rates during 2016 and a longer-run "neutral" rate of 3.5%. The doves, however, obtained an important concession in the form of a new sentence in the statement linking further action to actual progress in lifting (core) inflation, raising the bar for an early follow-up move. The reduction in near-term Fed uncertainty should allow markets to refocus on a reasonably favourable global economic backdrop, with moderate growth proceeding across the developed economies and signs of reacceleration in China.
US corporate finances improved in the third quarter, according to the Fed’s quarterly financial accounts, holding out hope of some relief from the recent sell-off in corporate credit.
The redemption yield on the Bank of America / Merrill Lynch high yield cash pay index reached 9.1% this week, the highest since 2011, when the yield peaked at 10.1%. The index yield is inflated by distressed pricing of energy bonds but the move higher this year has been general: the non-energy yield has increased from a low of 5.9% in February to 8.3% – see first chart.
A post in June suggested that yields would come under upward pressure following a deterioration in corporate finances in early 2015. The “financing gap” of non-financial corporations – i.e. the difference between their capital spending and retained earnings – was reported by the Fed to have risen to 1.2% of GDP in the first quarter, the highest since the second quarter of 2008. Companies, moreover, had stepped up borrowing to finance share buy-backs and cash M&A transactions. Their total net borrowing requirement – defined as the financing gap plus share purchases net of issuance – had reached 4.3% of GDP. This borrowing measure has been a good leading indicator of yield spreads historically – second chart.
The financing gap, however, fell back to 0.3% of GDP in the third quarter as companies cut capital spending on stocks and non-produced assets. Net share buying last quarter, moreover, was the weakest since the third quarter of 2009. The net borrowing requirement, therefore, declined sharply from 4.1% of GDP in the second quarter to 1.0% in the third.
This reversal may support a near-term stabilisation or recovery in corporate credit but it is doubtful that yields have yet reached a major cyclical peak, for several reasons. First, the current spread of high yield bonds over Treasuries remains well below the levels at previous major highs – second chart.
Secondly, the last three peaks occurred at least a year after the net borrowing requirement topped out. Assuming that the latter reached a maximum in the second quarter, this would suggest mid-2016 as the earliest date for a major yield decline to begin.
Thirdly, the third-quarter improvement in corporate finances may prove temporary. Capital spending on stocks should decline further but earnings and retentions are at risk from rising unit labour cost growth and higher borrowing costs. The third-quarter drop in net share purchases, moreover, is likely to have reversed in the current quarter, with Trim Tabs reporting strong buy-back activity and moderate issuance.
An additional caveat is that the Fed’s statistics are subject to significant revisions and further information could lead to the reported third-quarter improvement being scaled back.
Posts since September have argued that a Chinese economic growth revival is under way and will gather strength in early 2016. November activity data are consistent with this scenario: annual growth rates of industrial output, retail sales and private fixed investment rose notably on the month, beating consensus expectations – see first chart.
The PBoC, meanwhile, has released additional monetary detail for November, allowing calculation of the “true M1” measure followed here*. Annual growth of true M1 rose further to 13.9% last month, the fastest since March 2013. As in 2008-09 and 2012-13, growth started to pick up several months after cuts in official interest rates and reserve requirements, which began in November 2014 and February 2015 respectively – second chart.
Real (i.e. CPI-deflated) true M1 surged by 9.9%, or 20.8% at an annualised rate, in the six months to November, suggesting a powerful rebound in economic growth from early 2016 through the summer, allowing for a typical nine-month lead – third chart.
Demand deposits of non-financial enterprises, other corporate entities and households have all accelerated strongly over the past six months – fourth chart. A claim that the M1 surge has been narrowly focused on demand deposits of local government financing vehicles, therefore, is false. (Such vehicles are included in the “other corporate” segment.) The breadth of improvement suggests improving prospects for both business and consumer spending.
*True M1 = official M1 plus household demand deposits. Official M1 = currency in circulation plus corporate demand deposits.
Chinese money / credit statistics for November provide further evidence that policy easing is working, suggesting better economic news in early 2016.
Annual growth of the broader M2 money measure rose from 13.5% in October to 13.7% in November, the fastest since June 2014 – see chart. The solid level of growth, admittedly, partly reflects a rapid increase in financial deposits that may have limited implication for economic prospects. However, the annual increase in M2 excluding such deposits has also recovered significantly since early 2015.
Narrow money trends are more striking, with annual M1 growth surging to 15.7% in November, the fastest since December 2010. The preferred narrow aggregate here is “true M1”, which adds household demand deposits to the official M1 measure (comprising currency in circulation and corporate demand deposits). A November reading for true M1 is not yet available but annual growth was similar to that of the official measure in October and is likely to have risen further last month.
A claim has been made that the M1 surge is attributable to a temporary rise in demand deposits of local government financing vehicles. While this may have been a contributory factor, demand deposits of non-financial enterprises and households have accelerated strongly recently, suggesting that most of the pick-up is a genuine response to policy easing – see previous post.
Annual growth of the stock of “aggregate financing to the real economy” (i.e. bank loans and other forms of domestic fund-raising by households, non-financial enterprises and government organisations) eased to an estimated 12.2% in November from 12.5% at the end of the third quarter*. Financing growth, however, has been broadly stable over the past six months, having fallen significantly over 2013-14. The “credit impulse”, in other words, is no longer negative.
Within aggregate financing, annual growth of RMB bank loans was an estimated 13.9% in November and has also moved sideways in recent months. Rising money growth with stabilising credit expansion is usually a signal of improving economic prospects.
In other Chinese news, the annual rate of change in motor vehicle production rose to 17.7% in November, the fastest since December 2013, following the cut in the sales tax on smaller-engined cars in October. Vehicle production is a component of the OECD’s Chinese leading indicator.
*Official numbers available only for end-quarters; other months estimated from flow data.
As previously discussed, Chinese monetary trends suggest that economic growth has bottomed and will pick up significantly from end-2015. The OECD’s Chinese leading indicator supports this scenario.
The OECD presents its country leading indicators in “ratio to trend” form, i.e. a stable value indicates that an economy will grow at its trend pace. Its latest release refers to “tentative signs of stabilisation” in China. This somewhat underplays the positive signal because 1) Chinese trend growth is high so a return to this rate of expansion would represent a significant strengthening and 2) the ratio to trend indicator actually rose, rather than remained stable, in October, the latest month.
While the OECD prefers the ratio to trend presentation, it also calculates a leading indicator of the level of Chinese industrial output. The chart compares six-month and rescaled one-month changes in this indicator with the six-month change in output. The six-month indicator change has been firming gently since early 2015, while the one-month rise in October was the largest for two years.
The leading indicator comprises six components: production of chemical fertilizer, crude steel, buildings and motor vehicles, overseas orders from the PBoC’s quarterly survey of industrial enterprises and Shanghai stock exchange turnover value. The recent pick-up appears mainly to reflect stronger steel and vehicle production, along with a recovery in stock market turnover. Since the components are non-monetary, the positive signal is independent of better money / credit trends.
The stabilisation / recovery in the ratio to trend indicator suggests that annual industrial output growth will rise to about 8%, the OECD’s current estimate of trend. This compares with 5.6% in October, with a November number due shortly. One caveat: the OECD revises its leading indicators monthly, so another month or two of data are needed to confirm a change of direction.