Emerging market equities are slightly ahead of developed markets year-to-date but relative monetary trends question whether outperformance can continue.
The first chart shows the ratio of MSCI's emerging markets index in US dollars to its developed markets index, together with the six-month rates of change of real narrow money M1 in the G7 and seven large emerging economies. Emerging markets outperformance during the 2000s occurred when E7 real money growth was higher than G7 growth or was rising strongly. The E7 / G7 gap has been mostly negative during the sustained relative bear market since 2010.
Current conditions are unpromising, with G7 real money growth higher and rising strongly but E7 growth down sharply in December.
Weakness in the E7 aggregate is due to real M1 contraction in Russia, Brazil and China, and a recent slowdown in India. By contrast, monetary trends are strong in Korea, Mexico and Taiwan – second chart.
Russian real M1 fell by 9.1%, or 17.4% annualised, in the six months to December, reflecting both nominal money contraction and a currency-driven inflation surge. The economy was temporarily supported by panic spending of rouble money balances at end-2014 but industrial output should slump in early 2015 – third chart.
The monetarist / leading indicators forecasting approach used here suggested that the global economy would lose momentum during the first half of 2014 but revive during the second half. This proved broadly correct, although the activity trough occurred slightly later than expected: six-month growth of global* industrial output peaked in November 2013, falling to a low in August 2014 before recovering strongly through December 2014 – see first chart.
The forecasting approach now suggests that growth will remain solid or rise further during the first half of 2015. The global longer leading indicator continued to edge higher in December, while six-month real narrow money expansion has been boosted by falling energy prices – first chart.
A striking feature of the 2014 slowdown was its limited impact on labour markets. The G7 unemployment rate trended lower through the year, reaching its lowest since 2008. Stronger recent and prospective growth implies a significant further decline, a scenario consistent with consumer surveys showing less concern about labour market conditions – second chart.
Unemployment rates are now below 25-year averages in the four largest G7 economies. The US, Japanese and UK jobless rates are at their lowest levels since 2008, 1997 and 2008 respectively, with the German rate at a record low in data extending back to 1990 – third chart.
Job openings rates – unfilled vacancies expressed as a percentage of employment plus vacancies – are an alternative gauge of labour market tightness, with above-average readings signalling that employers are finding difficulty recruiting suitable workers. Openings rates in the US, Japan and the UK are the highest since 2001, 2006 and 2008 respectively, with the German rate at a post-1990 record – fourth chart.
The final four charts show, for each economy, a measure of wages / salaries growth along with the job openings rate. Current growth is higher than in 2013 in all four cases, with the current level of the openings rate suggesting a further, possibly sizeable, increase.
Central banks, in aggregate, are in the process of easing policy significantly, partly in response to a favourable oil supply shock, despite an upswing in the economic cycle and limited labour market slack. This is likely to prove a mistake, with a reassessment necessary later in 2015.
*G7 plus seven large emerging economies.
UK monetary trends remain consistent with solid economic growth but are no longer stronger than in the Eurozone, suggesting that the UK’s period of outperformance is nearing an end.
The preferred narrow and broad monetary aggregates here are “non-financial” M1 and M4, covering holdings of households and private non-financial firms but excluding “other financial corporations”. M1 comprises notes / coin and sight deposits, with M4 adding in other deposits, repos and short-maturity bank paper.
Six-month growth of non-financial M1 fell further in December to 2.8%, or 5.6% annualised, the lowest since July 2012. Non-financial M4 expansion, by contrast, was stable at 2.6%, or 5.3% annualised – above its level for much of 2013 and 2014. Narrow and broad money growth, therefore, have converged – see first chart.
The slowdown in non-financial M1 is unlikely to presage economic weakness, for three reasons. First, current growth remains respectable. Secondly, the slowdown reflects lower growth of household M1; corporate M1 is still rising fast and is usually a good guide to economic prospects. Thirdly, the deceleration of non-financial M1 has been matched by a decline in consumer price momentum – first chart. Its real growth, therefore, has moved sideways since summer 2014, while that of non-financial M4 has risen sharply – second chart.
Eurozone real non-financial M1 growth was below the UK level for most of 2012-2014 but is now significantly higher – third chart. The current gap is comparable with 2010-11, when Eurozone and UK GDP rose at a similar pace (2.0% and 1.9% respectively in 2010, and 1.7% and 1.6% in 2011).
Eurozone six-month real money growth continued to strengthen in December, supporting the optimistic view here of economic prospects – see also yesterday’s leading indicator report.
The monthly rise in narrow money M1 slowed to 0.3% last month, while the broad M3 measure was unchanged from November. Six-month growth rates, however, remained solid, at 4.8% and 2.2% respectively (9.7% and 4.5% annualised), reflecting strong gains in prior months.
Real growth was boosted by an energy-driven fall in consumer prices in December. Six-month real M1 expansion is now the highest since October 2009, and M3 expansion since February 2009. Real bank lending is also finally growing – see first chart. (The money supply leads the economic cycle, while lending is coincident / lagging.)
Sceptics argue that real money acceleration due to falling prices is not a positive economic signal. There are two responses. First, the recent pick-up in real money growth mainly reflects faster nominal expansion rather than weaker prices – second chart. Secondly, economic growth has strengthened after previous occasions when real money has been boosted by a decline in prices. A surge in real M1 in 2008-09, for example, was also partly due to a fall in energy costs but correctly signalled a strong economic rebound in 2009-10.
The country deposit breakdown shows solid real narrow money trends across the big four economies. Six-month growth in real M1 deposits remains fastest in Spain; Germany had been lagging but caught up with France last month – third chart.
Previous posts argued that QE had limited impact on monetary growth in the US, UK and Japan because it partly involved banks swapping securities for idle reserves at the central bank. The coming ECB programme could be more effective because rising excess reserve holdings will be penalised via the negative deposit facility rate, giving banks a greater incentive to expand lending.
In other Eurozone news today, German unemployment on an internationally-standardised definition fell to a new post-reunification low of 4.8% in December, with a corresponding further rise in the job openings (vacancies) rate. The labour market in Germany appears tighter than in the US / UK, suggesting greater upward pressure on wage growth – fourth chart.
The Eurozone longer leading indicator calculated here rose further in December, suggesting that economic growth will rise into mid-2015, at least – see first chart.
The indicator uses the same components as the OECD’s Eurozone leading indicator but is calculated independently and is designed to predict turning points in the six-month rate of change of industrial output*. The December reading is based on partial data but the direction of change is unlikely to be revised. The further increase last month partly reflects recent stronger business survey results in Germany and France**.
The leading indicator turned negative in early 2014 but has been recovering since mid-year, regaining positive territory in September. It usually leads economic momentum by about half a year so the recent improvement in Eurozone coincident data, reflected in a positive reading of the Citigroup surprise index, is occurring on schedule.
The indicator’s revival confirms the hopeful message from monetary trends. Real (i.e. inflation-adjusted) narrow money M1 also leads industrial output by about half a year and its six-month growth reached a five-year high in November – second chart. (December money numbers are released tomorrow.)
The combination of strong real money growth, perhaps to be boosted further by sovereign QE, with weak but rising industrial output expansion suggests a favourable backdrop for Eurozone risk assets.
*The OECD leading indicator predicts the level of output relative to trend rather than growth.
**The December reading of the indicator incorporates January data where available in the calculation of trends in the components.