UK MPC on course for risky rate hike

Posted on Tuesday, April 17, 2018 at 12:07PM by Registered CommenterSimon Ward | CommentsPost a Comment

UK labour market statistics confirm stronger wage cost pressures and suggest that the MPC will press ahead with another interest rate increase next month. The view here remains that the Committee should hold fire because of worryingly weak monetary trends.

Annual growth of average weekly earnings, smoothed over three months, was unchanged at 2.8% in February and below a consensus forecast of 3.0%. The undershoot, however, reflected lower growth of bonus payments – the ex. bonuses measure moved up to 2.8%, the highest since 2015.

Hourly pay, moreover, is rising considerably faster because of a fall in average weekly hours worked over the last year. Hourly earnings growth, including or excluding bonuses, is estimated to have increased further to 4.0% in February, with the ex. bonuses measure the highest since 2009 – see first chart.

The recent acceleration of hourly earnings has outpaced a modest improvement in growth of productivity (i.e. output per hour), implying stronger unit wage cost expansion – second chart. Annual productivity growth rose to 1.0% in the fourth quarter of 2017 and may have increased slightly further in the first quarter, reflecting the dropping-out of a quarterly decline a year earlier. With hourly earnings growth at 4.0%, however, annual unit wage cost expansion may have moved up towards 3% last quarter, after 2.4% in the fourth quarter.

MPC concern about labour market overheating will be heightened by a further fall in the unemployment rate to 4.2% in the three months to February and 4.0% in February alone – below a forecast of 4.3% for the first quarter in the February Inflation Report.

Increased labour cost pressures support the view here that consumer price inflation will be slower to return to the 2% target than the MPC projected. As previously discussed, however, these pressures reflect past monetary and economic strength – current weak monetary trends suggest diminishing medium-term inflation risks, with narrow and broad money growing at annualised rates of only 1.6% and 1.1% respectively in the three months to February. A May rate hike would risk exacerbating this weakness.

Are global money trends stabilising?

Posted on Monday, April 16, 2018 at 03:10PM by Registered CommenterSimon Ward | CommentsPost a Comment

A further fall in global real narrow money expansion in early 2018 suggests that a recent slowdown in economic activity will be sustained until late in the year, allowing for the typical nine-month lead. Previous posts (e.g. here) discussed reasons for thinking that real narrow money trends would stabilise or recover from the first quarter, a development that would provide some reassurance about economic prospects for end-2018 / early 2019. Partial monetary data for March are consistent with this scenario.

March monetary figures are available for the US, China, Japan and Brazil, together accounting for 60% of the G7 plus E7 aggregate tracked here. Assuming unchanged nominal money growth in the other economies, and taking into account March inflation data / forecasts, G7 plus E7 six-month real narrow money expansion is estimated to have returned to its December level, following February’s nine-year low. This would, however, still leave it below its range between September 2008 and November 2017 – see first chart.

The estimated March recovery reflects two factors: a rebound in US six-month nominal narrow money growth and a fall in the six-month rate of change of global consumer prices (seasonally adjusted).

As previously discussed, a rise in US narrow money growth into the third quarter of 2018 would fit the pattern after three previous large tax cuts. The Fed, as now, was raising interest rates as these tax cuts were enacted; the additional tightening implied by current and planned balance sheet contraction, however, could undermine the comparison. The weekly narrow money data fell back during March and will need to rebound in April to maintain alignment with the historical pattern.

Brazilian six-month narrow money growth also strengthened in March but Chinese and Japanese data were weak – second chart.

A fall in six-month global consumer price inflation had been suggested by recent commodity price trends – third chart. The March decline, however, was larger than expected – a further fall seems unlikely and a rebound is possible, unless commodity prices weaken significantly from current levels.

The estimated March recovery in global real narrow money expansion, therefore, is tentative and requires confirmation from April / May readings before concluding that nine-month-ahead economic prospects are improving. Such confirmation, of course, would not alter the forecast of a further economic slowdown through late 2018.

A firm March reading will be available in early May and will depend importantly on Euroland monetary data to be released on 30 April.

G7 yield curve echoing monetary slowdown signal

Posted on Thursday, April 12, 2018 at 10:47AM by Registered CommenterSimon Ward | Comments5 Comments

The assessment here that the global economy has entered a slowdown phase likely to last through late 2018 (at least) rests primarily on weaker monetary trends since mid-2017. The slope of the G7 yield curve – another longer leading indicator with a respectable historical record – is consistent with the monetary message.

G7 six-month real narrow money growth has displayed a significant positive correlation historically with the slope of the yield curve, defined as a GDP-weighted average of 10-year government yields minus three-month money rates – see chart. The correlation is maximised by applying a two-month lag on real money growth, i.e. money growth appears to move slightly ahead of the yield curve.

While the yield curve slope often gives a similar forecasting message to narrow money trends, the judgement here is that money signals are more reliable.

The yield curve has given some notable false signals historically, e.g. it inverted in 1986 and 1998 but no recession ensued over the following two years. Real narrow money trends did not suggest economic weakness on these occasions.

The yield curve, moreover, can be distorted by central bank efforts to control it through QE and forward guidance. Real narrow money growth picked up strongly between mid-2015 and mid-2016, correctly signalling global economic acceleration in late 2016 / 2017. The yield curve, by contrast, flattened over this period, possibly partly reflecting an increased G7 flow of QE following the start of the ECB’s programme in March 2015. The QE pick-up, indeed, may have both boosted money growth while distorting the yield curve signal.

A further consideration is that real narrow money appears to work better as a forecasting indicator than the yield curve slope in emerging economies. This may partly reflect financial market underdevelopment – the performance of the yield curve may improve as markets deepen and mature. A money-based global forecasting measure, therefore, is likely to outperform one based on interest rates.

Real narrow money trends and the yield curve slope are giving a similar message currently. The monetary slowdown has been accompanied by a flattening curve. Real money continues to grow and the curve has not inverted, so no recession signal has yet been given.

A "monetarist" perspective on current equity markets

Posted on Tuesday, April 10, 2018 at 12:07PM by Registered CommenterSimon Ward | Comments2 Comments

Our last quarterly commentary noted that global narrow money trends had weakened significantly during the second half of 2017, suggesting that the economy would lose momentum in 2018 while the liquidity backdrop for markets was no longer favourable. Money trends softened further in early 2018, adding to our concerns. It is possible that US and Chinese money data will rebound over coming months, reflecting, respectively, the lagged impact of tax cuts and policy easing. A defensive investment stance, however, is recommended until such a recovery is confirmed.

Our key forecasting indicator is the six-month growth rate of real (i.e. inflation-adjusted) narrow money* in the G7 advanced economies and seven large emerging economies (the “E7”). Real money growth has led turning points in economic growth by nine months on average historically. The indicator peaked most recently in June 2017, falling significantly later in the year. This suggested that global economic momentum would slow from a peak to be reached around March 2018 – see first chart.

Recent economic news appears consistent with global growth passing a peak. The Markit Economics / J P Morgan global composite purchasing managers’ index, for example, is widely followed as a coincident indicator of economic activity and fell sharply from a 41-month high in February to a 16-month low in March.

Monetary trends, meanwhile, have weakened further in early 2018, with G7 plus E7 six-month real narrow money growth falling to a nine-year low in February. Real broad money has also continued to decelerate. The emerging economic slowdown, therefore, could extend into late 2018, allowing for the usual lead.

Weak money trends also imply less liquidity support for equity prices. Significantly, G7 plus E7 six-month real narrow money growth crossed below industrial output growth in December 2017, with the shortfall increasing in January / February. Global equities have underperformed US dollar cash by 7.2% per annum on average historically (i.e. over 1970-2017) when real money growth has been lower than output growth. The February / March set-back in markets is consistent with this experience.

Why could this prognosis be too gloomy? Economic optimists expect US tax cuts and higher federal spending to boost US / global growth later in 2018 and in 2019. Our view is that a significant positive impact should be signalled in advance by monetary reacceleration. We examined money trends around three previous large tax cuts and found a pattern of money growth rebounding two to four months after legislation was enacted. Recent behaviour has been consistent with the historical pattern, which suggests a rise in money growth in the second and third quarters – second chart. Such a recovery would imply better economic prospects for late 2018 / early 2019.

Another upside risk is an early easing of Chinese monetary policy. A clampdown on speculative credit and shadow banking activity since late 2016 has been reflected in much weaker money trends, an economic slowdown and falls in house and producer price inflation. The authorities, on our assessment, are likely to need to relax restrictions to prevent GDP growth undershooting the 6.5% target. A recent decline in interbank interest rates may be an early sign of policy shift.

A rebound in US / Chinese money trends over the next three to six months would not alter the forecast here of a loss of global economic momentum through late 2018 but would suggest a reacceleration into 2019. A monetary rebound, coupled with near-term economic weakness, could conceivably result in global real money growth moving back above output growth later in 2018, reversing the current negative signal for equity markets.

Downside risks, however, are also present. Federal Reserve balance sheet contraction could offset any boost to monetary trends from tax cuts. Major central banks appear overly optimistic about economic prospects and may be slow to offer policy support as momentum cools. A late-cycle pick-up in labour cost inflation remains possible. Rising trade tensions, meanwhile, threaten to undermine business confidence and investment plans.

The recent global monetary slowdown has been remarkably synchronised across economies. Real narrow money trends remain particularly weak in Australia and Canada, with the UK joining the rear carriage following the November 2017 interest rate hike – third chart. These three equity markets underperformed in the first quarter. The UK Monetary Policy Committee is worried about rising labour cost pressures but monetary weakness argues for delaying a further rise in rates.

At the opposite end of the range, real narrow money growth remains respectable by historical standards in Japan and Euroland but has nonetheless fallen significantly since mid-2017. In contrast to the US and China, moreover, there are no strong grounds for expecting a monetary rebound. The recent success in Italian elections of parties advocating fiscal loosening is likely to strengthen the ECB’s resolve to wind down QE by end-2018.

Country-level monetary trends, therefore, are not currently giving strong signals for regional / country selection. The main strategy suggestion from our analysis is to reduce exposure to cyclical equity market sectors in favour of defensive sectors. This follows from the forecast of a near-term global economic slowdown and is also directly implied by the low level of global real narrow money growth – fourth chart.

Emerging equity markets often underperform developed markets during global economic downswings but the sign of the gap between E7 and G7 real narrow money growth is also relevant for assessing relative return prospects, according to our analysis of historical data. While both E7 and G7 trends have weakened, the gap is currently positive, suggesting maintaining exposure to emerging markets despite a less favourable cyclical economic backdrop – fifth chart.

*Narrow money = currency in circulation plus demand deposits and close substitutes. Broad money = narrow money plus time deposits, notice accounts, repos and bank securities. Precise definitions vary by country. Narrow money has been more reliable than broad money for forecasting purposes historically and is consequently emphasised in the analysis here. Real = inflation-adjusted.

Is China starting to ease?

Posted on Wednesday, April 4, 2018 at 12:43PM by Registered CommenterSimon Ward | CommentsPost a Comment

Previous posts (e.g. here) suggested that weaker economic growth and a cooling of inflationary pressures would prompt the Chinese authorities to take steps to ease monetary conditions in mid-2018. A recent fall in interbank rates could be an early indication that a policy shift is under way.

Significant policy tightening since late 2016 has been achieved mainly via regulatory / macroprudential measures, rather that Western-style changes in central bank money market intervention rates. The PBoC seven-day reverse repo rate, which sets the floor for short-term market rates, rose by only 25 basis points (bp) between end-September 2016 and end-December 2017. The regulatory clampdown, however, restricted access to and boosted the cost of term market funding. Three-month SHIBOR climbed 210 bp over the same period. Restrictive policy, that is, has operated to a significant extent through the wider three-month SHIBOR / seven-day reverse repo rate spread.

A recent fall in the spread, therefore, may be meaningful. The PBoC raised the seven-day reverse repo rate by a further 5 bp on 22 March following the latest FOMC quarter-point hike, contributing to a consensus view that policy remains on a tightening tack. Three-month SHIBOR, however, has, fallen by 30 bp since 21 March, reducing the spread to the lowest since July – see first chart.

Recent economic news, admittedly, has been mixed and not obviously a trigger for a policy shift towards easing. The authorities, however, may be concerned about a continued slowdown in credit and monetary aggregates: three-month annualised growth of total social financing, seasonally adjusted by Datastream, fell to a new low of 7.1% in February – second chart. Producer price pressures, meanwhile, have cooled, with input price balances in the March NBS and Markit manufacturing  PMI surveys at nine-month lows. Rising trade tensions with the US may also be shifting policy-makers’ bias towards precautionary easing.

Policy easing, if confirmed, would be expected, as usual, to be reflected swiftly in a revival in money trends, in turn suggesting improving economic prospects for late 2018 / early 2019. If accompanied by a stabilisation or recovery in US money trends, which – as previously discussed – would be consistent with experience after previous large tax cuts, this would temper concern here that an expected global economic slowdown over the remainder of 2018 will extend and deepen in 2019.