The OECD today released three months’ worth of data on its composite leading indicators for OECD countries and major emerging economies, following a bizarre decision to suspend publication over the summer because of supposed Brexit-related uncertainty. The indicators signal an emerging markets-led pick-up in global growth, confirming the message from recent narrow money trends.
The first chart shows six-month changes in G7 plus emerging E7 industrial output, real narrow money and a leading indicator derived from the OECD country data. Real narrow money growth started to pick up in late 2015, with leading indicator momentum following in early 2016. Industrial output has shown signs of life in June / July, while the leading indicator has gained further strength.
The second and third charts show the E7 and G7 groupings separately. The upswing in the aggregate leading indicator has been driven by the E7 component but G7 weakness has abated, with G7 narrow money trends suggesting further improvement. The E7 pick-up has been broadly based among the constituent countries but China has been a major contributor, consistent with earlier narrow money buoyancy – fourth chart.
A rise in UK money growth over the past year signals faster nominal GDP expansion over coming quarters. The Brexit uncertainty shock and associated sterling weakness suggest that higher inflation will drive the pick-up, although output growth is also likely to exceed consensus expectations.
The chart shows annual growth rates of nominal GDP and the narrow / broad money measures tracked here – non-financial M1 and M4 – along with the Bank of England’s M4ex broad measure*. A directional leading relationship is apparent between non-financial M1 growth and nominal GDP expansion. The relationship is looser but still visible for the broader measures, with non-financial M4 outperforming M4ex.
Annual growth rates of non-financial M1, non-financial M4 and M4ex have been rising since June 2015, February 2015 and November 2014 respectively. Consistent with the “monetarist” relationship, nominal GDP expansion has recovered from a low reached in the third quarter of 2015. The lead time between non-financial M1 growth and nominal GDP expansion has averaged 7.5 months at the four turning points since 2010, suggesting that nominal GDP will continue to accelerate through early 2017, at least.
The pick-up in annual growth of the Bank’s M4ex measure was modest until May, reflecting falls in money holdings of financial corporations, i.e. fund managers, insurance companies / pension funds, securities dealers etc. These holdings, however, have surged at a 70.0% annualised rate over the past three months, pushing annual growth of M4ex above that of non-financial M4.
The prospect of a further rise in nominal GDP growth casts doubt on the wisdom of the MPC’s recent easing moves. The decision to launch more QE with M4ex growing by 6.9% annually and at a 14.7% annualised pace in the latest three months is particularly questionable. The MPC is, in effect, gambling that the Brexit shock will cause the recent monetary pick-up to reverse but there was no sign of weakness in the July-only data.
*The non-financial measures cover holdings of households and private non-financial firms. M1 = notes / coin plus sterling sight deposits. M4 additionally includes sterling time deposits, money funds, repos and short-term bank securities. M4ex = non-financial M4 plus M4 holdings of non-bank financial corporations, excluding intermediaries.
Negative data surprises yesterday and today have dealt a superficial blow to the view here that US economic growth is gathering pace. The surprises, however, are judged to be of minor significance and more than outweighed by August monetary data showing a further pick-up in narrow money expansion.
The first surprise was a drop in the Institute for Supply Management (ISM) manufacturing purchasing managers’ index to 49.4 in August from 52.6 in July. The new orders component was particularly weak, falling to 49.1 from 56.7.
The first chart compares the ISM new orders index with an average of current and future order balances in five regional Fed manufacturing surveys (New York, Philadelphia, Richmond, Kansas, Dallas). The ISM series had been stronger (relative to history) than the Fed average over the prior three months and appears to have overcorrected in August. The Fed series remained in expansionary territory last month and well above a low reached in May / June.
The second chart separates the Fed average into current and future components. The current component mirrored the weakness of the ISM new orders index in August but the future component rose to a 20-month high.
ISM weakness, therefore, seems partly to reflect statistical noise and will probably prove temporary.
The second negative surprise was today’s August employment report, showing smaller-than-expected rises in non-farm payrolls and average earnings, and a fall in average weekly hours. The payrolls miss, however, was minor and follows blockbuster gains in June and July: the three-month moving average rose to 232,000, the strongest since January – third chart.
Annual growth of hourly earnings of private production and non-supervisory workers edged down from 2.5% to 2.6% but the trend remains up, consistent with a high job openings rate – fourth chart. Earnings growth stood at 2.0% when the Fed hiked rates in December.
The above indicators are coincident (at best) measures of the economy. Narrow money trends are of much greater significance for judging prospects: changes in real (i.e. inflation-adjusted) narrow money growth have consistently led swings in GDP expansion in recent years. Weekly data through 22 August indicate that real money growth rose further last month to its highest level since February 2015 – fifth chart.
The view here remains that the Fed will raise rates before year-end, with a move this month still possible. The narrow money backdrop, moreover, is much stronger now than in December 2015, suggesting that a further increase will occur in early 2017 as economic growth exceeds Fed and consensus expectations.
The buoyancy of UK retail spending in the wake of the Brexit vote had been signalled by strong July growth of notes and coin in circulation. Weekly Bank of England data on the note issue suggest that the stock of currency rose solidly again in August, hinting that spending has remained firm.
Annual growth of notes and coin has been trending higher since late 2015, reaching 8.2% in July, the fastest since 2009. Annual growth in the note issue, meanwhile, rose from 8.6% in July to 8.8% in August, according to the weekly Bank of England data – see chart. This suggests that the monthly rise in currency in circulation in August exceeded a 0.6% increase in August 2015. (Notes account for more than 90% of the currency stock.)
In addition to spending resilience, currency demand may have been boosted by further cuts in instant-access deposit rates and fears that banks will start to charge for operating current accounts. As previously discussed, data in the Bank’s Annual Report show that the stock of £50 notes has been growing particularly strongly, possibly indicating rapid expansion of illegal economic activity and / or “hoarding” of such notes.
The CBI’s expected growth indicator – a weighted average of business expectations from its manufacturing, distribution and services surveys – is likely to have recouped part of its July loss in August, based on already-released data. The current level of the indicator is consistent with weak economic expansion.
The expected growth indicator slumped from +16% in June to -3% in July but even the latter was above a level suggesting economic contraction, based on historical evidence. The indicator is estimated to have recovered to about +4% in August, reflecting gains in all three component surveys, with a particularly large rebound in retail / wholesale trade expectations – see chart*.
The historical correlation of the CBI indicator with quarterly GDP / gross value added (GVA) changes is similar to that of the more widely-followed composite PMI output index, the July level of which was consistent with quarterly contraction of 0.4%, according to the index compilers. The CBI indicator suggests that the PMI will recover in August but it may remain below the “breakeven” 50 level, partly because its coverage excludes distribution.
*The CBI indicator values in the chart have been seasonally adjusted. Seasonal influences appear to have contributed to the large fall in the indicator in July.