Why is US economic news holding up?

Posted on Thursday, June 21, 2018 at 12:58PM by Registered CommenterSimon Ward | CommentsPost a Comment

Global economic activity news has surprised negatively since March, with the Citigroup G10 composite index recently reaching its lowest level since 2012 – see first chart. This is consistent with the “monetarist” view that global economic momentum would peak in early 2018 and soften into the second half of the year.

Global data weakness, however, conceals continued, though moderating, positive surprises in the US offset by very negative news elsewhere – second chart. Yet real narrow money growth – as measured by the six-month rate of change of M1 deflated by consumer prices – has been no less weak in the US than in most other major economies.

Why has US news remained resilient despite an apparently negative monetary backdrop?

An obvious answer is that fiscal stimulus has insulated the US from monetary tightness and global economic weakness. A post in December, indeed, argued – contrary to the consensus view – that US tax cuts were well-timed from a cyclical perspective, albeit reckless in terms of longer-term fiscal health.

The view here, however, was – and still is – that an effective fiscal stimulus would be signalled by a pick-up in narrow money trends. As previously discussed, such a pick-up occurred following the tax reductions in 1964, 1978 and 1981 – the three largest cuts since World War Two before the current programme (which ranks third of the four).

The explanation for the puzzle may be that US money trends have been less negative than suggested by the headline M1 data. This view is supported by additional monetary details in the Fed’s financial (flow of funds) accounts for the first quarter of 2018, released two weeks ago.

The preferred narrow money measure here for forecasting purposes is non-financial M1, comprising holdings of households and non-financial businesses. Aggregate M1 includes checkable / overnight deposits of financial institutions, fluctuations in which often reflect portfolio allocation shifts, with no economic implications.

Non-financial M1 can be calculated monthly in the Eurozone and UK, while Japanese headline money measures are non-financial by construction. In the US, by contrast, non-financial M1 is available only on a quarterly basis with a significant lag from the Fed’s financial accounts.

The third chart shows the two-quarter / six-month changes in US GDP and real M1 / non-financial M1. Turning points in real money momentum have consistently led turning points in GDP momentum in recent years. As expected, non-financial M1 appears to have given slightly more reliable signals.

The six-month change in real non-financial M1 was weaker than that of real M1 in the second half of 2017 but rebounded sharply in the first quarter of 2018. The financial accounts show that M1 was held back by a fall in checkable deposits of financial institutions – in particular, money market funds and government sponsored enterprises (GSEs). Money funds moved funds out of banks and the repo market in order to buy Treasury bills, probably in response to attractive interest rates caused by a surge in supply, while GSEs increased their repo lending. These shifts are unlikely to carry any significance for economic prospects.

The recovery in real non-financial M1 momentum may help to explain recent US data resilience and suggests that economic growth will continue to hold up better than elsewhere near term. The judgement here, however, remains that US monetary trends are signalling a second-half slowdown, with data likely to surprise negatively relative to upbeat consensus expectations. This judgement reflects three additional considerations.

First, while the six-month change in real non-financial M1 was above that of real M1 in March, year-on-year growth rates were similar and near the bottom of the range in recent years – fourth chart.

Secondly, real M1 momentum – both six-month and year-on-year – has weakened since March. It seems likely that six-month real non-financial M1 growth has fallen back in the second quarter, although confirmation, unfortunately, will not be possible until the next financial accounts are released in early September.

Thirdly, the rebound in the six-month change in real non-financial M1 in the first quarter partly reflected a large quarterly rise in holdings of non-financial corporations, and this increase may have been connected with foreign earnings repatriation due to the tax changes. If so, it may represent a temporary rise in money demand as corporate balance sheets are reorganised, rather than signalling stronger business spending.

Global industrial activity cooling, money trends stable

Posted on Wednesday, June 20, 2018 at 10:00AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global six-month industrial output growth appears to have fallen sharply in May, consistent with the long-standing forecast here, based on monetary trends, of an economic slowdown starting around spring 2018. Global six-month real (i.e. inflation-adjusted) narrow money growth, meanwhile, was little changed for a second month in May and slightly above the nine-year low reached in February – the monetary message is that economic prospects remain weak but have not deteriorated further.

The May estimate of global (i.e. G7 plus E7) six-month industrial output growth shown in the chart incorporates data for the US, China and Russia – together accounting for 50% of the global aggregate – and an assumed 0.25% monthly rise in other economies. The latter assumption appears reasonable and possibly optimistic based on survey and other evidence, while output in those economies would have to surge by 1.5% to prevent a fall in global six-month growth. The global measure appears to have peaked in March, consistent with a peak in real narrow money growth in June 2017, allowing for the historical-average nine-month lead. 


The US, China, Japan, Brazil and India have released May monetary data, with numbers for most of the remaining countries due next week. The May estimate of global six-month real narrow money growth in the chart extrapolates recent nominal monetary trends in missing countries while incorporating near-complete consumer price data.

The February low in real money growth suggests that industrial output growth will continue to decline into around November 2018.

Monetary trends, it should be emphasised, are signalling a slowdown, not a recession. Six-month real narrow money growth bottomed well above zero. Real money contracted before the six global recessions since 1970. 

The lack of a significant recovery to date in real money growth suggests that global economic momentum will remain soft into early 2019.

Chinese economy slowing, signals mixed

Posted on Thursday, June 14, 2018 at 02:56PM by Registered CommenterSimon Ward | CommentsPost a Comment

Chinese monetary trends remain worrying but non-monetary leading indicators are giving a more hopeful message for economic prospects. A further slowdown is expected over the remainder of 2018 but weakness may be contained.

The forecasting approach followed here uses non-monetary leading indicators – usefully summarised by the OECD’s composite measures – to cross-check the message from monetary trends. In China’s case, the signals currently conflict, reducing confidence in the forecast.

Monetary trends are unambiguously weak. Annual growth of the official M1 measure fell further to 6.0% in May, the least since 2015, while M2 growth was stable at 8.3%, just above December’s record-low 8.1%. The alternative money measures preferred here were similarly soft, as was the “total social financing” credit measure – see first chart.

Previous posts suggested that monetary trends would revive in response to an apparent policy reversal towards easing in April, reflected in a sharp fall in term money market rates, although the timing and extent of a recovery were uncertain. The May money and credit data indicate that the policy shift has yet to gain traction, while money rates have recently partially retraced their decline – second chart.

Activity news for May released today appears, on the surface, to be consistent with the negative message from money trends. Annual growth rates of industrial output, retail sales and fixed asset investment fell from April and undershot consensus estimates. Investment growth weakened particularly sharply – third chart.

Some details of the reports, however, jar with a negative interpretation. Annual growth of housing sales and starts rose smartly – fourth chart. Steel production was also notably strong. The sharp fall in investment growth, meanwhile, reflected weakness in infrastructure spending, with private capex expansion only slightly lower.

The OECD’s Chinese composite leading indicator, meanwhile, rose for a second month in April, according to data released yesterday – fifth chart. The six components of the indicator are: steel production, motor vehicle production, building completions, production of chemical fertilisers, the export orders balance from the PBoC’s quarterly 5000 enterprise survey and stock market turnover. New data for the first three components released today imply a positive contribution to the indicator reading for May, according to our calculations.

The decline in the leading indicator into February suggests an economic slowdown through late 2018, consistent with the message from monetary trends. Prospects further out are cloudy but a pessimistic bias will be retained here pending a revival in money trends.

Is the MSCI EM index fit for purpose?

Posted on Wednesday, June 13, 2018 at 11:10AM by Registered CommenterSimon Ward | CommentsPost a Comment

The characteristics of the MSCI emerging markets (EM) equities index have changed significantly in recent decades, raising questions about its suitability as a benchmark for EM investing.

The index is now dominated by China, the weight of which rose to 33.2% on 1 June following the addition at end-May of more than 200 A shares with an inclusion factor of 2.5% of their market capitalisation.

China’s weight on 1 June, surprisingly, was not the largest single-country weight in the history of the index – Malaysia’s weight was 33.8% at the inception of the index on 1 January 1988, when there were only 10 country constituents, compared with the current 24 – see first chart.

The largest single-country weight, however, has averaged 20.5% over the 30-year history of the index – well below the current Chinese level. China’s weight, moreover, is likely to increase further – the A share factor is scheduled to rise to 5% at end-August, while it is reasonable to assume full inclusion within 10 years. (The phased inclusion of Korea and Taiwan in the 1990s / 2000s occurred over seven and nine years respectively.) MSCI previously estimated that China would account for about 42% of the index if the A shares were included fully, based on then-prevailing market capitalisations.

The rise of China has resulted in the index providing less regional diversification. At end-1999, Europe, the Middle East and Africa (EMEA) accounted for 31.5% of the index, with Latin America at 28.2%. The weights on 1 June were 13.9% and 10.6% respectively, with Asia up to 75.5%. Asia’s weight could exceed 80% if / when the Chinese A shares are fully included – second chart.

The index has also become less “emerging”. The third chart shows the relative income levels of the EM index (a market capitalisation-weighted average of the constituent countries) and selected countries. Relative income is measured by GDP per capita at purchasing power parity expressed as a percentage of the G7 level. At its inception in 1988, the index represented countries with an average income of about one-third of the G7 level. That proportion has risen to about a half, mainly reflecting the inclusion and rapid growth of Korea and Taiwan. Taiwan’s GDP per capita is now close to the G7 average while Korea’s is within the G7 range. From an economic perspective, neither country should be represented in an EM index.

Investors, arguably, should now allocate to Korea and Taiwan within the developed markets portion of their equity portfolio. Removing them from the EM benchmark, however, would further magnify China’s dominance. There is a case for separating out China, to reflect its size and unique economic characteristics, and to make explicit the allocation decision between China and the rest of EM – in the same way that investors often separate a developed markets portfolio into US and “international” buckets.

Stripping China, Korea and Taiwan from the MSCI EM index would create a benchmark with similar characteristics to the “old” EM index: GDP per capita of the benchmark constituents would be less than 40% of the G7 level – third chart – while the weights of EMEA and Latin America would be much closer to that of Asia – fourth chart.

Are the profits / investment cycles peaking?

Posted on Tuesday, June 12, 2018 at 10:15AM by Registered CommenterSimon Ward | CommentsPost a Comment

Underlying profits growth in the G7 economies cooled in the first quarter of 2018 and is modest by historical standards, casting doubt on expectations of economic strength based on a further pick-up in business investment.

The underlying profits numbers are from the national accounts and refer to the gross domestic operating surplus of corporations (or the closest available measure), which is equivalent to “EBITDA” (i.e. earnings before interest, tax, depreciation and amortisation). The G7 series is a GDP-weighted average of country data. Annual underlying profits growth was 2.8% in the first quarter of 2018, down from 3.7% in the fourth quarter of 2017 and below an average of 3.8% since 1995 – see first chart.

The G7 series has been dragged down by slowdowns in Japan and the UK. Euroland profits growth has also eased, while US growth has been stable but modest – second chart.

Post-tax US profits, of course, have been boosted by recent tax changes, growing by an annual 8.9% in the first quarter versus 3.9% for the pre-tax measure. Tax cuts, however, are less likely to feed through to business investment if underlying profitability is deteriorating.

Operating margins in the US and several other G7 countries are under threat from rising unit wage cost growth due to stretched labour markets and weak productivity trends. The gap between the US unemployment and job opening rates is an indicator of labour market slack and has displayed a leading relationship with margins historically, with the current message very negative – third chart.

Annual growth of G7 real underlying profits (i.e. current-price profits divided by the GDP deflator) is correlated with, and usually leads, annual business (i.e. non-residential) investment growth. Real profits growth appears to have peaked in the second quarter of 2017, suggesting that investment growth is at or close to a top – fourth chart.

A peak in investment growth would be consistent with the assessment here that the seven- to 11-year Juglar business investment cycle will enter a downswing by 2019. As the fourth chart shows, the annual change in G7 business investment reached lows below -3% in 1975, 1983, 1993, 2002 and 2009. The interval between troughs, that is, ranged from 7.25 to 10.5 years, consistent with the longer-term historical evidence on the length of the Juglar cycle. With the last bottom reached in the second quarter of 2009, another trough is scheduled by the second quarter of 2020 at the latest, implying a downswing starting in 2018-19.