Chinese money trends signalling further slowdown

Posted on Thursday, January 17, 2019 at 11:13AM by Registered CommenterSimon Ward | CommentsPost a Comment

Weak Chinese December money and credit numbers signal that policy easing has yet to translate into an improvement in economic prospects.

The preferred narrow and broad monetary aggregates here are M1 plus household demand deposits – i.e. true M1 – and M2 excluding deposits of financial institutions. Six-month growth of true M1 fell back towards the recent August low – see first chart.

Growth of M2 excluding financial institutions’ deposits rose to an 18-month high, a development some commentators may cite as a hopeful signal. The interpretation here is that broad money is being boosted by the contraction of the shadow banking system and a consequent shift of assets and liabilities onto banks’ balance sheet. The rise in bank deposits, that is, has probably been the counterpart of a larger fall in unrecorded shadow bank liabilities.

If the rise in broad money growth signalled stronger spending and activity, it would be expected to involve an acceleration of demand as well as time deposits, i.e. narrow money growth would also have recovered.

A similar divergence of broad and narrow money trends occurred in G7 economies in late 2007 / early 2008 as shadow banking systems collapsed – second chart. Narrow money correctly signalled coming economic weakness. A contraction in broad money was delayed until 2009-10, when shadow banking stabilised – economic activity was then recovering strongly.

Credit trends are consistent with the negative message from narrow money. Six-month growth of total social financing, which partially includes shadow credit, fell to a new low in December on the historical definition excluding local government special bonds (among other items) – first chart.

Sectoral money trends suggest weaker prospects for business than consumer spending. The six-month change in demand deposits of non-financial enterprises (NFEs) remained negative in December but household growth has recovered recently, possibly partly reflecting the impact of actual and scheduled tax cuts – third chart.

Real as well as nominal money trends are weak. Six-month growth of true M1 deflated by consumer prices reached a low in October, barely recovering in November / December – fourth chart. Allowing for a typical nine-month lead, this suggests a further slide in economic momentum into the third quarter.

Policy easing has accelerated in December / January. January money numbers will be make-or-break for hopes of a second-half economic rebound.

US C&I loan surge signalling stocks cycle downswing

Posted on Monday, January 14, 2019 at 02:56PM by Registered CommenterSimon Ward | CommentsPost a Comment

A surge in US banks’ commercial and industrial (C&I) loans in late 2018 supports the view here that the stockbuilding cycle has peaked and will act as a drag on GDP growth in 2019.

Commercial banks’ loans and leases rose by 1.6% between September and December, or 6.5% at an annualised rate – the fastest since 2016. The pick-up reflected a 4.0% surge, or 17.1% annualised, in C&I loans, which account for about a quarter of the total – see first chart.

C&I loan growth is related to the level of stockbuilding, since companies typically draw down bank credit lines to finance an increase in inventories. Changes in stockbuilding, meanwhile, influence GDP growth. It follows that GDP growth depends on the rate of change of C&I loan growth, i.e. the C&I loan “impulse”.

The year-on-year change in three-month C&I loan growth rose to its highest since 2011 in December, suggesting that stockbuilding will have made a strong positive contribution to year-on-year GDP growth in the fourth quarter – second chart. The level of the impulse is consistent with a cycle peak, i.e. the stockbuilding contribution is likely to weaken and turn negative over coming quarters, with “multiplier” effects on other GDP expenditure components.

A "monetarist" perspective on current equity markets

Posted on Tuesday, January 8, 2019 at 10:07AM by Registered CommenterSimon Ward | CommentsPost a Comment

In late 2016, the forecasting approach employed here – relying on monetary and cycle analysis – signalled that the global economy would grow strongly in 2017. A year ago, it suggested that a significant slowdown would unfold during 2018. The current message is that this slowdown is likely to extend and deepen, at least through mid-2019. A recovery in momentum is possible during the second half of the year but such a scenario requires confirmation from stronger monetary trends in early 2019.

The forecasting approach utilises the “monetarist” rule that turning points in real (i.e. inflation-adjusted) money growth lead turning points in economic growth, typically by around nine months. The narrow M1 aggregate – comprising currency in circulation and demand or overnight deposits – has provided more reliable signals historically than broader money measures. Global six-month real narrow money growth peaked in June 2017, falling sharply through February 2018. Allowing for the usual nine-month lead, this suggested that six-month industrial output growth would peak around March 2018 and trend lower into the fourth quarter. This forecast has played out – see first chart.

Real narrow money growth moved sideways after February 2018 before falling to a new low in October. The latter development implies that the six-month rate of change of industrial output is unlikely to reach a trough until around July 2019 (or later), i.e. the current economic slowdown is expected to intensify during the first half of the year.

The forecasting approach focuses on the direction of real money growth rather than its level. It may, however, be significant that the October level of global real narrow money growth was the weakest since the 2008-09 recession and only slightly higher than the low reached before the 2001 recession. This suggests that the current global economic slowdown will be more severe than the previous two since the 2008-09 recession, in 2011-12 and 2015-16.

Real money growth appears to have recovered in November and December, raising the possibility of a revival in economic momentum later in 2019. The judgement here is that monetary trends need to strengthen further in early 2019 to warrant adopting such a turnaround as a central scenario. There are some grounds for optimism: Chinese monetary and fiscal policy easing is expected to lift money growth, while recent oil price weakness is curbing global inflation, supporting real money trends. A significant pick-up in global real narrow money growth, however, probably requires a Fed policy shift – at a minimum, a halt to interest rate rises and “quantitative tightening”.

Supporting such a possibility, US money trends and other leading indicators suggest that US economic growth will undershoot Fed and consensus expectations in early 2019. Business narrow money holdings, in particular, have contracted in recent quarters, a development that historically has usually preceded a cut in business spending. A decline in the OECD’s US composite leading indicator, meanwhile, gathered pace through November 2018, implying below-trend and weakening GDP expansion – second chart.

A rise in “core” inflation above 2% could, in theory, force the Fed to continue tightening despite an economic slowdown. US and global core inflation, however, has moved sideways recently, defying predictions of a pick-up in response to faster wage growth – third chart. With oil price weakness pushing down headline inflation, and slower economic growth likely to ease labour market pressures, wage rises may moderate during 2019. If not, restrictive monetary conditions suggest that profit margins, rather than core prices, will take the strain.

The cycles component of the forecasting approach attempts to place current economic developments within a longer-term framework and acts as a cross-check of the monetary signals. There are three key cycles: the stockbuilding or inventory cycle, which has averaged 3.5 years in length in recent decades (measured from trough to trough); the business investment cycle, which has averaged 8.5 years, with a maximum of 10.5 years; and a longer-term housing cycle, averaging about 18 years. The cycles are global, though have been dominated by US developments in recent decades, and shorter-term cycles “nest” within longer ones, in the sense that troughs tend to coincide. The three cycles reached simultaneous lows in 2009, explaining the severity of the 2008-09 recession.

According to our cycle dating, the stockbuilding cycle reached subsequent lows in the fourth quarter of 2012 and the first quarter of 2016. The downswings into these lows contributed to the 2011-12 and 2015-16 global economic slowdowns. Based on the cycle’s 3.5 year average length, another trough could occur in the third quarter of 2019. A rise in stockbuilding during 2018 in G7 national accounts data is consistent with the cycle reaching a peak.

The difference from 2011-12 and 2015-16 is that the business investment cycle is also scheduled to enter a downswing. The last trough in this cycle coincided with a low in the stockbuilding cycle in the second quarter of 2009. With a maximum length in recent decades of 10.5 years, another trough is likely by the fourth quarter of 2019. The longer-term housing cycle, by contrast, is not scheduled to enter another downswing until the mid 2020s.

The stockbuilding and business investment cycles, therefore, are expected to exert a drag on global economic momentum during the first three quarters of 2019. A combined downswing would suggest a deeper economic slowdown than in 2011-12 and 2015-16, or even a mild recession – consistent with the message from monetary trends.

A reasonable working hypothesis is that both cycles will bottom out during the second half of 2019 and recover in 2020. The cycle analysis, that is, suggests that, if a recession is on the horizon, it is more likely to occur in 2019 than in 2020. The consensus view, by contrast, has been that any recession will be delayed until 2020-21 – in a September survey of US business economists, only 10% expected a contraction to begin in 2019, with 56% favouring 2020 and 33% 2021.

The consensus view appears to be informed partly by the observation that the US Treasury yield curve – i.e. the spread between the 10-year and two-year yields – inverted well in advance of most post-war recessions but has yet to do so. The current global economic slowdown, however, originated in China / Asia and spread to Europe, with spill-over to the US only now beginning. The Chinese government bond yield curve inverted in 2017, with a maximum negative spread in June of that year, consistent with maximum economic weakness in late 2018 / early 2019. The Chinese curve normalised in 2018, suggesting that China / Asia will lead any global economic recovery later in 2019 or in 2020. The US yield curve may prove to be a late or lagging indicator on this occasion.

The approach to assessing equity market prospects here emphasises the concept of “excess” money, defined as a positive differential between actual monetary growth and the rate of increase required to support economic expansion. Excess money is associated with excess demand for financial assets at their prevailing prices, and consequent upward pressure on those prices. By contrast, a negative differential – “deficient” money – is associated with weak markets.

Excess money cannot be measured directly but our analysis indicates that two simple proxy indicators would have been informative about market prospects historically – the differential between global real narrow money growth and industrial output growth, and the differential between real money growth and its long-run average. These two indicators are shown in the fourth chart, along with an index measuring the cumulative return on global equities relative to US dollar cash.

Between 1970 and 2017, global equities outperformed cash by 3.6% a year on average. This outperformance was concentrated in periods when the excess money indicators were positive – the excess return averaged 11.0% per annum or more during these phases. Equities, by contrast, underperformed cash on average when the indicators were negative, signalling deficient money.

Both indicators were consistently positive between June 2011 and November 2017 but one or other was negative in every month in 2018. The indicators, that is, suggested lowering equity market exposure and adopting defensive strategies in 2018, and have yet to signal a reversal.

A further reason for a defensive stance discussed in previous commentaries is the historical relationship of market returns with the stockbuilding cycle. Equities and other risk assets have tended to weaken in the 18 months leading up to a cycle trough, with gains concentrated in the first 18 months of upswings. The fifth chart shows our suggested cycle dating and the implied 18-month “risk-off” periods for markets (shaded). Six of the last seven such periods were associated with a crisis and / or major bear market in one or more assets.

On the working assumption that the next trough in the stockbuilding cycle will occur in the third quarter of 2019, another of these risk-off periods started in early 2018 and is scheduled to last for another seven or eight months. The pattern of returns since early 2018 – both across asset classes and within equity markets – has been consistent with previous risk-off phases, e.g. defensive sectors and “quality” have outperformed, US equities have been relatively resilient, the US dollar has strengthened and credit spreads have widened.

This approach suggests preparing for a major turning point in markets in the second half of 2019, possibly the third quarter, assuming that first-half evidence on stockbuilding and business investment is sufficiently weak, consistent with the two cycles moving towards lows. Equities would start to recover later in 2019, with the pattern of returns in the risk-off phase reversing. Such a scenario would be expected to be preceded by a rise in global real narrow money growth in the first half of 2019, resulting in the excess money indicators described earlier turning positive.

An extension of recent market trends in the first half of 2019, that is, could create buying opportunities. The cycle analysis suggests that longer-term investors should use any recessionary repricing of markets to add to inflation hedges. Overarching the three cycles discussed earlier is a longer-term inflation cycle averaging about 54 years, with peaks occurring in the last century in 1920 and 1975, and another scheduled for 2027-29. The next economic upswing, expected here to be under way in 2020, may prove to be the most inflationary since the 1970s. The upswing is likely to begin with unemployment rates considerably lower than in previous recovery phases in recent decades, while demographic trends are expected to place upward pressure on economic demand relative to supply. The global banking system, meanwhile, may emerge relatively unscathed from the current slowdown, and healthy capital / liquidity positions could support much faster bank credit expansion in the next upswing, creating the monetary conditions for a sustained inflation rise.

Euroland money numbers: mixed signals

Posted on Thursday, January 3, 2019 at 01:59PM by Registered CommenterSimon Ward | CommentsPost a Comment

Euroland monetary trends have stabilised since mid-2018, suggesting weak GDP growth in the first half of 2019 but no further slowdown. The sectoral breakdown of the latest numbers, however, is troubling: corporate narrow money trends have deteriorated, particularly in Germany, signalling likely business retrenchment.

Six-month growth of real narrow money, as measured by non-financial M1 deflated by consumer prices, edged down in November but remained above a double-bottom low in April / July 2018. The corresponding growth rate of the broader real non-financial M3 measure rose further to an 11-month high, having bottomed in March / April – see first chart.

GDP appears to have grown at an annualised rate of only about 1% during the second half of 2018, well below ECB and consensus expectations. The headline money trends suggest little or no improvement during the first half of 2019. The December ECB staff forecast of a rebound in growth to 0.5% per quarter, or 2.0% annualised, looks fanciful.

The sectoral breakdown of non-financial M1 deposits reveals a divergence between resilient household and weak corporate trends. Six-month growth of real deposits of non-financial corporations (NFCs) fell in November and is back near July’s six-year low – second chart. The concern is that corporate money weakness is signalling further cuts to investment and hiring plans, with knock-on effects to household incomes and money demand. Corporate money often leads household and aggregate trends, e.g. before the 2011-12 recession and the subsequent recovery.

The country breakdown shows that corporate real M1 deposits have contracted in Germany and Italy, contrasting with a recent recovery in growth rates in France and Spain. German weakness is comparable with that observed before the last two recessions – third chart.

Simple forecasting rule giving negative signal for UK economic prospects

Posted on Thursday, December 20, 2018 at 09:25AM by Registered CommenterSimon Ward | CommentsPost a Comment

A simple forecasting rule based on money growth and share prices suggests that 2019 will be a “bad” year for the UK economy – even if a no deal Brexit is avoided.

The forecasting rule has been informative historically, often outperforming economist predictions. It was pessimistic in late 2008 ahead of a 4.2% GDP slump in 2009. Another negative signal was given in late 2011 before the 2012 double-dip scare. It was optimistic a year later, foreshadowing a pick-up in growth in 2013. The rule has given neutral signals for the last five years.

The forecasting rule classifies the economic outlook for the following calendar year as good, bad or neutral depending on whether December levels of real (i.e. inflation-adjusted) money growth and share prices are higher or lower than 12 months earlier. Real money growth is measured by the annual rate of change of the broad M4ex measure deflated by the retail prices index excluding mortgage interest (RPIX). Share prices are measured by the FTSE local UK index, constituents of which derive at least 70% of sales from the UK and the rest of Europe, again deflated by the December RPIX*.

Annual GDP growth averaged 2.3% in the 52 calendar years from 1966 to 2017. The forecasting rule gave a positive signal for 16 of these years, i.e. both real money growth and real share prices at the end of the prior year were higher than 12 months before. GDP growth in these years averaged 3.8%.

There were 11 years for which the forecasting rule gave a negative signal, reflecting falls in both real money growth and real share prices. Growth in these years averaged 0.3%. In the remaining 25 years for which the two components of the rule gave conflicting signals, GDP expansion averaged 2.2%, close to the overall average.

The rule gave a neutral message for 2018 at this time last year: real money growth had risen since December 2016 but real share prices had fallen. The current consensus estimate of 2018 GDP growth is 1.3%, below the 2.2% average for neutral years**. The undershoot could reflect a Brexit effect, or a fall in the economy’s potential growth rate.

The current negative signal for 2019 will not be confirmed until 30 January, when December monetary data will be released. As of October, the annual rate of change of real M4ex was -0.6%, down from 0.7% in December 2017 – see chart. The average level of the FTSE local UK index so far in December, meanwhile, is 16% lower than in December 2017. With annual RPIX inflation at 3.1% in November, real share prices are on course for a 19% decline.

The current consensus forecast is for GDP growth to rise to 1.5% in 2019, despite recent slower global expansion and the increase in Bank rate from 0.25% to 0.75% since October 2017. The consensus view appears partly to reflect expectations of support from fiscal easing and a “Brexit dividend” as delayed spending plans are reinstated following an assumed smooth departure.

The forecasting rule, by contrast, suggests that the economy will slow further in 2019, with a significant risk that GDP growth will undershoot all economist predictions***.

*The FTSE local UK index goes back to 1994. The FT 30 index, which is also domestically orientated, was used for earlier years. Local UK stocks accounted for 20% of the market capitalisation of the FTSE all-share index as of end-November.
**Source: Forecasts for the UK Economy, HM Treasury.
***The current minimum forecast is 0.9%, by Peter Warburton of Economic Perspectives, according to the Treasury survey.