Global economic update: beware "false dawn" PMI bounce

Posted on Friday, July 19, 2019 at 10:55AM by Registered CommenterSimon Ward | CommentsPost a Comment

As discussed in Tuesday’s post, global narrow money trends suggest that economic momentum will bottom out in the third quarter of 2019 but remain weak into early 2020.

The monetary signal has been confirmed by a global non-monetary leading indicator based on the OECD’s country leading indicators. The six-month rate of change of this indicator appears to have bottomed in early 2019 and typically leads by 4-5 months – see first chart.

Neither money trends nor the leading indicator are yet suggesting an economic recovery, in the sense of a return to trend growth.

A further reason for expecting economic momentum to bottom out around the third quarter, discussed in previous posts, relates to the global stockbuilding or inventory cycle, which averages 3.5 years in length, i.e. measured from trough to trough.

The second chart shows the contribution of stockbuilding to annual G7 GDP growth. The last trough occurred in the first quarter of 2016, suggesting another low in the third quarter of 2019, assuming that the current cycle is of average length.

The growth contribution was still significantly positive in the first quarter of 2019 – the last data point in the chart – raising the possibility that the current cycle will be longer than average, implying a later trough.

However, two pieces of evidence suggest a rapid weakening in recent months – a third-quarter low, in other words, remains plausible.

First, an indicator derived from G7 business survey responses about inventories correlates with the GDP stockbuilding data but is more timely and sometimes leads, and this indicator turned significantly negative in early 2019, though has yet to reach an extreme suggestive of a cycle low – third chart.

Secondly, global retail sales volumes have rebounded strongly since end-2018, far outpacing industrial output – fourth chart. This suggests a significant drawdown in inventories unless spending on capital goods has collapsed.

Retail sales strength is likely to fizzle. It partly reflects a US bounce-back after weakness associated with the government shutdown. In addition, a fall in sequential inflation was a tailwind during the first half but is now reversing. Softening labour markets, meanwhile, are starting to erode consumer confidence.

The forecast of a trough in global industrial momentum in the third quarter suggests that the global manufacturing PMI – a coincident indicator – is at or near a low. The forthcoming July flash results, moreover, could reflect some hope engendered by the Trump-Xi trade truce in late June – this may have influenced yesterday’s stronger Philadelphia Fed manufacturing survey.

The danger is that markets and policy-makers wrongly interpret a bottoming of the manufacturing PMI as a precursor to an economic recovery in late 2019 / early 2019 – ignoring evidence from monetary trends and other leading indicators that prospects remain worryingly weak.

A rebound in bond yields as expectations of central bank policy easing are reined back would risk aborting the recent tentative monetary recovery. It could also trigger another sell-off in equities, which have displayed a strong inverse correlation with real yields in recent months – fifth chart.

Labour market watch: ominous UK vacancies fall

Posted on Tuesday, July 16, 2019 at 10:42AM by Registered CommenterSimon Ward | Comments1 Comment

The stock of vacancies – a leading indicator of the number of employees – peaked in January (three-month moving average basis), with another hefty fall in June. Employee numbers appear to have peaked in February (also three-month moving average) – see first chart. A stable unemployment rate of 3.8% reflects slower labour force expansion and a rise in “self-employment”, which have – so far – balanced the stall in employees.

Vacancies are down by 3.9% from the January peak but the fall has been cushioned by a rise in public sector openings: the decline outside public administration, education and health was 6.8% – second chart.

Manufacturing vacancies have plunged 12.5% since January. Other large declines include real estate and “other service activities” (-20%), information and communication (-13%), arts, entertainment and recreation (-9%), financial and insurance activities (-8%) and construction (-7%).

By size of business, the decline has been concentrated among firms with fewer than 50 employees – vacancies for this group are down by 9.6% versus 1.7% for larger employers.

Global money update: signal still downbeat

Posted on Tuesday, July 16, 2019 at 09:33AM by Registered CommenterSimon Ward | CommentsPost a Comment

Global money trends still aren’t signalling an economic recovery.

Six-month growth of real narrow money in the G7 economies and seven large emerging economies is estimated to have edged up to 1.9% (not annualised) in June but remains well below a post-GFC average of 3.2% (i.e. calculated over 2010-18) – see first chart. A rise to this level is probably needed to signal an economic recovery, in the sense of a return to trend expansion.

The June increase in real money growth was driven by China – second chart. US growth remains weak and there was a sharp slowdown in Japan, partly inflation-driven. The final June figure will depend importantly on Euroland and UK monetary data, to be released on 24 and 29 July respectively.

The implication that global economic growth will remain below trend at least through early 2020 suggests a coming rise in unemployment, with attendant additional pressure for central bank policy easing.

The forecast of an unemployment turn is supported by G7 consumer surveys: the net percentage of consumers expressing a negative view of labour market conditions rose to a 21-month high in June – third chart.

Same old: UK MPC U-turns after ignoring money trends

Posted on Friday, July 5, 2019 at 11:53AM by Registered CommenterSimon Ward | CommentsPost a Comment

Bank of England Governor Mark Carney’s “sea change” speech this week has laid the foundation for a dovish MPC shift in August, with a rate cut possible if economic news continues to deteriorate and the Fed goes first at its 30-31 July meeting.

Governor Carney blames global economic deterioration on a confidence shock from trade wars but the dominant driver has been monetary weakness due to excessive policy tightening in 2017-18 – including by the Bank of England. Global narrow money trends were slowing rapidly before the US administration ramped up its trade offensive in early 2018.

UK money trends have been ringing alarm bells for over a year. Annual growth rates of narrow money and broad liquidity fell steeply after the November 2017 rate hike and are currently the lowest since 2011-12 – see first chart*.

The monetary slowdown was the reason why the follow-up August 2018 hike was opposed here. More recent posts have argued for the August move to be reversed.

Corporate money trends have been giving a recession warning, with the six-month change in real narrow money holdings of private non-financial corporations (PNFCs) turning negative in March / April – second chart. A small recovery in May was welcome but does not negate the earlier signal.

MPC easing would be embarrassing for professional economists, most of whom projected that rates would rise in 2019 – none of the forecasters surveyed by the Treasury in the three months to January 2019 expected Bank rate to finish the year below its opening level of 0.75%.

*The preferred measures here are “non-financial”, i.e. they cover money holdings of households and non-financial firms but not non-bank financial institutions such as fund managers and securities dealers – holdings of the latter group are unrelated to spending on goods and services. The broad liquidity measure (“M4++”) includes foreign currency deposits and National Savings, and adjusts for retail mutual fund flows. The Bank of England’s M4ex broad money measure has shown similar weakness.

A "monetarist" perspective on current equity markets

Posted on Tuesday, July 2, 2019 at 09:40AM by Registered CommenterSimon Ward | CommentsPost a Comment

The forecasting approach used here signalled the 2018-19 global economic slowdown and suggests that the downswing is entering its final stage. Early indications are that 2020 will be a recovery year for the global economy, although this requires confirmation from a further rise in monetary growth. A bottoming of economic momentum may be associated with an increase in market volatility and a reversal of several recent trends.

A key basis for the forecast that the global economy would lose momentum in 2018-19 was a significant fall in global six-month real narrow money growth between July 2017 and October-November 2018. Allowing for an average nine-month lead, this suggested that the six-month rate of change of industrial output would peak in early 2018 and fall through the third quarter of 2019. This forecast continues to play out, with the six-month output change turning negative in April 2019, the latest available month – see first chart. The Markit / J P Morgan global manufacturing PMI, meanwhile, fell to a seven-year low in June.

Real narrow money growth has recovered since late 2018 but, as of May, remained weak by post-GFC standards. Monetary trends, that is, are consistent with global economic momentum reaching a low in the third quarter of 2019 but have yet to suggest a meaningful rebound. The judgement here is that six-month real money growth needs to rise to 3% (not annualised) during the second half of 2019 to confirm that 2020 will be a recovery year for the global economy. The 3% level was exceeded before all previous economic reaccelerations since the 2008-09 recession.

The forecasting approach does not attempt to predict monetary trends but there are reasons to be hopeful. Six-month nominal money growth reached a 16-month high in May and may be boosted by recent bond yield declines and central bank policy easing. Real money growth has been suppressed by a rise in six-month consumer price inflation but this is likely to fall back, assuming stable commodity prices.

The forecast that the global economy would weaken in 2018-19 also rested on an assessment that the 3-5 year stockbuilding (inventory) cycle and the 7-11 year business investment cycle were about to enter downswings that would continue into the second half of 2019 and possibly beyond. Recent business survey evidence confirms weakness in the two cycles but readings have yet to reach extremes suggestive of lows. The current working assumption here is that the stockbuilding cycle will bottom in the third quarter of 2019 with the business investment cycle following one or two quarters later.

Economic weakness is now feeding through to labour markets and a rise in global unemployment is expected over the next 12 months even if an economic recovery begins in early 2020. Together with soft headline and core inflation, this will trigger belated and probably excessive monetary policy easing, laying the foundation for another bout of strong economic growth, possibly in late 2020 or 2021.

The stockbuilding and business investment cycles are “nested” within longer-term housing and inflation cycles. The current constellation of the cycles was last replicated in 1966-67, suggesting that economic developments will play out somewhat similarly. The US Treasury yield curve inverted in 1966 and the economy slowed sharply into 1967, while avoiding a recession. US weakness followed recessions in Japan and Germany – a mirror, perhaps, of China’s leading role in the current global downswing.

The US slowdown resulted in a rise in the unemployment rate from a low of 3.6% in 1966 to a high of 4.0% in 1967, prompting the Federal Reserve to ease policy – prime rate fell by 50 basis points, with money market rates dropping by significantly more. This policy shift triggered a bear steepening of the Treasury curve and contributed to a rebound in growth and inflation into 1968. Other major economies were also strong in 1968 – a possible template for late 2020 / early 2021.

Recent market behaviour is consistent with the cyclical position. As discussed in previous commentaries, returns are correlated with the stockbuilding cycle, with the 18 months leading into a trough usually associated with “risk-off” market moves, which reverse in the following 18 months. The first two columns in the table show average returns on various instruments or long / short pairs around the last seven cycle troughs. The final column shows returns so far in the current downswing, on the provisional assumption that the cycle will reach bottom in the third quarter of 2019.

Recent performance has in most respects displayed the expected defensive pattern, with Treasury yields falling, credit spreads widening, US and quality stocks outperforming, emerging market equities underperforming, commodity prices weakening and the US dollar strengthening. The suggestion is that investors should prepare for a reversal of these trends in late 2019, assuming that incoming data confirm a third-quarter stockbuilding cycle trough and global real money growth continues to recover.

A notable discrepancy in the recent returns pattern is the resilience of equities in aggregate – the MSCI World index showed the expected weakness in late 2018 but this year’s rebound has pushed it above the level at the suggested start of the current “risk-off” phase. This raises the possibility of another sharp sell-off as the stockbuilding cycle moves into its low.

Index resilience, however, may partly reflect an unusual contraction in the global share float, with buy-backs and cash take-overs boosted by US tax reform and low corporate borrowing costs. The second chart shows an index of the number of shares outstanding derived by dividing the market cap of the MSCI World index by its price. The share float rose during the previous seven stockbuilding cycle “risk-off” phases but has fallen so far in the current downswing.

The implication may be that equity market weakness has been deferred until a rise in borrowing costs or other development curtails share-buying. Equities, that is, could underperform the historical average as interest rates rebound in the early stages of the next stockbuilding cycle upswing.

Previous commentaries described equities / cash switching models based on the concept of “excess” money. Excess money exists when monetary growth exceeds the level needed to support economic expansion. An excess is associated with additional demand for financial assets and upward pressure on prices.

Excess money cannot be measured directly. Two proxy indicators are monitored here – the global real money / industrial output growth gap and the deviation of real money growth from its long-run average. Between 1970 and 2017, global equities outperformed cash by 16.3% per annum (pa) when both indicators were positive but underperformed by 10.1% pa when they were negative.

The indicators were both consistently positive over 2012-17 but have been mixed or both negative in most months in 2018-19. Currently, the real money / industrial output growth gap is positive but this mainly reflects economicweakness, with real money growth still below its long-run average. Historically, a mixed signal has been associated with positive but weak relative equity returns, i.e. the opportunity cost of defensive positioning under such circumstances has been modest, on average.

The third chart shows monetary developments in individual major economies. US real narrow money contracted in mid-2018 and has yet to stage a convincing recovery. The economy has slowed – the income-based measure of GDP rose by only 0.8% at an annualised rate in the fourth and first quarters combined – and weakness is likely to extend through late 2019, at least.

China led the global downswing – its Treasury yield curve (10-year versus 1-year) inverted in June 2017, 21 months ahead of the US. The PBoC relaxed monetary policy from mid-2018 and real narrow money growth has recovered but remains weak by historical standards. As expected, recent economic data have disappointed consensus hopes of an early recovery and further easing is in train. This suggests better monetary news during the second half, which would confirm a 2020 economic rebound.

Real narrow money growth has risen and is relatively strong in Euroland and Japan. This questions the necessity of further monetary policy easing, which is, nevertheless, likely to be forthcoming. Both economies could surprise positively next year if global activity recovers as expected – conditional on no negative shock from trade wars and / or Brexit.