Recent solid US economic and stock market performance was signalled by earlier monetary strength. Six-month growth of real narrow money, however, peaked in October and is estimated to have fallen sharply in February, based on weekly monetary data – see chart.
The earlier narrow money surge was partly but not completely explained by distortions due to regulatory changes, as described in a previous post. The recent slowdown may reflect an unwind of this regulatory effect. Six-month real growth is still healthy. This would argue for retaining a positive view of economic prospects.
An alternative possibility, however, is that the monetary slowdown is the consequence of QE2 stimulus fading – the expansion of the Fed's securities holdings stopped in June. “Operation twist and shout” – Fed purchases of longer-dated Treasuries financed by selling shorter-maturity bonds coupled with a campaign to talk down interest rate expectations – does not inject cash directly into the economy so is less powerful. The slowdown, on this view, signals deteriorating economic prospects.
The October peak in six-month real money growth suggests an April top in industrial output expansion, allowing for the typical six-month lead. The fall in the ISM manufacturing new orders index in February reported yesterday – which had been foreshadowed by other indicators – is consistent with such a scenario.
Optimistic economic commentary may be overemphasising lagging labour market indicators and underestimating the temporary positive effect of mild weather as well as leap year data distortions. It is early days but first-quarter GDP growth could be surprisingly weak. January real personal consumption was unchanged from the fourth-quarter average. Nominal capital goods shipments – a proxy for business equipment investment – fell by 1.6% on the same basis. Stockbuilding was 0.4% of GDP in the fourth quarter versus an average of 0.25% since 1995, suggesting a decline this quarter. Real government spending may fall for the sixth successive quarter. A rise in GDP, therefore, may depend on strength in construction investment and net exports – possible but not guaranteed.
