As explained in a post last week, the two key forecasting indicators relied on here – real narrow money growth and a longer leading indicator derived from OECD leading index data – are giving a positive message for global economic expansion through late 2013. Six-month real money growth may have risen slightly further in May, judging from data covering 60% of the global aggregate – see first chart. This reflects increases in four of the five countries available – second chart.
Business surveys this week appear consistent with the prognosis. The US Philadelphia Fed manufacturing survey improved notably in June, suggesting that last month’s ISM weakness will be reversed – third chart. The Eurozone PMI composite output index rose to a 15-month high of 48.9, a reading historically consistent with GDP expansion. Japan’s Reuters Tankan manufacturing survey, meanwhile, strengthened again. One significant disappointment was a further fall in China’s Markit manufacturing PMI although this is regarded here as less reliable than the “official” measure, for which a June reading will be available at the start of July – the official PMI was more encouraging last month.
If the near-term economic outlook is respectable, why have markets weakened? The conventional view is that investors are running for cover as central banks prepare to wind down stimulus. The Fed and Bank of Japan, however, are committed to a further significant monetary injection over the next year. As expected, G3 bank reserves recently reached a new record and are on course to rise by a further 15% by end-2013 – fourth chart.
An alternative explanation is that, rather than worrying about the imminent end of central bank largesse, investors are losing faith in the ability of QE to backstop economies and markets. Several recent posts have argued that central bank bond purchases have had a surprisingly small impact on the broad money supply because they have induced offsetting transactions by commercial banks. Concern about policy impotence has been heightened by the surge in Japanese yields since mega-QE was announced in early April. With policy rates close to zero, markets may fear that the QE emperors with no clothes will be powerless to arrest the next downswing in the global economic cycle.
While current monetary trends are reassuring, recent financial market weakness could trigger a loss of confidence and a slowdown in real narrow money expansion, in turn signalling weaker economic prospects for 2014. This would be analogous to developments in 2007-08: global real narrow money was growing solidly in summer 2007 but slowed sharply during the second half as financial strains increased and was contracting by early 2008, ahead of the “great recession” – first chart.
Such a scenario is not the “central case” here – economic / financial imbalances and risks are judged to be much reduced compared with 2007 – but its assessed probability will rise if monetary trends deteriorate. Note that the real money slowdown in 2007 preceded the equity bear market, giving investors an opportunity to respond – the MSCI World index in US dollars peaked at end-October.
The favoured scenario here remains that the global economy will perform solidly during the second half of 2013 and that this prospect – rather than QE magic – will support markets. There is, however, no presumption that economic resilience will be sustained in 2014-15. This caution partly reflects the similarity noted in previous posts between the current economic upswing and the recovery after the “first oil shock” recession of 1974-75. Global industrial output continues to track the late 1970s path remarkably closely, with the “template” suggesting renewed difficulties from next year – final chart.
