Global real narrow money continued to slow in July, suggesting dimming prospects for economic growth next spring, allowing for the usual lead.
Six-month growth of real (i.e. consumer price-adjusted) narrow money in the G7 and emerging E7 economies is back at its level in late 2014, having peaked in February – see first chart. While growth remains weaker in the E7 than the G7, the latter has been responsible for the recent decline – second chart.
Statistical research shows that real narrow money outperforms broad money and bank lending as a leading indicator of the economy, with an average lead time at turning points of nine months*. A rise in global real narrow money growth between August 2014 and February 2015 suggests that economic momentum will recover over the remainder of 2015. Industrial activity remained very weak through July – first chart – although the divergence between industry and a more resilient services sector is unusually large**. Manufacturing surveys for June and July hinted at an improvement in industrial prospects but August results were disappointing, possibly reflecting worries about a Chinese “hard landing” and associated market volatility.
The odds still favour a near-term pick-up in economic growth but the real money slowdown since February suggests that momentum will fade again in early 2016.
The global and G7 / E7 aggregates conceal considerable variation across countries. Within the G7, real narrow money growth is strong in the Eurozone and respectable in Japan / the UK but has fallen sharply in the US – third chart. In the E7, Korea and Mexico are leading growth while real money continues to contract in Russia and Brazil, in the latter case at a faster rate – fourth chart.
A further decline in global real narrow money growth would be concerning. Inflation developments, however, are likely to be supportive near term, with commodity prices signalling a temporary slowdown in the six-month consumer price rise – fifth chart.
Research shows that, in addition to real narrow money, the slope of the G7 yield curve – i.e. the difference between a weighted average 10-year government bond yield and a three-month money market rate – performs well as a leading indicator of the global economy. This suggests combining the two signals to create a superior forecasting indicator.
A simple method of combination is to add the yield curve slope to the six-month change in real narrow money. One rationale for such an adjustment is that the yield curve affects the relative attraction of money versus bonds. A steeply positive curve will tend to reduce the demand to hold money, meaning that a given level of real money growth has more positive economic implications than would otherwise be the case. Conversely, an inverted curve will encourage a shift from bonds into money; the observed level of real money growth, therefore, may be associated with lower future spending than under normal circumstances.
The final chart shows a forecasting indicator based on yield curve-adjusted real narrow money growth, with additional trend and scaling adjustments. The indicator is advanced by nine months, to reflect the average lead from real narrow money to the economy. An alternative indicator that excludes the yield curve is presented for comparison.
The current prediction is in line with the commentary above, i.e. a near-term recovery in global economic growth followed by another slowdown from early 2016. Comparing the two indicators, the yield curve adjustment makes a small but worthwhile difference to the historical performance, a conclusion confirmed by analysis of long-term data.
*Further details on request.
**For example, the difference between the new business / orders components of the US ISM non-manufacturing and manufacturing surveys is currently more than two standard deviations above its long-run average.