Eurozone money trends remain too weak to support an economic recovery. A relapse in the latest business surveys could mark the start of a “double dip”.

Three-month rates of change of narrow and broad money – as measured by non-financial M1 and M3 – were zero and 3.3% annualised respectively in May. Current readings are well up on a year ago but significantly short of pre-pandemic averages – see chart 1.

Chart 1

May month-on-month changes were soft, with narrow money contracting by 0.1% and growth of the broad measure slowing to 0.1%.

Six-month real narrow money momentum – the “best” monetary leading indicator of economic direction – moved sideways in May, remaining significantly negative and lower than in other major economies. (The latest UK reading is for April.)

Chart 2

June declines in Eurozone PMIs and German Ifo expectations may represent a realignment with negative monetary trends following a temporary overshoot – chart 3. A recent correction in cyclical equity market sectors could extend if Ifo expectations stall at the current level – chart 4.

Chart 3

Chart 4

Growth of bank deposits is similar in France, Germany and Spain but lagging in Italy – chart 5. The country numbers warrant heightened scrutiny, given a risk that French political turmoil triggers deposit flight to Germany.

Chart 5

A recovery in the OECD’s US composite leading indicator could be reversing, in which case recent underperformance of cyclical equity market sectors versus defensives could extend.

The OECD indicator receives less attention than the Conference Board US leading economic index but its historical performance compares favourably.

The correlation coefficient of six-month rates of change is maximised with a two-month lag on the OECD indicator, i.e. the OECD measure slightly leads the Conference Board index.

The OECD indicator recovered from early 2023, signalling that recession risk was (temporarily?) receding. The Conference Board index continued to weaken, although the rate of decline slowed.

The latest published numbers show the OECD measure still rising in May. New information, however, is available for four of the seven components. An updated calculation suggests that the indicator peaked in April, with small declines in May and June – see chart 1.

Chart 1

A firmer indication will be available at the end of next week, following release of data on the remaining three components – durable goods orders, the ISM manufacturing PMI and manufacturing average weekly hours.

The suggested stall in the OECD leading indicator recovery has coincided with larger month-on-month declines in the Conference Board measure in April and May.

The price relative of MSCI World cyclical sectors, excluding tech, versus defensive sectors has mirrored movements in the OECD US leading indicator historically – chart 2. A rally in the relative peaked in late March, consistent with the suggestion of an April leading indicator top.

Chart 2

Chinese May money numbers were weak even allowing for a distortion from a recent regulatory change.

The preferred narrow and broad aggregates here are “true M1” (which corrects the official M1 measure for the omission of household demand deposits) and “M2ex” (i.e. M2 excluding bank deposits held by other financial institutions – such deposits are volatile and less informative about economic prospects).

Six-month rates of change of these measures fell to record lows in May – see chart 1.

Chart 1

April / May numbers, however, have been distorted by a clampdown on the practice of banks making supplementary interest payments to circumvent regulatory ceilings on deposit rates. This appears to have triggered a large-scale outflow from corporate demand deposits.

The April / May drop in six-month narrow money momentum into negative territory was entirely due to a plunge in demand deposits of non-financial enterprises (NFEs), with household and public sector components little changed – chart 2.

Chart 2

Where has the money gone? The answer appears to be into time deposits (included in M2ex) and wealth management products (WMPs), with a small portion used to repay debt.

NFE demand deposits contracted by RMB3.82 trillion in April / May combined. Their time and other deposits grew by RMB1.14 trillion over the same period. Total sales of WMPs with a term of six months or less, meanwhile, were unusually large, at RMB2.60 trillion, according to data compiled by CICC.

It has been suggested that banks were paying supplementary interest to meet lending targets – the additional payments gave NFEs an incentive to draw down credit lines while leaving funds on deposit at the lending bank (“fund idling” or “roundtripping” in UK parlance). Repayments of short-term corporate loans, however, were a relatively modest RMB0.53 trillion in April / May.

The appropriate response to regulatory or other distortions to monetary aggregates is to focus on a broadly-defined measure that captures shifts between different forms of money.

Chart 3 includes the six-month rate of change of an expanded M2ex measure including short-maturity WMPs. While momentum is stronger than for M2ex – and not quite at a record low – a decline since December 2023 continued in April / May, suggesting still-deteriorating economic prospects.

Chart 3

The Bank of Japan’s attempt to withdraw policy accommodation is understandable but misguided. Monetary weakness suggests that the economy is on course to return to deflation.

The BoJ’s difficulties stem from the inflationary policy mistake of the Fed and other G7 central banks in 2020-21. Subsequent tightening to correct this error works partly by boosting currencies to export inflation to – and import disinflation from – countries with responsible policy-making, including Japan.

What about Japan’s home-grown inflation? This was minor and is fading fast. Annual broad money growth peaked in 2020-21 at 8.1% in Japan versus 24.5%, 12.5% and 16.0% in the US, Eurozone and UK respectively. Japanese growth was back at its pre-pandemic (i.e. 2010-19) average by end-2022.

A bumper 5.08% pay award in the spring Shunto is an echo of an inflation pick-up driven mainly by a weakening yen. Most workers are non-unionised / employed by SMEs and will receive smaller increases. Falling inflation, slowing profits and a softening labour market suggest a much lower award next year.

The latest money numbers are ominous. Broad money M3 fell by 0.1% in both April and May, following the BoJ’s removal of negative rates in March. May weakness was driven by f/x intervention– record yen-buying of ¥9.8 trillion last month equates to 0.6% of M3.

Annual M3 growth slumped to 1.3% in May, the lowest since the GFC and half the 2010-19 average, suggesting a fall in annual nominal GDP growth below its respective average of 1.2% – see chart 1.

Chart 1

The BoJ, meanwhile, had moved towards QT before the June MPC announcement of a reduction in JGB purchases from July, with gross buying in May well below the run-rate of redemptions – chart 2.

Chart 2

Monetary weakness contrasts with respectable bank lending expansion – commercial bank loans and leases rose by an annual 3.0% in May. The contribution to money growth, however, has been offset by a combination of increased non-deposit funding, reduced BoJ JGB buying and, in May, a fall in net external assets due to f/x intervention – chart 3*.

Chart 3

What should the BoJ do? A monetarist purist would argue for reversing policy tightening and accepting the currency consequences. Likely further yen weakness, however, would prolong current high inflation – a significant cost to balance against the benefit of avoiding a medium-term return to deflation.

The least bad option may be to signal tightening but delay meaningful action in the hope that a dovish Fed shift will lift pressure off the currency soon. This could be a reasonable description of the BoJ’s recent behaviour.

*Note: the counterparts analysis is available through April.

Previous posts suggested that a recovery in US money growth would stall in Q2 / Q3 as Fed QT was no longer offset by monetary deficit financing (at least temporarily).

The broad M2+ measure – which adds large time deposits at commercial banks and institutional money funds to published M2 – fell by 0.1% in April, with available weekly data suggesting marginal growth in May.

Unexpectedly, however, the narrow M1A measure tracked here – comprising currency in circulation and demand deposits – rose by a bumper 1.8% in April. This follows a 1.3% gain in March – see chart 1.

Chart 1

Positive narrow money divergence typically occurs when rates are falling. Lower rates encourage a shift of money holdings from time deposits and savings accounts to demand deposits and cash. Such a shift is usually a signal of rising spending intentions.

Are money-holders front-running rate cuts? The narrow money pick-up is a hopeful signal but there is a risk that it goes into reverse if the Fed continues to delay.

The impact of the US April rise on the global aggregate calculated here was offset by a large monthly drop in Chinese narrow money, as measured by “true M1”, which corrects for the omission of household demand deposits from official M1.

So the six-month rate of change of global real narrow money was little changed in April, following a move back into positive territory in March – see prior post for more discussion.

US six-month momentum moved to the top of the ranking across major economies in April, while China returned to negative territory – chart 2.

Chart 2

Falling interest rates suggest that the Chinese relapse will prove temporary – chart 3 – but the signal for near-term economic prospects is negative.

Chart 3

Eurozone / UK real narrow money momentum continued to recover in April but remains negative. The current UK lead may prove temporary unless the MPC follows the ECB in cutting rates soon.

The Chinese relapse resulted in E7 real money momentum falling back in April, while G7 momentum crossed into positive territory – chart 4.

Chart 4

The still-positive E7 / G7 gap coupled with a recent cross-over of global six-month real narrow money momentum above industrial output momentum could signal improving prospects for EM equities. The MSCI EM index outperformed MSCI World by 10.5% pa on average historically under these conditions.

G7 annual broad money growth recovered further in April but, at 2.8%, remains well below a 2015-19 average of 4.5% – chart 5.

Chart 5

The roughly two-year leading relationship suggests that annual inflation will bottom out in H1 2025 but remain at a low level into H1 2026.

Global (i.e., G7 plus E7) six-month real narrow money momentum returned to positive territory in March, consolidating in April. It has also crossed above six-month industrial output momentum, turning one measure of global “excess” money positive – see chart 1.

Chart 1

Should investors, therefore, adopt a positive view of economic and market prospects? The judgement here is no – or at least, not yet.

Six-month real narrow money momentum bottomed in September 2023 and lows have preceded those in industrial output momentum by between four and 14 months so far this century. This suggests that a recent decline in output momentum will bottom out by December.

The lag may be at the top end of the range on this occasion, for three reasons.

First, lags tend to be longer when real money momentum reaches extremes, and the September reading was the weakest since 1980.

Secondly, the real money stock is below its long-run trend relationship with industrial output – chart 2. A prior overshoot cushioned the impact of a negative rate of change in 2022-23; the reverse effect could apply in 2024-25.

Chart 2

Thirdly, prior recoveries in real money momentum from negative to positive were followed by a recovery in output momentum always in the context of a positively-sloped yield curve (10-year government bond yield minus three-month money rate) – chart 3. The curve is still inverted.

Chart 3

The recovery in real narrow money momentum is a hopeful signal for H1 2025 but there remains a risk of surprisingly negative economic data over the next six months. A pessimistic bias will be maintained until real money momentum returns to its long-run average and the yield curve disinverts.

The cross-over of real money momentum above industrial output momentum is similarly judged to be a necessary but not sufficient condition to adopt a positive view of market prospects.

Global equities have outperformed cash on average historically only when a positive real money / industrial output momentum gap partly reflected above-average real money expansion (measured as a 12-month rate of change). The latter condition is unlikely to fall into place before late 2024 at the earliest.

The current combination was associated with mixed equity market performance with some notably bad periods, e.g. mid-2001 and late 2008 / early 2009 – chart 4.

Chart 4