US core consumer price momentum is likely to slow sharply in early 2022 but monetary trends appear inconsistent with inflation returning to its pre-pandemic level.

Headline and core (i.e. ex. food and energy) annual inflation rates rose to their highest levels since 1982 and 1991 respectively in November (6.8% and 4.9%) – see chart 1.

Chart 1

On a six-month rate of change basis, however, core momentum eased for a third month, albeit remaining high at 2.7% or 5.5% annualised – chart 2. Headline momentum was boosted by a further acceleration of food prices.

Chart 2

The moderation in core momentum mirrors a slowdown in six-month growth of broad money 14 months earlier – chart 3. The apparent relationship suggests a further significant fall in six-month core inflation.

Chart 3

A 14-month lead is notably shorter than the average in historical studies of the relationship between money and prices. The judgement here is that supply disruption due to the pandemic has accelerated the transmission mechanism.

While core momentum could slow faster than expected in early 2022, broad money trends argue against a return to the pre-pandemic level: core inflation averaged 2.0% over 2015-19. Six-month growth of the broad measure calculated here* is running at an annualised rate of about 9% versus a 2015-19 average of 5%.

Broad money growth is being boosted by strong expansion of commercial bank assets as well as ongoing QE. Adjusting for PPP loan forgiveness, banks’ lending book grew by about 9% annualised in the six months to November, with securities holdings rising by 18% – chart 4.

Chart 4

Banks are well capitalised and highly liquid but the October Fed loan officer survey suggested a cooling of credit demand – chart 5. Securities purchases, meanwhile, could slow as QE tapering and a rebound in the Treasury’s cash balance at the Fed following Congressional approval of a rise in the debt ceiling relieve upward pressure on bank reserves.

Chart 5

*M2+ = M2 + large time deposits at commercial banks + institutional money funds.

The expectation here has been that monetary policy easing since Q2 would result in a recovery in Chinese money growth into end-2021, in turn presaging better economic performance in 2022. The Evergrande default threatened to derail the scenario by triggering an endogenous tightening of credit conditions but November money data suggest that it remains on track.

A disappointing feature of the November numbers is that six-month growth of narrow money – as measured by “true” M1, which includes household as well as corporate demand deposits – appears* to have risen only slightly and has yet to break away decisively from a July low. Growth of the broader non-financial M2 measure and aggregate credit, however, increased further, in the former case to a 12-month high – see chart 1.

Chart 1

The forecasting approach here generally places greater weight on narrow than broad money for assessing directional changes in economic momentum. In China’s case, however, the signals from the measures have been similar; indeed, there are several examples of broad money growth leading narrow money growth at lows (e.g. 2008, 2011-12, 2018).

Sectoral data show a pick-up in M2 deposit growth of non-financial enterprises and continued solid household expansion – chart 2.

Chart 2

The judgement here is that the broad / narrow money divergence reflects current low economic confidence – the monetary position of households and firms has improved but this has yet to feed through to spending intentions and an associated switch out of time into demand deposits. The delayed transmission of money to the economy may reflect covid restrictions and property sector uncertainty but should proceed barring further negative shocks.

The case for optimism would be strengthened if three-month SHIBOR were to resume a decline following the latest cut in reserve requirement ratios. A July cut did not feed through to lower rates partly because the PBoC offset the impact in other money market operations – chart 3.  Easing inflationary pressures – chart 4 – and property sector weakness suggest that the latest reduction is more likely to represent a genuine policy loosening.

Chart 3

Chart 4

Consensus views about Chinese economic prospects are influenced by the “credit impulse” – the change in the flow of credit expressed as a percentage of GDP. Previous research here analysing long-term G7 data found that the credit impulse underperformed real narrow money growth as a leading indicator, partly because it gave more false turning point signals. Regardless, some economists / strategists are likely to call attention to a bottoming-out of the 12-month impulse and a sharp recovery in the six-month version – chart 5.

Chart 5

*The household demand deposit component is currently estimated.

The global manufacturing PMI new orders index – a timely indicator of industrial demand momentum – eased to a 15-month low in November, continuing its decline from a May peak that was signalled by a July 2020 top in six-month real narrow money growth. With additional October data confirming a further fall in real money growth, the PMI orders slide is expected to extend into Q2 2022, at least – see chart 1.

Chart 1

The monetary slowdown signal is supported by the OECD’s leading indicators, November estimates of which are included in chart 2. The OECD indicators mostly exclude monetary aggregates and display a shorter lead time than money.

Chart 2

The November decline in global new orders reflected a slight firming in developed markets offset by EM weakness driven by a relapse in China.

The most striking feature of the global report was a further surge in the stocks of purchases index – a gauge of the pace of input stockpiling – to a record. Finished goods inventory accumulation, by contrast, remains “normal” – chart 3.

Chart 3

Input purchases by downstream manufacturers have boosted order flow for firms higher up the production chain. Such stockbuilding, however, is peaking and even a stabilisation at the current extreme pace would imply a drag effect on new orders – chart 4.

Chart 4

Cooling demand is starting to feed through to an easing of supply pressures. The supplier delivery times index recovered from an October record low (rise = faster), with an extension of an earlier turnaround in Taiwan, which typically leads, suggesting further improvement – chart 5.

Chart 5

Easing supply problems and a possible pick-up in finished goods inventory accumulation suggest that the PMI output index will catch up with and temporarily overtake new orders – chart 6. An improved supply / demand balance should also be associated with moderating price indices, which probably topped in October.

Chart 6

The judgement here is that markets will focus on softening demand / price momentum and “look through” a temporary output pick-up. Any reignition of the cyclical / reflation trade is likely to require a prior rebound in global real money growth.

The consensus expects US consumer spending to continue to grow solidly despite the current inflation squeeze on real wages and associated weakness in sentiment / confidence – the average forecast is for a rise of 3.6% in 2022, according to Consensus Economics Inc. This partly reflects an assessment that spending has been supply-constrained while consumers have substantial unused fire-power in the form of money balances accumulated against a background of high saving over the past 18 months.

The suspicion here is that much of the increase in money holdings reflects portfolio and precautionary demand, with little implication for near-term spending prospects.

The personal saving ratio has now fully reversed its 2020 surge, with October’s 7.3% reading the same as in December 2019 – see chart 1.

Chart 1

The ratio, moreover, continues to be inflated by temporary pandemic-related benefits, which are winding down and will expire at year-end. Excluding such benefits from the income definition, the saving ratio was 5.9% in October, close to a post-GFC low of 5.8% reached in 2013.

Bulls argue that the saving ratio will remain low or fall further as supply shortages and pandemic disruption fade, allowing consumers to spend accumulated money balances. According to the Fed’s financial accounts, households’ broad money (M3*) holdings surged by 29.9% between end-2019 and mid-2021, pushing their ratio to disposable income to a record – chart 2.

Chart 2

The demand for money, however, depends on portfolio considerations as well as income / spending. With household wealth – housing as well as financial – growing strongly before and during the pandemic, the ratio of money holdings to total assets remains within its post-GFC range and below the long-term historical average.

The suggestion that much of the money surge reflects portfolio demand rather than unsatisfied consumer spending is supported by Fed data breaking down money holdings by income level.

M3 holdings of the top 1% of income-earners rose by 45.7% between end-2019 and mid-2019, accounting for 9.5 pp of the 29.9% increase in total household money balances over this period – charts 3 and 4.

Chart 3

Chart 4

The bulk of the remaining increase was absorbed by other households in the top 60% of the income distribution – their money balances grew by 27.4%. The bottom 40% of income-earners accounted for only 1.5 pp of the 29.9% increase in household M3, their holdings growing by 15.0%.

The money growth ranking of the three groups mirrors relative increases in wealth: total assets of the top 1% of income-earners rose by 30.6% between end-2019 and mid-2020 versus growth of “only” 12.4% for the bottom 40% – chart 5

Chart 5

Independent of portfolio money demand considerations, the marginal propensity to consume out of money balances is likely to be lower for higher-income households.

If the above argument – that high money balances may not imply future spending – is correct, the consensus forecast for consumption growth in 2022 is likely to require strong expansion of employment incomes. This, in turn, may depend on a significant recovery in labour force participation.

A CBO study in 2018 presented a long-term projection for the “potential” (i.e. cyclically-adjusted) labour force participation rate based mainly on demographic factors (i.e. the changing age structure of the population). This projection suggests that most of the recent decline is “structural”, in which case Fed / consensus assessments of labour market slack (and possible employment growth as this is absorbed) may be overoptimistic – chart 6.

Chart 6

*Checkable deposits and currency, time and savings deposits, and money market fund shares.