Gas price relief and Chinese reopening have tempered pessimism about Eurozone economic prospects, contributing to a Q4 rally in equities. Monetary trends, by contrast, suggest a worsening outlook due to the ECB’s scorched earth policy tightening. 

The preferred narrow money measure here – non-financial M1 – contracted for a third straight month in November. The three-month annualised rate of decline of 5.3% compares with a maximum fall of 1.7% during the GFC – see chart 1. 

Chart 1

Narrow money weakness is being driven by households and firms switching out of overnight deposits into time deposits and notice accounts – a normal pre-recessionary development. Broad money, in addition, is slowing – non-financial M3 rose by only 0.2% in November, pulling three-month annualised growth down to 3.4%, the slowest since 2018. 

The headline M1 and M3 measures are displaying greater weakness, reflecting a fall in money holdings of non-bank financial corporations.

Broad money growth had been supported by solid expansion of bank loans to the private sector but, as expected and signalled by the ECB’s lending survey, momentum is now fading – chart 2. Slumping credit demand and forthcoming QT suggest that broad money will follow narrow into contraction. 

Chart 2

Corporate loan demand had been boosted by inventory financing but stockbuilding reached a record share of GDP in Q3 – chart 3 – and is probably now being cut back sharply, contributing to a move into recession. Consistent with this story, short-term loans to corporations contracted in both October and November. 

Chart 3

A sharp fall in inflation will support real money trends but has yet to arrive. The six-month rate of contraction of real non-financial M1 reached another new record in November – chart 4. 

Chart 4

Monetary tightening in 2007-08 and 2010-11 was associated with a divergence of money trends across countries, reflecting and contributing to financial fragmentation. This is occurring again, with weakness focused on Italy. 

Italian real narrow money deposits contracted by 9.7%, or an annualised 18.4%, in the six months to November, with the larger decline than elsewhere due to both greater nominal weakness and higher CPI inflation – chart 5.

Chart 5

In nominal terms, total bank deposits in Italy were unchanged in the year to November – chart 6. Italian banks’ assets grew modestly over this period. The banks funded this expansion by increasing their net borrowing from Banca d’Italia, which in turn accessed additional funding from the Eurosystem, resulting in a further widening of Italy's TARGET2 deficit. This reached a record €715 billion in September following a surge in Italian BTP yields, falling back in October / November – chart 7. Another rise in yields since early December may have been associated with deposit outflows from the banking system and renewed upward pressure on the TARGET2 shortfall. 

Chart 6

Chart 7

US non-farm payrolls have risen by an average of 337,000 per month in the eight months since the Fed started hiking rates in March. The household survey measure of employment was essentially flat over this period.

The gap between the eight-month changes in the two series is at a record high, excluding April-May 2020 when data were distorted by the pandemic*. (This comparison, however, uses revised data for the two series.) 

The payrolls numbers have informed the FOMC’s judgement that “job gains have been robust”, in turn influencing the magnitude of the rise in rates this year. 

The payrolls survey covers about 670,000 worksites, while the household survey has a sample size of about 60,000. Sampling error, therefore, is larger for the household survey – the standard error of the monthly change in the household survey employment measure is more than four times that of the monthly payrolls change, according to the BLS. 

The payrolls survey, therefore, is conventionally regarded as the more reliable gauge of short-term employment movements. 

A focus on monthly sampling error, however, ignores sometimes large revisions to the payrolls data due to annual benchmarking against unemployment insurance tax records. There is no comparable annual revision to historical household survey data. 

The annual payrolls revisions have averaged close to zero over the long run but there have been clusters of negative revisions around recessions – see chart 1. 

Chart 1

Benchmark revisions occur with a long lag. The BLS in August issued a preliminary estimate of a 462,000 upward revision to the March 2022 level of payrolls. This will be incorporated in monthly historical data up to March 2022 in February 2023. 

Benchmark revisions to recent monthly data, therefore, will occur in February 2024 under current BLS practice. 

Research by the Philadelphia Fed suggests that these revisions will be negative and potentially very large. The researchers have attempted to replicate the annual BLS benchmarking procedure using quarterly UI records. They estimate that the currently-reported level of payrolls in June 2022 of 151.9 million will be revised down by 843,000, or 0.55% – chart 2. 

Chart 2

This would imply that payrolls grew by only 3,500 per month on average between March and June compared with the currently-reported 349,000. 

Chart 3 compares three-month growth rates of the official payrolls series, the household survey employment measure and the Philadelphia Fed benchmarked payrolls series. The May / June readings of the latter two are equal.

Chart 3

The official payrolls measure has risen by an average of 329,000 per month in the five months since June. Monthly gains in the household survey employment measure averaged 72,000 over this period. 

A benchmarked payrolls estimate for September won't be available until March but timely data on withheld income and employment taxes – including UI taxes – suggest that the official payrolls series has continued to overstate gains. The daily tax data are noisy but year-on-year growth of a moving average has fallen sharply since June, widening an undershoot of the normal relationship with aggregate private sector earnings growth from the payrolls survey – chart 4. 

Chart 4

*The payrolls series measures jobs while the household survey measures people. The wide gap partly reflects a rise in the number of people with multiple jobs. A BLS research series is available that attempts to convert household survey employment data to a payrolls concept, including by adding multiple jobs. This series rose by an average of 103,000 per month in the eight months to November. The difference with payrolls growth is also a record excluding 2020 data.

The BoJ’s decision to widen the fluctuation band of the 10-year JGB yield around the zero target follows an apparent withdrawal of monetary policy support by the PBoC in recent weeks. 

Three-month SHIBOR has risen by 75 bp since late September and is now only 15 bp below its start-of-year level – see chart 1. Upward pressure has been partly market-driven but the PBoC has chosen not to accommodate increased demand for liquidity. 

Chart 1

The PBoC’s Q3 monetary policy report, issued in November, expressed concern about medium-term inflation risks, stressing the importance of avoiding excessive monetary growth. An apparent hawkish shift may have been reinforced by the shock abandonment of the zero covid policy, which officials may view as likely to boost near-term price pressures via a faster demand recovery and / or an increase in supply bottlenecks. 

The Japanese / Chinese policy moves are worrying because monetary trends in the two economies have been providing a modest offset to significant US / European weakness – chart 2. That support could now fade. 

Chart 2

A rise in Japanese six-month narrow money growth in November was accompanied by a further pick-up in bank lending, consistent with stronger credit demand expectations in the BoJ’s Q3 loan officer survey – chart 3. The hope is that firmer bank loan growth / money creation will survive a modest policy adjustment. 

Chart 3

Global six-month real narrow money momentum is estimated to have risen for a fifth month in November but remains negative – chart 3. Allowing for the usual lag, the suggestion is that global manufacturing PMI new orders will bottom by next spring but remain in recessionary territory into Q3. 

Chart 4

The recovery in real money momentum continues to be driven by a slowdown in six-month CPI inflation, with nominal money growth languishing – chart 5. The inflation decline will extend but overly hawkish central banks risk pushing nominal money momentum to new lows. 

Chart 5

UK payrolled employment rose solidly again in November, while pay growth numbers for October surprised to the upside. It has been suggested that this news reinforces the case for a Bank rate hike of at least 50 bp this week. 

Employment is a lagging economic indicator. There is ample coincident evidence that a recession is under way. Annual broad money growth – as measured by non-financial M4 – is down to 3.4%, a level suggesting a medium-term inflation undershoot. The view here is that any rate rise this week will be a mistake. 

The monthly payrolled employment measure has a short history but it correlates closely with the quarterly (and less timely) Workforce employee jobs series. In the 2008-09 recession, the latter measure peaked two quarters after GDP.

Labour market indicators that lead employment / unemployment include the stock of vacancies and average hours worked. These indicators are usually roughly coincident with GDP.

The headline vacancies series is a three-month moving average but non-seasonally-adjusted single-month numbers are available and can be adjusted using a standard procedure. The resulting series peaked in April, one month before GDP, and fell again in November – see chart 1. The recent pace of decline is comparable with the 2008-09 recession.

Chart 1

The weak November vacancies number suggests that GDP contracted significantly last month after October’s catch-up from reduced September activity due to the Queen’s funeral.

Average weekly hours tell a similar story. The series, which is available only as a three-month moving average, peaked in March and fell again in October, reaching its lowest level – excluding the pandemic recession – since 2012.

Should the MPC react to strong pay numbers? The monetarist view is that pay pressures are an effect rather than a cause of high inflation and will moderate as the dramatic slowdown in money growth since 2021 feeds through to slower price rises.

The latest upside surprise, in any case, reflects a belated catch-up in public sector pay; six-month growth of private sector regular pay is high but moving sideways – chart 2. A public sector pay pick-up may be bad news for real government spending and / or the public finances but will have little effect on the pricing behaviour of private sector suppliers of goods and services – especially against a backdrop of deepening recession and a loosening labour market.

Chart 2

The global manufacturing PMI new orders index was little changed in November, the six-month rate of change of the OECD’s G7 leading indicator has hooked up and cyclical sectors have been outperforming defensive sectors in the recent equity market rally. Do these developments signal a bottoming of global economic momentum and a prospective H1 2023 recovery? 

Monetary trends argue not. Global (i.e. G7 plus E7) six-month narrow money momentum rose slightly for a fourth month in October but remains in negative (i.e. recessionary) territory. All previous recoveries through the 50 level in global manufacturing PMI new orders were preceded by real money momentum rising above 2% – see chart 1. 

Chart 1

The June low in real narrow money momentum will probably hold but a corresponding PMI new orders low is unlikely before Q1 2023. There was a 10-month lag between the most recent real money growth peak (July 2020) and the matching PMI top (May 2021). 

There are additional negative considerations. The rise in real money momentum since June has been due to an inflation slowdown, with nominal money growth weakening further – chart 2. Previous PMI recoveries were preceded by nominal as well as real money accelerations. 

Chart 2

The rise in global real money momentum reflects the E7 component, with G7 momentum still weakening – chart 3. China, India, Mexico and Brazil have contributed to the E7 recovery but the increase has been exaggerated by a nominal money surge and inflation drop in Russia – chart 4. The latter may be of limited global relevance given Russia’s partial economic isolation. 

Chart 3

Chart 4

The six-month rate of change of the OECD’s G7 leading indicator rose slightly for a third month in November, according to calculations here. This appears to be a hopeful signal – bottomings historically have usually been followed by sustained recoveries, as chart 5 shows. The uptick is also consistent with recent better relative performance of cyclical equity market sectors. 

Chart 5

Initial indicator readings, however, are often revised significantly and previous sustained recoveries in the six-month rate of change from negative territory were accompanied or more usually preceded by a revival in G7 real narrow money momentum – chart 6. With the latter yet to bottom, the uptick in indicator momentum may be either revised away or reversed. 

Chart 6