The two measures of global “excess” money tracked here remain negative, arguing for a cautious view of equity market prospects. 

Excess (or deficient) money refers to the difference between the actual money stock and the demand for money to support economic transactions. According to “monetarist” theory, a surplus is associated with increased demand for financial / real assets and upward pressure on their prices, assuming no change in supply. 

Excess money is unobservable so two proxies are followed here: the difference between six-month rates of change of global (i.e. G7 plus E7) real narrow money and industrial output; and the deviation of 12-month real narrow money growth from a slow moving average. 

Historically (i.e. over 1970-2021), global equities outperformed US dollar cash on average only when both measures were positive. Unsurprisingly, average performance was worst when both were negative (underperformance of 8.9% pa). These results allow for reporting lags in monetary / economic data. 

The second measure turned negative in October 2021, which was known by end-November. The first measure followed in November, which was known by end-January 2022 (a longer lag because industrial output numbers are released after monetary / CPI data). 

Previous posts noted a recovery in global six-month real narrow money momentum during H2 2022*. With industrial output expected to weaken, it was suggested that the first measure would turn positive, possibly by December. 

The second measure – based on 12- rather than six-month real money momentum – was deeply negative in late 2022, with a switch to positive deemed unlikely before mid-2023. 

The suggested switch positive in the first measure has yet to occur. The six-month rate of change of industrial output crossed below zero in December but remained just above real narrow money momentum – see chart 1. 

Chart 1

Will a cross-over have occurred in January? Partial data suggest that the recovery in real money momentum stalled last month. A reliable January estimate of industrial output won’t be available until mid-March. A reopening bounce in China could offset weakness elsewhere. 

A further point is that the recovery in global real narrow money momentum since mid-2022 partly reflected a strong pick-up in Russia, which may be of limited global relevance given the country’s enforced economic and financial isolation. 

Chart 2 shows the result of replacing Russia with Indonesia in the G7 plus E7 real money calculation from January 2022, before the February invasion of Ukraine**. The trough in real money momentum is placed in October rather than August, with the subsequent recovery even more anaemic. 

Chart 2

*The trough in real money momentum originally occurred in June but is now placed in August, partly reflecting revisions to US CPI seasonal adjustments.

**The other E7 countries (as defined here) are Brazil, China, India, Korea, Mexico and Taiwan.

US and UK CPI data this week elicited opposite market reactions but core momentum has recently slowed notably in both cases, consistent with a moderation in money growth rates two years earlier. 

Chart 1 shows three-month annualised rates of change of preferred core measures – CPI ex. food, energy and shelter for the US and CPI ex. energy, food, alcohol, tobacco, education and VAT change effects for the UK. US three-month momentum was just 1.5% in January, while UK momentum fell sharply to 2.8%.

Chart 1

The ”monetarist” rule of thumb is that money leads prices by about two years. Chart 2 superimposes three-month rates of change of broad money. Growth peaked in May 2020. The recent significant declines in core CPI momentum began in June 2022 in the UK and July in the US.

Chart 2 

Average broad money growth of 4.5% pa in both the US and UK over 2010-19 was associated with sub-2% average core CPI inflation. Three-month rates of change of broad money moved below 4.5% annualised on a sustained basis in March 2022 in the US and June in the UK. A reasonable expectation, therefore, is that core CPIs will be rising at a sub-2% by mid-2024 in both cases.

The path lower in money growth from the May 2020 peak was bumpy and core CPI momentum is likely to display similar volatility around a declining trend.

Japanese monetary trends continue to argue that current inflation is “transitory” and there is no case for BoJ policy tightening. 

Broad money M3 rose by just 0.1% in January, pulling annual growth down to 2.3%, below a 2010-19 average of 2.6%. Annual M1 growth is also below its corresponding average – see chart 1. 

Chart 1

M3 showed little growth on the month despite BoJ net JGB purchases reaching a record ¥20.3 trillion, equivalent to $155 billion or 1.3% of the stock of M3 – chart 2. The modest M3 increase pushes back against claims that BoJ JGB buying has “pumped liquidity into markets”. 

Chart 2

A counterparts analysis of M3 is not yet available for January but the lack of impact of QE is probably explained by the BoJ transacting mainly with commercial banks. A purchase from a bank involves a JGB / reserves swap with no effect on deposits held by non-banks. 

A further technical point is that Japanese money definitions exclude holdings of non-bank financial institutions, so purchases from such institutions also have no direct effect on M3. 

Chart 3 shows the contributions to annual M3 growth of selected credit counterparts through December. A substantial positive contribution from QE (domestic credit to government from BoJ) was offset by weakness in domestic credit to other sectors and negative contributions from commercial bank JGB sales (domestic credit to government from other banks) and net external flows. The latter drag partly reflects BoJ intervention to support the yen in late 2022. 

Chart 3

The weakness of credit expansion to non-government domestic sectors in the M3 counterparts analysis contrasts with a recent pick-up in annual growth of loans and discounts by major, regional and Shinkin banks – chart 4. The explanation for the divergence is that the M3 credit measure encompasses lending to non-bank financial institutions, including by the BoJ. Such lending surged during the pandemic but has contracted recently. 

Chart 4

Annual all-items consumer price inflation rose to 4.0% in December, the highest since 1981, and may have reached 4.5% in January, based on Tokyo data. Core inflation adjusted for the impact of major policy changes was 1.7% in December and may have increased to 2.0-2.1% in January. The recent pick-up partly reflects yen weakness, which may be reversing – chart 5. 

Chart 5

Annual cash earnings growth surged to 4.8% in December as winter bonuses reflected recent strong profits. Scheduled earnings growth of 1.8% is a better guide to trend but also represents a multi-decade high. 

The reversal of the 2020-H1 2021 M3 growth surge suggests that inflation and earnings growth are at or near a peak and will return to pre-pandemic levels in 2024-25.

The unusually high level of job openings may be affecting the seasonality of US labour market data. An accurate read on the non-seasonal employment trend may not be possible until the spring. 

The normal seasonality of US private payrolls is captured by the difference between BLS unadjusted and seasonally adjusted stock series, shown in chart 1. The seasonal effect is roughly neutral in September, rises to a peak in November, turns substantially negative in January and recovers back to neutral in May. 

Chart 1

The normal pattern of employers shedding jobs on a large scale in January but rehiring into the spring / summer could change when the labour market is unusually tight, as currently. Firms may prefer to hold onto workers as seasonal activity slackens, anticipating difficulties refilling jobs later in the year. Laid-off employees may find alternative work more rapidly than in a normal year. 

A change of behaviour may explain the blockbuster January payrolls rise, i.e. the seasonal adjustment may have significantly overestimated the seasonal drop in employment this year. 

An alternative approach to assessing the underlying jobs trend is to compare months when the seasonal effect is neutral. As noted, September and May are neutral months, while seasonal deviations are significant over October-April. The average change in unadjusted payrolls over September-May should be an undistorted measure of employment growth. 

If the suggestion of a seasonal distortion is correct, headline payrolls growth numbers for February-May could understate the underlying trend, compensating for January’s (possible) overstatement. 

Suppose, for illustration, that monthly growth in unadjusted payrolls turns out to average 150,000 between the two seasonally neutral months of September 2022 and May 2023. (This equates to an annualised growth rate of 1.4%, in line with the reported expansion of the labour force in the year to January, i.e. the assumption is consistent with a stable unemployment rate.) 

Such growth would imply a payrolls level of 132,686,000 in May 2023, with no significant seasonal element. This compares with a currently reported seasonally adjusted level of 132,684,000 for January. The headline payrolls measure, on these assumptions, would show negligible growth over February-May.

The consensus is gloomy about UK economic prospects but is it gloomy enough? 

The current debate has echoes of mid-2008. Q2 2008 was the first quarter of the most severe post-war recession. The consensus that summer was that the economy would eke out growth with a limited rise in unemployment and no need for significant policy easing. 

A recession is widely acknowledged / expected now but the majority view is that it will be shallow and short-lived, partly reflecting recent energy price relief. Labour market damage is projected to be modest and there is general approval of recent MPC policy tightening. 

Monetary trends warned of worse-than-expected outcomes in 2008 and are giving an equally negative message now. 

The six-month rate of contraction of real narrow money (i.e. non-financial M1 deflated by consumer prices) was unchanged at 5.9% (not annualised) in December, close to a 6.1% peak reached in October 2008 – see chart 1. 

Chart 1

As in 2008, the real money squeeze reflects both high inflation and nominal money weakness. Sectoral nominal money trends are uncannily similar to mid-2008. Corporate M1 and M4 are contracting rapidly, consistent with a sharp fall in profits and suggesting cuts in employment and investment – chart 2. 

Chart 2

Household M4 is still growing modestly but there has been a large-scale switch out of sight into time deposits in response to rising rates – a classic signal of a shift in consumer behaviour from spending to saving. 

A continued rise in employee numbers in recent months has fed a narrative of labour market “resilience” that is expected to persist. Data and complacency were similar in mid-2008. The quarterly employee jobs series rose into Q3 2008 but the stock of vacancies in June was already down by 9% from its peak, warning of trouble ahead – chart 3. The level of vacancies is higher now but the fall from the peak has been larger, at 14%. 

Chart 3