Entries from July 1, 2021 - July 31, 2021
Global slowdown on track, is real money growth bottoming?
Global six-month real narrow money growth appears to have moved sideways in June and could be bottoming after a 10-month slide. If confirmed, and allowing for the usual lead time, this would suggest a stabilisation of industrial momentum in early 2022 following a H2 2021 slowdown.
The June real narrow money growth estimate is based on monetary data covering 70% of the G7 plus E7 aggregate tracked here and near-complete inflation numbers. The prior fall in real money growth is expected to be reflected in “surprising” weakness in global PMI manufacturing new orders and other coincident indicators of industrial momentum during H2 2021 – see chart 1.
Chart 1
Global stabilisation conceals a June recovery in Chinese six-month real narrow money growth offset by further slowdowns in the US and Japan, with European data yet to be released – chart 2.
Chart 2
The recent cut in reserve requirements is judged here to confirm a trend shift in Chinese monetary policy, probably heralding a sustained rebound in money growth. Another indication of a policy turn is a rise in the differential between the loan approvals and loan demand indices in the PBoC Q2 bankers’ survey, suggesting that banks have been instructed to loosen credit – chart 3.
Chart 3
Street claims that last week’s Chinese activity data were solid, implying no need to adjust policy settings, are puzzling. GDP grew by only 3.4% annualised between Q4 and Q2. Monthly indicators are stagnant in real seasonally adjusted level terms – chart 4.
Chart 4
The view here is that the economy faced a “hard landing” without a policy change but the authorities have recognised the risk and will act to avert it.
Support to global real money growth from Chinese easing should be supplemented by a slowdown in global six-month CPI inflation in H2, assuming stable commodity prices – chart 5. Commodity prices could weaken as industrial activity decelerates.
Chart 5
China continues to lead US / global economic momentum. The six-month rate of change of the OECD’s US leading indicator peaked four months after that of a Chinese indicator – chart 6*. This fits with a four-month interval between peaks in 10-year government bond yields – November in China, March in the US.
Chart 6
Street descriptions of US June retail sales as "robust" are also questionable. With prices surging, sales fell for a third month in real terms, consisent with a fading boost from March / April stimulus payments – chart 7.
Chart 7
Markets have already partially discounted a H2 economic slowdown, with quality stocks outperforming and bullish flattening of yield curves. Non-tech cyclical sectors of developed equity markets have so far held up against defensive sectors and could be the next shoe to drop – chart 8.
Chart 8
*The indicators shown use the OECD’s methodology but are calculated independently.
A "monetarist" perspective on current equity markets
Monetary trends continue to suggest a slowdown in global industrial momentum in H2 2021, with a rising probability that weakness will be sustained into H1 2022 – contrary to the prior central view here that near-term cooling would represent a pause in a medium-term economic upswing. Pro-cyclical trends in markets have corrected modestly but reflationary optimism remains elevated, indicating potential for a more significant setback if economic data disappoint. Chinese monetary policy easing is judged key to stabilising global prospects and reenergising the cyclical trade.
Global six-month real narrow money growth – the “best” monetary leading indicator of the economy – peaked in July 2020 and extended its fall in May, dashing a previous hope here of a Q2 stabilisation / recovery. This measure typically leads turning points in the global manufacturing PMI new orders index by 6-7 months but a PMI peak was delayed on this occasion by a combination of US fiscal stimulus and economic reopening. A June fall in new orders, however, is expected to mark the start of a sustained decline, confirming May as a significant top – see chart 1.
Chart 1
The magnitude of the fall in global real narrow money growth and its current level suggest a move in the manufacturing new orders index at least back to its long-run average of 52.5 during H2 (May peak = 57.3, June = 55.8).
China continues to lead global monetary / economic trends, as it has since the GFC. A strong recovery in activity through 2020 prompted the PBoC to withdraw stimulus in H2, resulting in a money / credit slowdown that has fed through to weaker H1 2021 economic data. The central bank, however, has been reluctant to change course, partly to avoid fuelling house and commodity price speculation, and six-month real narrow money growth has now fallen to a worryingly low level, suggesting rising risk of a “hard landing” in H1 2022 – chart 2.
Chart 2
Real narrow money growth remains above post-GFC averages in other major economies but has also fallen significantly, reflecting both slower nominal expansion and a sharp rise in consumer price inflation. Six-month inflation is likely to fall back during H2 but nominal trends could weaken further in response to higher long-term rates and as money-financed fiscal stimulus moderates.
The suggestion from monetary trends of a deeper and more sustained economic slowdown could be argued to be inconsistent with cycle analysis. In particular, the global stockbuilding or inventory cycle bottomed in Q2 2020 (April) and, based on its 40-month average length, might be expected to remain in an upswing through early 2022, at least. This understanding informed the previous view here that a cooling of industrial momentum in mid-2020 would prove temporary.
A reassessment, however, may be warranted to take account of the distorting impact of the covid shock, which stretched the previous cycle to 50 months. A compensating shortening of the current cycle to 30 months would imply a cycle mid-point – and possible peak – in July 2021.
This alternative assessment is supported by a rise in the business survey inventories indicator monitored here to a level consistent with prior cycle peaks – chart 3.
Chart 3
The previous quarterly commentary suggested that cyclical equity market sectors and value were less attractive in the context of an approaching PMI peak, while quality stocks had potential to rally. MSCI World non-tech cyclical sectors lagged defensive sectors during Q2, with quality and growth outperforming value – chart 4. These trends could extend if the slowdown scenario described above plays out. Chinese policy easing would support the cyclical / value trade but the impact could prove temporary unless the Chinese shift resulted in an early rebound in global real narrow money growth.
Chart 4
Counter-arguments to the relatively pessimistic economic view outlined above include the following:
1. Fiscal policy remains highly expansionary and will offset monetary weakness.
Response: Economic growth is related to the change in the fiscal position and deficits, while large, are falling in most countries. Even in the US, President Biden’s stimulus package served mainly to neutralise a potential drag as earlier measures expired. The US fiscal boost peaked with the disbursement of stimulus cheques in March / April.
2. Household saving rates and money balances are high, implying pent-up consumer demand.
Response: Savings rates have been temporarily inflated by government transfers and will normalise as these fall back and consumption recovers to its pre-covid level. High money balances probably reflect “permanent” savings. US households planned to spend only 25% of the most recent round of stimulus checks, according to the New York Fed, using the rest to increase savings and reduce debt. The implied spending boost has already been reflected in retail sales, which may fall back in Q3.
3. Services strength as economies reopen will offset any industrial slowdown.
Response: The services catch-up effect is temporary and momentum is likely to reconnect with manufacturing in H2. Industrial trends dominate economic fluctuations and equity market earnings.
4. Profits are rising strongly, with positive implications for business investment and hiring.
Response: Profits are still receiving substantial support from government subsidies, withdrawal of which will offset much of the additional boost from economic normalisation. An increase in net subsidies relative to their Q4 2019 level accounted for 10% of US post-tax corporate economic profits in Q1, according to national accounts data – see chart 4.
Chart 5
5. Inventories to shipments ratios remain low, implying that the stockbuilding cycle is far from peaking.
Response: Economic growth is related to the change in stockbuilding, not its level. Stockbuilding is highest when inventories are low – the subsequent fall is a drag on growth even though stockbuilding usually remains high until inventories normalise. Low inventories to shipments ratios, therefore, are consistent with a cycle peak.
6. Industry has been held back by supply constraints – output and new orders will surge as these ease.
Response: Supply difficulties have probably resulted in firms placing multiple orders for inputs, inflating PMI readings – this effect will unwind as bottlenecks ease. Historically, manufacturing PMI new orders have fallen, not risen, following a peak in supply constraints.
7. Rising inflation will boost bond yields, supporting cyclical / value outperformance.
Response: Last year’s global money surge was expected here to be reflected in high inflation in 2021-22 but six-month broad money growth has moved back towards its pre-covid average, suggesting that medium-term inflation risks are receding. Bond yields usually track industrial momentum more closely than inflation data so would probably remain capped in a slowdown scenario even if inflation news continues to surprise negatively.