A surge in global money growth starting in March suggested that the economy and markets would rebound strongly from virus-driven losses. The monetary forecast, so far, has been on track. Global (i.e. G7 plus E7) retail sales volume surpassed its pre-covid peak in June, with industrial output likely to have done the same in October.

Hospitality, travel and leisure activities have remained constrained by virus restrictions but the services sector as a whole has also recovered impressively. Global GDP was on course to return to peak in early 2021.

International forecasting organisations have been forced to revise up their 2020 growth projections substantially.

Glass-half-empty commentary has focused on labour market weakness. The labour market is a lagging economic indicator but the US unemployment rate had reversed 60% of its spike by September, with weekly claims data suggesting a further decline – see first chart. Adjusted for furlough and short-time working schemes to make them comparable with US data, European unemployment rates have traced a similar profile. The global composite PMI employment index moved back above 50 in September.

Markets are fearful that the reimposition of virus restrictions in Europe will be mirrored globally, derailing recovery. Market weakness could trigger credit tightening and a downward spiral into a “double dip”. These worries are occurring against a backdrop of moderating money growth.

Economic forecasters can’t avoid incorporating assumptions about virus developments. The rise in global new case momentum has been rather modest, with the European pick-up partly offset by declines in India and Brazil. European momentum, moreover, is weaker than in the spring. Current restrictions could be effective more swiftly than projected by epidemiologists incentivised to emphasise tail risks.

The monetary backdrop remains supportive. Three-month growth of global real narrow money has subsided from a May record but stabilised in September at an above-average level by historical standards – second chart. Governments are ramping up fiscal support again with central banks to provide the financing.

The global industrial pick-up could power through virus disruption as a stockbuilding cycle recovery moves into overdrive. Inventories contributed 6.6 percentage points to the 33.1% annualised growth of US GDP in Q3  but this reflected a stabilisation of levels after record Q2 destocking rather than any rebuild: the ratio of inventories to sales plunged as final demand surged – third chart. Japanese manufacturing inventories fell again in September to their lowest level since 2017. Euroland manufacturing surveys suggest that the cycle recovery is accelerating – fourth chart.

Industrial output is a better guide to equity market earnings than overall GDP. Forward earnings estimates have been recovering but are lagging well behind output, suggesting limited downside even if the output pick-up now stalls – fifth chart.

The negative market reaction to virus news may partly reflect a temporary loss of “excess” money support. As previously discussed, the gap between six-month growth rates of global real narrow money and industrial output will have turned negative in October but is likely to move back above zero in December or January – sixth chart.

A post two weeks ago discussed limiting pro-cyclical positioning until the six- and three-month excess money growth gaps returned to positive alignment and / or a market correction presented an opportunity to increase exposure at more attractive levels. The correction may have further to run but monetary trends and cycle analysis argue against shifting to a defensive strategy.

Euroland money growth is moderating but remains solid, signalling favourable economic prospects for 2021. Relative money trends suggest much greater strength in the US, however.

As usual, the focus here is on non-financial monetary aggregates, i.e. comprising money holdings of households and non-financial businesses. The headline M3 and M1 measures include financial sector holdings, which are volatile and less informative about future economic trends. There is little divergence between the non-financial and headline measures at present.

Three-month growth of non-financial M3 peaked at 22.7% annualised in May, falling steadily to 10.0% in September – still high by historical standards. Three-month growth of non-financial M1 eased from 28.9% to 12.8% over the same period – see first chart.

Year-on-year growth rates continued to rise in September, reflecting weak monthly increases in September 2019.

Why has shorter-term momentum slowed? According to the M3 “credit counterparts”, the fall in its three-month growth is attributable roughly equally to a moderation of bank lending growth to the private sector and a slowdown in banking system purchases of government bonds – second chart. The latter reflects both a reduced pace of ECB buying and a cessation of purchases by commercial banks, following a March-May spike.

The ECB Q3 bank lending survey, also released today, reports subdued expected credit demand across loan categories, suggesting that lending growth to the private sector will moderate further – third chart. Maintenance of solid broad money expansion, therefore, is likely to depend on ongoing large-scale QE.

The fourth chart shows six-month growth rates of narrow money in real terms (i.e. deflated by consumer prices) in the major economies. The September Euroland fall mirrors declines in the US and China – global money trends are clearly now cooling. US growth, however, remains far higher – true of broad money too. The global money backdrop continues to suggest stronger economic growth and inflation in 2021 than forecast by, for example, the IMF but upside risks appear much greater in the US than Europe, while China could disappoint an overbullish consensus.

The IMF’s new forecast that Chinese GDP growth will rise from 1.9% in 2020 to 8.2% in 2021 is representative of current consensus bullishness. Recent monetary trends sound a note of caution, however.

The IMF’s projections imply that Chinese GDP will expand by 10.3% over the two years despite a 2.1% GDP contraction in advanced economies – an implausibly large divergence.

As reported in a post last week, six-month growth rates of narrow and broad money peaked over the summer and fell further in September. Growth of broad credit – “total social financing” (TSF) – has been more resilient, partly reflecting government bond issuance, which may slow as fiscal stimulus moderates. The first chart shows six-month credit growth on the previous definition, which excluded such issuance and several other recently added components; this has shown a more pronounced recent fall, echoing the money measures.

The money / credit slowdown is unsurprising given a significant rise in market rates since the PBoC withdrew excess money market liquidity in the spring. The three-month interbank rate is up by 145 bp from its trough – second chart. With inflation low and the currency strengthening, the PBoC has ample scope to resume easing if economic data show a loss of momentum.

The money / credit slowdown is also consistent with the most recent PBoC quarterly bankers’ survey, which showed a decline in the loan approvals index, although this remained at a historically high level – third chart. By contrast, the September Cheung Kong Graduate School of Business survey of private sector firms reported a further rise last month in the corporate financing index, measuring ease of obtaining external funds – fourth chart. This index generally trends in the same direction as money growth, suggesting a pullback in the upcoming October survey.

The message, for now, seems to be that monetary conditions, though tightening at the margin, remain growth supportive. The PBoC’s reduction of policy support may prove wise: officials may be anticipating a significant external boost to growth next year as advanced economies boom in response to this year’s monetary largesse – a possibility ignored by the (usually wrong) IMF.

Six-month growth of the “global” (i.e. G7 plus E7) real narrow money measure tracked here is estimated to have fallen again in September, confirming July as a peak – see first chart. Allowing for an average nine-month lead, this suggests a slowdown in six-month industrial output growth from around April 2021.

Three-month real narrow money growth, however, stabilised last month and remains above average – second chart. So money trends are still suggesting solid economic prospects for mid 2021.

Cycle analysis also argues against overemphasising recent monetary cooling. As previously discussed, the global stockbuilding or inventory cycle is now in a recovery phase, with a cycle peak unlikely until late 2021 at the earliest. Money-signalled economic slowdowns tend to be minor during stockbuilding cycle upswings. For example, falls in six-month real narrow money growth in 2012-13 and 2016-17 were followed by small and temporary dips in industrial output momentum, with significant weakness delayed until 2014 and 2018 after the stockbuilding cycle had peaked (following lows in late 2012 and early 2016).

Market prospects depend on not the level of (real) money growth but rather any deviation of actual growth from the demand for money based on economic needs. Assessment of current “excess” money conditions is complicated by recent extreme volatility in money and output data.

As previously reported, the gap between six-month growth rates of global real narrow money and industrial output has been informative about future equity returns historically, outperforming both 12-month and three-month growth gaps. A surge in the six-month growth gap from March signalled a V-shaped recovery in markets.

The six-month growth gap appears to have remained positive in September but will turn negative in October, reflecting an output growth base effect from a record 12.9% month-on-month fall in April – see third chart, in which the output projection assumes 0.8% monthly increases in September and October. A negative cross-over would normally suggest shifting defensively, based on the historical risk-return trade-off. The backtesting allowed for a two-month reporting lag, i.e. a negative October gap would suggest cutting equity exposure at end-December.

The negative signal, however, is very likely to prove short-lived. The three-month growth gap, which turned negative in July, is already starting to close as output growth normalises and could turn positive in October just as the six-month gap gives a cautionary signal – fourth chart.

A further consideration is that stockbuilding cycle upswings are usually associated with outperformance of equities and other cyclical assets, albeit punctuated by sometimes significant corrections.

A possible compromise could be to maintain but limit pro-cyclical positioning until the six- and three-month excess money growth gaps return to positive alignment and / or a market correction presents an opportunity to increase exposure at more attractive levels.

Chinese money and credit trends appear to be cooling following a reduction in PBoC policy support, reflected in a significant rise in interbank rates since June.

The consensus interpretation of today’s September numbers is likely to be bullish. Monthly flows of broad credit (total social financing) and bank lending topped expectations, while annual growth of M2 rebounded to 10.9%.

The focus here is on six-month rates of change (seasonally adjusted) of outstanding stocks of money and credit. These peaked over the summer, moderating further in September – see chart.

Growth rates remain well above last year’s lows. The PBoC is probably aiming for stability rather than a slowdown. Business survey evidence of easier credit conditions suggests that lending and money flows will hold up.

The message is that economic momentum may cool from early 2021 but there are no monetary grounds for concern yet. Equally, though, there is no monetary case for additional policy restraint and a further rise in rates.

Most countries have released August industrial output data. The “global” measure tracked here, covering the G7 economies and seven large emerging economies, is estimated to have risen by a further 0.9% on the month, implying that more than 90% of the 18.0% fall between December 2019 and April 2020 has now been retraced – see first chart. An additional increase of 1.7% is needed to regain the peak and is likely to be delivered by October. If so, the round trip in output back to the peak will have occurred four times faster than in the GFC recession / recovery, i.e. in 10 versus 41 months (February 2008-July 2011).

Retail sales had already surpassed the prior peak in June and rose to a new record in August.

Strong growth of industrial output and retail sales over the summer occurred despite a significant rise in G7 plus E7 new covid cases, which have slowed recently as falls in Brazil and India have balanced pick-ups in Europe and the US. The latter are disrupting recoveries in certain service activities but pose little threat to industrial output / goods demand strength.

Equity market earnings are geared to industrial output rather than GDP. A likely return of global output to the peak suggests the same for global earnings per share. The consensus forecast based on bottom-up analyst estimates has recovered but appears to have considerable further upside – second chart.

Does this imply additional strength in equities? Not necessarily. The forward earnings estimate has risen in 238 months since 1988 but the MSCI All-Country World Index in US dollars rose in only 162 of those months, i.e. 68% of cases. There were, in other words, 76 months in which a derating of the market offset a rise in forward earnings.

In 36 of these 76 months, the derating was associated with a rise in real government bond yields. September 2020 was a case in point: equities ended the month lower, despite a rise in forward earnings, as real TIPS yields edged higher – third chart.

A further rise in real yields as global “excess” money is absorbed by economic growth could cap equity market upside despite favourable earnings revisions. Such a scenario offers the best hope of a sector rotation in favour of cyclical value (financials, energy) at the expense of long duration cyclical growth (IT, communication services). September estimates of global narrow and broad money measures will be available later thls week, allowing an updated assessment of current excess money trends.