The US broad money supply, on the superior flow of funds accounts measure, slowed during the second half of 2011, consistent with economic growth moderating during the first half of 2012, as also suggested by recent narrow money developments – see previous post.

The flow of funds accounts provide detailed information on the financial holdings of US households, businesses and financial institutions, permitting the calculation of a comprehensive broad money supply measure with an accompanying sectoral breakdown. Fourth quarter accounts were released yesterday. The definition used here comprises currency, US bank deposits (checkable, time and savings), foreign deposits, money market mutual funds and security repurchase agreements. The official M2 definition, by contrast, omits US large time deposits, foreign deposits, institutional money funds and repos.

The flow of funds measure grew by an annual 6.0% in December, up from 5.8% in September – see first chart. Quarterly expansion, however, slowed further from 3.4% annualised to 3.0% – well down from 9.4% in the second quarter of 2011 and 8.3% in the first. The change between the two halves probably reflects QE2 finishing in mid 2011.

A silver lining is that money holdings of non-financial businesses continued to rise strongly during the second half, with the fall in aggregate growth due to a slowdown in household liquidity and an outright fall in the financial sector. Non-financial business money holdings climbed 13.6% in the year to December, a development that should provide support for investment, hiring and take-over activity – second chart.

Chinese money supply figures for February warrant continued concern about downside economic risks, while a larger-than-expected fall in inflation may partially reverse in March, delaying necessary significant policy easing.

The forecasting approach employed here emphasises the six-month rate of change of real narrow money – M1 in China’s case.  This turned negative in January but was expected to rebound in February as New Year holiday timing distortions unwound. It did, but only back to zero. Similar weakness in mid 2008 preceded a rare contraction in industrial output – see first chart.

Broad money and loans are growing faster in real terms now than then but six-month changes seem to have peaked in December – first chart. A provisional verdict is that monetary trends are signalling a loss of economic momentum during 2012 following a brief revival late last year but the extent of the slowdown is unclear. The OECD’s Chinese leading index – released on Monday – will provide further clues.

Annual consumer price inflation of 3.2% in February, down from 4.5% in January, was probably flattered by a post-holiday fall in food prices occurring earlier this year than last, suggesting a partial reversal in March. Producer price inflation may also recover as firms pass on recent rises in input costs – second chart. Early further policy easing is expected but lingering inflationary pressures may prevent action on a scale necessary to avert a bumpy economic landing.

As previously discussed, global real narrow money is suggesting a peak in growth – as measured by the six-month rate of expansion of G7 plus emerging E7 industrial output – in May. Such a peak, however, has yet to be confirmed by a shorter-term leading indicator derived from the OECD’s country leading indices – next update on Monday.

A May peak in output momentum would be expected to be preceded by a top in purchasing managers’ manufacturing new orders indices, possibly in March or April. G7 PMI new orders fell back in February following a solid recovery in December / January. This raises the possibility that a slowdown is emerging earlier than suggested by the monetary runes.

Changes in equity analysts’ views about the earnings prospects of the companies they follow provide a higher frequency and more timely cross-check of the PMIs. The global “earnings revisions ratio” – the net number of analyst upgrades, expressed as a proportion of the number of forecasts – is strongly correlated with G7 PMI manufacturing new orders. The ratio retreated in January, signalling the February fall in PMI orders, but has since rebounded strongly, reaching its highest level for a year – see chart. The suggestion is that the February orders decline will be reversed in March.

Investors inclined to become defensive in anticipation of an economic slowdown later in 2012 may be on the right track but risk missing out on near-term gains as news remains favourable for a while longer and recent central bank liquidity injections filter into markets. The view here is neutral awaiting further monetary evidence – including important February Chinese data due shortly – and the leading indicator update.

As suggested in a post last week, the second ECB three-year LTRO had a much larger impact on bank reserves than the first such operation in December, despite gross lending being only moderately higher. Banks’ current account and deposit facility balances at the ECB rose by €341 billion or 60% in the week to Friday versus a €165 billion or 32% increase in the week to Friday 23 December, following the first three-year LTRO on 21 December.

Total bank reserves in the US, Japan, Eurozone and UK, therefore, rose by $395 billion or 13% last week to a new record 10% above the prior weekly closing high on 23 December – see chart.

The further increase suggests near-term liquidity support for markets but reserves may now plateau. The US component has been flatlining since QE2 ended in June and may decline if an easing of financial market tensions reduces foreign demand for the Fed’s dollar swap loans. Eurozone reserves will probably drift lower as banks use part of the cash borrowed in the three-year LTROs to repay shorter-term loans as they fall due. Japanese and UK reserves should rise as a consequence of ongoing QE operations (although the former, strangely, have fallen recently) but may not offset a US / Eurozone decline.

Can markets keep rising without additional infusions of central bank cash? Fed Chairman Bernanke last week downplayed talk of further stimulus but QE3 would return to the table in the event of US economic data disappointing, as seems possible – see Friday’s post. A liquidity boost, however, might be delivered only after a market correction sufficiently scary to suppress opposition to further monetary experimentation.