The widely-watched ISM manufacturing new orders index – a gauge of industrial momentum – rebounded from February / March falls to reach a 12-month high in April. The index, however, may be in the process of peaking out, based on the following considerations.

First, six-month real narrow money growth has slowed from a peak in October and typically leads economic momentum by about six months. (Real money, however, is still expanding, so does not support the long-standing recession calls of the ECRI, Hussman etc.)

Secondly, the recent pick-up in the ISM measure fits the historical cyclical pattern. This pattern suggests a peak in June followed by a gradual decline during the second half.

Thirdly, a leading indicator derived from the OECD’s US leading index appears to have peaked in January, consistent with a spring ISM top. (A March update of the indicator will be available next week.) 

Fourthly, Korean manufacturing expectations often lead ISM new orders and have softened recently.

The suggestion from monetary trends of a slowdown rather than anything worse is supported by recent retail sales resilience.

Worries, meanwhile, that the labour market is softening are not supported by April data on withheld taxes – a timely but noisy proxy for wage incomes.

UK monetary trends continue to suggest a recovery in economic momentum during the course of 2012, though to an uncertain extent.

Recent economic weakness was signalled by a contraction in real broad and narrow money in late 2010 and early 2011 – see first chart. The preferred broad measure here is non-financial M4, comprising holdings of households and non-financial companies. Its six-month real change reached a low of -2.7% (not annualised) in April 2011 but was recovering before the MPC launched QE in October. Today’s March release shows a further rise to 0.8% – the strongest since early 2009, just ahead of a spurt in growth.

The hopeful message from broad money, however, is clouded by continued weakness in real narrow money M1, although its decline has slowed since early 2011. M1 may have been depressed by banks’ bidding more aggressively for term funding – the spread between the average rates on household time and interest-bearing sight deposits has widened from 1.67% to 1.83% over the last year. The non-interest-bearing component of M1, moreover, is growing solidly. These considerations suggest placing more weight on the broad money signal at present.

A further positive development is a recovery in the corporate liquidity ratio (i.e. sterling plus foreign currency deposits of non-financial companies divided by their bank borrowing) in the first quarter, reversing a decline during the second half of 2011 – second chart.

Note that the traditional M4 broad money measure is currently being distorted by a contraction of interbank financial activity channeled through “intermediate other financial corporations” – such activity is of little relevance to the wider economy, which is why direct interbank business is excluded from money supply definitions. Bearish analysis based on the fall in M4, in other words, should be ignored.

Eurozone monetary trends are improving at the margin, suggesting that the ECB’s rate cuts and liquidity injections have been at least partially effective and consistent with a stabilisation of EMU-wide output by the late summer. A recovery, moreover, has occurred in the periphery as well as the core in the last two months, a development that – if sustained – could herald an end to recessions in the former group by late 2012.

The key monetary forecasting indicator employed here is the six-month change in real narrow money M1, which outperforms the broader M3 measure. This turned heavily negative in early 2011, warning of the current recession. It recovered to -0.1% (not annualised) in March, consistent with industrial output stabilising from around September, allowing for the usual six-month lead – see first chart.

M1 comprises currency in circulation and overnight deposits. The ECB publishes a country breakdown of deposits but not currency. In the six months to March, real M1 deposits rose by 2.8% (not annualised) in the “core” (i.e. Germany, France, Benelux, Austria) but fell by 3.7% in the “periphery” (Italy, Spain, Greece, Portugal, Ireland). The peripheral decline, however, eased from 5.6% in February – second chart.

The six-month changes continue to be dominated by monetary weakness in late 2011 / January 2012. EMU-wide real M1 deposits rose by a solid 1.0% in February and March combined, with similar increases in the core and periphery – third chart.

It is still early days but a further recovery in peripheral real M1 would suggest an end to recessions by late 2012. The risk, however, is that the lagged impact of the ECB’s rate cuts and liquidity injections will be offset by the recent renewed rise in financial tensions, reflected in wider peripheral / core spreads. Further ECB rate cuts are warranted to reduce this risk.