The spring sell-off in US equities (the S&P 500 and Dow Industrials peaked in early April and early May respectively) followed a fall in US bank reserves from a peak in mid-February – see chart. Reserves have led stock market turning points on several previous occasions in recent years, consistent with changes in Fed liquidity policy being an important influence on investor behaviour, a relationship termed “the Bernanke market” by Andy Kessler – see previous post.

From a low in early May, however, reserves have climbed for six consecutive weeks, with the latest increase the largest of the series. Has the Fed been injecting liquidity in response to Eurozone-related financial stress and weak economic news even before it considers formal policy easing at the Open Market Committee meeting scheduled for 19-20 June?

The reserves increase is the counterpart of a fall in the balance in the US Treasury’s account at the Fed, which could reflect funds being shifted into private banks or else a slowdown in market borrowing designed to leave more liquidity in investor hands.

US economic news is likely to remain soft – six-month real narrow money growth slowed further last month – but the Fed’s change of tack may offer near-term support to stocks.

The suggestion here has been that the Bank of England should eschew more QE and instead offer ECB-style medium-term funding to banks at a low interest rate and against wide collateral, in order to reduce borrowing rates and credit rationing. In his Mansion House speech last night, however, the Bank’s Governor, Sir Mervyn King, signalled an extension of QE while announcing two liquidity provision measures that, while helpful, fall short of the ECB’s three-year longer-term refinancing operation (LTRO) initiative.

The more significant of the two measures is the launch of the “extended collateral term repo (ECTR) facility”, under which the Bank will lend at least £5 billion of six-month money each month against a wide range of collateral at a rate to be determined in an auction but subject to a low minimum of 25 basis points (bp) above Bank rate. The Bank previously stated that the ECTR, when activated, would lend for only one month and at a minimum bid rate of 125 bp over Bank rate.

The facility, however, compares unfavourably with the ECB’s three-year LTROs because 1) the amount lent is decided – and will presumably be limited – by the Bank rather than banks, 2) the six-month loan period is relatively short and does not address banks’ medium-term funding difficulties and 3) the lending rate is auction-determined rather than fixed.

The still-formative “funding for lending” initiative, meanwhile, seems designed to inject liquidity only to the extent that banks commit to advancing new loans, suggesting that it will take a long time to grow to the mooted £80 billion. It does not affect the cost of funding existing loan books so promises little if any interest rate relief for current borrowers.

The suspicion, therefore, is that take-up under the two facilities will be much smaller – relative to the size of the economy – than for the ECB’s two three-year LTROs. Such an outcome would suggest that Sir Mervyn, once again, has skilfully resisted political demands for the Bank to deploy the full weight of its balance sheet to improve private-sector credit supply.

Weak US retail sales for May are further evidence of an economic slowdown predicted by real narrow money and confirmed by recent softness in leading indicators – see yesterday’s post.

May sales excluding food and gasoline were lower than three months earlier, in February. The three-month change tends to lead the widely-watched ISM manufacturing new orders index – see first chart.

A fall in the ISM index is also suggested by a recent pick-up in earnings downgrades by equity analysts – second chart.

Eurosystem gross lending to banks in euros rose by a further €8.5 billion last week, consistent with continued deposit flight from the periphery, necessitating increased borrowing from the ECB and national central banks. Lending has increased by €52.8 billion over the last five weeks (i.e. since 4 May).

The gross figure comprises “lending related to monetary policy operations” and “other claims”, under which the Greek and Irish “emergency liquidity assistance” (ELA) operations are recorded. The latter component fell by €61.0 billion last week as a recapitalisation of Greek banks allowed them to switch from ELA into the weekly refinancing operation – lending under this operation surged by €68.2 billion.

“Lending related to monetary policy operations” will rise further this week since €150.7 billion has been drawn down in the weekly and one-month refinancing operations settling tomorrow versus a maturing total of €132.4 billion.

Greece and Spain probably account for the bulk of the €52.8 billion lending rise over the past five weeks. Calendar May figures show an increase in Banco de Espana lending to banks of €26.3 billion. Banca d’Italia lending, by contrast, was little changed – up by only €0.6 billion. The gap between the €52.8 billion system-wide rise over the past five weeks and the €26.3 billon Spanish increase in May suggests that Greek banks have suffered an outflow of up to €26 billion, equivalent to 6% of their total assets at the end of April and 15% of their domestic deposit base.

The increase in Eurosystem lending has been “financed” by the Bundesbank, whose net TARGET2 claims rose by €54.4 billion during May to €698.6 billion, equivalent to 27% of annual German GDP.

A proprietary leading indicator of global growth derived from the OECD’s country leading indices remained positive but fell further in April, signalling that the current economic slowdown will extend at least through July, allowing for the typical three-month lead – see first chart.

The decline in the indicator confirms an earlier slowdown in global real narrow money expansion, which peaked in November 2011 and typically leads output by six months. Like the indicator, real money growth remained positive but fell again in April, implying no economic reacceleration before late 2012. Real money trends, however, may lift over the summer as inflation slows sharply.

Neither real money nor the leading indicator is yet giving a recession signal – both turned negative ahead of the 2008-09 output slump.

The country detail shows that the US leading indicator has fallen particularly sharply, consistent with more subdued US real money growth since last winter after QE2-related buoyancy earlier in 2011 – second chart. US economic deterioration, in other words, is domestically-driven as well as reflecting spill-over from weakness in Europe and China / Asia.

Growth fluctuations in the current cycle continue to resemble the pattern of the late 1970s, a similarity discussed in several previous posts extending back to late 2009 – third chart. This “template” will break down at some point but suggests that the economy will slow into 2013 while avoiding a recession – broadly consistent with the current signals from real money / leading indicators.