A further rise in G7 PMI manufacturing new orders in October is mildly supportive of the forecast here that the global economy will lift in late 2012 in lagged response to faster real money expansion since the spring. The index, however, needs to climb above the 50 level to provide stronger confirmation.

The October increase was again driven by the US component, with readings elsewhere slightly weaker.


Korean manufacturers are a bellwether of the global economy and their export expectations correlate with and sometimes lead G7 PMI new orders. A further recovery last month increases confidence that the G7 / US improvement is more than a blip.


The suggestion of an earlier post, meanwhile, that six-month global real money expansion would rise further in September has been confirmed by more complete data. Allowing for the typical half-year lead, this suggests that the incipient economic upswing will extend at least through next spring.


The real money pick-up has been broadly-based across regions / countries. The US remains in the lead, explaining the relative health of the economy – reflected in the PMI results – and equities. The Far East region ex Japan has also scored well since mid-year – stocks have outperformed since late August. Real money growth remains satisfactory in the Eurozone and UK but markets elsewhere may enjoy a stronger liquidity tailwind.

A key release for tracking the forecast here will be September OECD leading indicator data due on 12 November. A third consecutive rise is expected in a proprietary global lead measure derived from the country indicators – see previous post.

The forecast here that the MPC will suspend QE at its meeting next week is supported by the “MPC-ometer” model discussed in previous posts. This attempts to predict the monthly decision based on the latest values of 12 economic and financial inputs, including business / consumer confidence measures, GDP growth, inflation, wage increases, measures of price expectations, credit spreads and the stock market.

The provisional model reading for November is negative, indicating an easing bias, but within the range consistent with no change in policy – see chart. This incorporates new data for 10 of the 12 inputs, with the remaining two components – from the PMI manufacturing and services surveys to be released on Thursday and Monday respectively – assumed to be unchanged from last month. The PMIs would need to weaken sharply to tip the model into the easing zone.

The no change prediction has been influenced by stronger third-quarter GDP growth (adjusted for the bank holiday distortion), a rise in consumer inflation expectations, firm stock prices and a fall in interbank interest rates, among other factors.

Note that the model correctly predicted the launch of QE2 in October 2011 and its extension in February. It also signalled the further £50 billion addition in July, though was early, turning dovish from May.

US stocks have displayed a positive correlation with bank reserves (i.e. banks’ account balances at the Fed) since QE1 was launched in late 2008. A post on 18 September noted that the Dow Industrials index, then at 13,553, was 1,300 points above the level implied by the current level of reserves, based on the historical relationship. Put differently, the market seemed already to be discounting unsterilised QE3 bond purchases of $40 billion per month sustained until spring 2013.

Since the prior post, the Dow has corrected while QE3 has started to boost bank reserves. (The latter effect has been slow to come through because of delayed settlement on the Fed’s purchases of mortgage-backed securities.) The index deviation from the level implied by current reserves, therefore, has fallen to 970 points. The Dow, moreover, is now slightly below the “forecast” for the end of the first quarter of 2013, assuming that the Fed maintains a $40 billion monthly rate of QE3 purchases – see red dotted line on chart.

“Operation Twist”, under which the Fed swaps $45 billion a month of short- for longer-term Treasuries, is scheduled to finish at the end of 2012. Many commentators expect the Fed to boost QE3 bond purchases to $85 billion a month at this time. The implied level of the Dow at the end of the first quarter under this scenario is more than 13,700, 600 points higher than currently – dotted green line.

This analysis, admittedly simplistic, suggests that the correction in equities is creating a buying opportunity, assuming that the Fed maintains its commitment to liquidity expansion at least through next spring – plausible given perceived economic risks stemming from the “fiscal cliff” and global fragilities.

Non-financial broad money (i.e. M4 held by households and private non-financial corporations) increased by a modest 0.2% in September but six-month growth rose again to 2.6%, or 5.3% annualised – the fastest since May 2008. Such a pace, if sustained, is probably incompatible with achieving the 2% inflation target, allowing for an upward trend in the velocity of circulation stemming from super-low interest rates.

Deflated by seasonally-adjusted consumer prices, non-financial M4 rose by 1.3% (2.7% annualised) in the six months to September. This is down from a peak of 1.6% in June but still higher than in any month between May 2009 and April 2012. Similar real growth in early 2009 preceded a year of solid economic expansion – non-oil GDP rose by 2.5% between the third quarters of 2009 and 2010.

“Monetarist” economists of a dovish persuasion argue that QE has been key to the money supply pick-up so an extension is necessary to prevent a relapse. There are two counter-arguments. First, recent gilt-buying will probably have significant lagged effects and, as noted, current money growth is probably too high. This argues for suspending QE pending clarification from the data about underlying monetary strength.

Secondly, QE is not the sole driver of faster monetary expansion – there has also been a significant positive contribution this year from banks’ reducing their non-deposit sterling funding. This trend may continue, with banks using cheap FLS borrowing to buy back debt. FLS should also lead to some revival in private-sector lending: one glimmer of hope is a moderation in the annual decline in sterling credit facilities – including loans arranged but not yet drawn down – from 11.1% in August to 6.6% in September, the smallest since August 2010.

Rather than a monetary slump should QE end, the main domestic threat to economic prospects is another inflation squeeze on real money expansion – the six-month change in seasonally-adjusted consumer prices has already started to firm, as the chart shows. However, recent oil price weakness and sterling appreciation – if sustained – should temper the near-term inflation pick-up.