Global economic weakness highlighted by below-expected output data this week was signalled by slower real narrow money expansion in late 2013. Money trends have since improved, with incoming April numbers mostly positive: investors should beware of economic pessimism.

US industrial output fell by 0.6% in April, Chinese production was flat, while Japanese manufacturing is expected to have contracted by 1.4%, according to a METI survey. Eurozone first-quarter GDP growth, meanwhile, was 0.2% versus a consensus 0.4% and the US number will probably be cut to negative later this month.

The available April information suggests that global six-month industrial output growth fell to about 1.5% last month, a 10-month low – see first chart. The forecast here has been for growth to reach a trough around May.

Global six-month real narrow money expansion rebounded from November 2013 and remained solid in April, based on available data. US growth was little changed while Brazil, China and India rose – second chart. Japanese April money numbers were disappointing – see Wednesday’s post – but the sharp fall in real growth mainly reflects a temporary inflation spike caused by the sales tax hike. This explains the currently-estimated small decline in the global measure last month – first chart.

Stronger global industrial expansion over the summer should be led by the US, which has driven the improvement in monetary trends. Consistent with this view, US retail sales have rebounded from winter weakness, suggesting that the ISM manufacturing new orders index, a good indicator of the industrial cycle, will recover by June – third chart.

Japanese monetary trends continue to defy the predictions of QE supporters. The Bank of Japan (BoJ) bought ¥70 trillion of government securities in the year to April, equivalent to 15% of annual GDP and 6% of the M3 broad money supply. Yet annual M3 growth has hardly budged – 2.8% in April versus 2.6% a year earlier.
 
M3 expansion might have been weaker in the absence of QE but the policy has clearly failed to deliver the intended big liquidity injection to the wider economy. A key reason is that the BoJ’s bond-buying has been significantly offset by selling by banks, as had seemed likely at the outset. The BoJ and banks have, in effect, swapped securities and central bank reserves, with no impact on the money holdings of households and firms.

The first-round effect has been small but will there be a secondary boost, as banks deploy their increased reserves? US / UK experience is discouraging and money trends are currently losing, not gaining, momentum: six-month growth of the main aggregates has declined sharply since January – see chart.

QE supporters cite its role in pushing the yen lower and moving the economy out of deflation, at least temporarily. With nominal money and wage trends little changed, however, the inflation rise has squeezed real liquidity and incomes, cutting domestic demand. The yen slump, meanwhile, has failed to boost exports, partly because firms have widened margins: volumes in March were up only 1% on a year earlier.

Japan’s experience argues against Eurozone QE. Low Eurozone inflation is attributable to restrictive monetary conditions two years ago. Faster money growth in 2012-13 laid the foundations for the current economic recovery and should be reflected in a slow revival in inflation through 2015. The ECB is unlikely to launch full-scale QE but, if it did, the net impact on the economy would probably be small or even negative.

As expected, the global longer leading indicator followed here rose further in March, consistent with the forecast that economic growth will strengthen over the summer after a lull in early 2014.

The leading indicator is designed to provide advance warning of turning points in global* six-month industrial output growth. Its lead time has averaged 4-5 months in recent cycles. The indicator fell between July and December 2013, signalling that industrial momentum would reach a peak in late 2013 and moderate in early 2014. The peak occurred on schedule in November-December, with growth slowing through March – see first chart.

The recovery in the indicator since December suggests that industrial output growth will bottom in April-May and rise through July-August (at least). This is consistent with monetary trends: global real narrow money expansion increased between November 2013 and February-March 2014 and usually leads the economic cycle by about six months.

The rise in the global indicator reflects improvements in both the G7 and E7 components. The latter runs counter to a widespread view that economic risks in emerging economies are rising, but fits with a recent modest revival in E7 real money expansion – second chart.

*Global = G7 developed and E7 emerging economies.

Chinese monetary trends suggest moderately stronger economic growth over the next six months.

Six-month expansion of real M2 fell between May and November 2013, signalling that the economy would lose momentum in early 2014, allowing for the usual half-year lead. Six-month industrial output growth fell sharply between December and March, with an April reading due tomorrow – see first chart.

Real M2 expansion, however, has been recovering since late 2013 and reached an 11-month high in April. Real M1 growth is softer but has also revived. The message is that the recent industrial slowdown is not a precursor to more significant weakness; economic momentum, instead, is likely to revive over the summer.

Real credit trends have also firmed modestly, although the broad “total social financing” measure is growing more slowly than a year ago – second chart.

The suggestion that economic prospects are improving at the margin is supported by a small rise in the new orders component of the manufacturing purchasing managers’ survey in April. Export performance, meanwhile, was better than expected last month.

Firmer Chinese signals are consistent with the forecast of a rebound in global industrial output growth from May through late 2014 – see previous post. Confidence in this forecast would be strengthened by confirmation that the longer leading indicator followed here rose in March – key component data are released tomorrow.