Having warned of recent economic weakness, US narrow money trends are now signalling a revival of growth during the second half of 2016, suggesting renewed upward pressure on interest rates and, possibly, the US dollar.

As previously discussed, turning points in six-month real (i.e. inflation-adjusted) narrow money growth have consistently led turning points in two-quarter GDP expansion in recent years – see first chart. Real money growth bottomed in October 2015 and had shown a modest revival through March. Weekly data through 11 April suggest a marked acceleration this month. (The final data point in the chart assumes no further change over the remainder of April and a 0.2% monthly rise in consumer prices.)


Narrow money is a much more reliable leading indicator of the economy than broader aggregates. Six-month growth of real M2, however, has also revived recently. A broader measure including institutional money funds and large time deposits remains subdued but is expanding in real terms at close to its average pace in recent years – second chart.


The narrow money signal is provisional. The recent pick-up needs to be confirmed by full April data. There is a risk that six-month growth will fall back in May, reflecting a large monthly increase in November 2015.
 
Monetary trends, it should be emphasised, typically lead the economy by between six and 12 months. The central expectation here is that activity will remain soft for several more months, mirroring narrow money weakness last autumn. Consistent with this, the Federal Reserve Bank of New York’s “nowcasting” model currently predicts GDP growth of only 1.2% at an annualised rate in the second quarter, after 0.8% in the first.

The labour market, moreover, is likely to lag any GDP rebound. Employment / unemployment data may soften during the current quarter. While low weekly jobless claims indicate that firms remain reluctant to lay off workers, business survey evidence and the Conference Board’s online help-wanted tally point to a slowdown in hiring – third chart.


Markets, therefore, could enjoy several more months of improving global economic news and a neutral Fed before needing to grapple with a scenario of uncomfortably strong US growth in late 2016.

Narrow money trends in emerging economies continue to support optimism about near-term economic prospects. Inflation, meanwhile, is falling, giving a direct boost to real money growth and creating scope for central bank policy easing.

Six-month growth of real (i.e. consumer price-deflated) narrow money in the “E7” large emerging economies rose sharply in mid-2015, signalling an economic pick-up in the first half of 2016, allowing for the normal six to 12 month lead. Consistent with this forecast, industrial output growth rebounded in February and March – see first chart.


Prior economic weakness and recent currency stabilisation, meanwhile, have resulted in a marked reduction in inflationary pressures. E7 annual “core” consumer price inflation peaked in June 2015 and dropped to a 23-month low in March. Headline inflation is also now falling, despite strong food price rises and a waning benefit from lower energy prices – second chart.


E7 inflation trends contrast with G7 developments: G7 core inflation is at a 47-month high and the headline rate is likely to move up sharply to equal or exceed it by late 2016, assuming that commodity prices remain at current levels – third chart.


Falling E7 inflation and currency reversals have relieved upward pressure on interest rates in some countries and opened the door to cuts in others. Among the E7, Brazil, India and Russia may cut rates soon.

China, however, is unlikely to ease further, reflecting recent better economic data and rising concern about renewed housing market speculation. Annual new house price inflation rose to 4.9% in March, a 22-month high, and the historical relationship with narrow money growth suggests a further increase through late 2016, barring an official clamp-down – fourth chart.


Lower inflation and stable or easier monetary policies are likely to sustain solid E7 real narrow money growth, which remained higher than G7 growth in March – fifth chart. The E7 / G7 gap, however, could narrow or close over coming months as real money growth normalises from its recent buoyant pace in China and recovers in the US and Japan – sixth chart.