Global real narrow money trends appear to have weakened further in October, suggesting that nine-month-ahead economic prospects are still deteriorating.

Six-month growth of real narrow money in the G7 economies and seven large emerging economies is estimated to have fallen again in October, moving below the previous low reached in February, based on monetary data covering two-thirds of the aggregate and near-complete inflation readings – see first chart.  If confirmed, the implication is that six-month industrial output momentum is unlikely to bottom before mid-2019.

Real narrow money growth has fallen below the lows reached in 2011 and 2014, suggesting that the current global economic downswing will be at least as significant as the 2011-12 and 2015-16 slowdowns, associated respectively with the Eurozone crisis / recession and China’s near-hard landing.

Annual growth of G7 plus E7 nominal narrow money has more than halved since 2016 and is approaching the low reached in 2008 – second chart. Annual nominal GDP expansion probably peaked in the second quarter of 2018, with a sustained decline in prospect. This slowdown is likely to squeeze profits and snuff out a recent pick-up in wage pressures. Central bankers worrying about inflationary risks are facing the wrong way.

In contrast to 2008, six-month real money momentum is still comfortably positive because consumer price inflation is significantly lower now than then. A recent pick-up in six-month inflation has contributed to the further fall in real money growth – third chart. This pick-up, however, should unwind as a result of falls in oil and other commodity prices, assuming these are not reversed – fourth chart. Commodity price weakness should be reflected in a sharp decline in prices paid indices in purchasing managers’ surveys – fifth chart.

The further fall in G7 plus E7 six-month real narrow money growth has been driven by the E7 component – sixth chart. A previous post discussed an alarming deterioration in trends across the Far East ex. China / Japan and weakness has now spread to Latin America, with six-month changes in real M1 in Brazil and Mexico turning negative – seventh chart.

Equity analysts are cutting earnings forecasts for EM companies at a faster pace, consistent with a significant economic downturn – eighth chart. The sharp fall in the oil price is similarly suggestive of weakening Asian / EM demand.

A post in September 2017 argued that the Fed would become more hawkish as the unemployment rate moved below 4%, partly reflecting concern about a replay of the 1960s, when inflation rose sharply after this level was crossed. A key difference, however, from the 1960s is that broad money trends remain subdued, which may be helping to contain inflation expectations. With the economy expected to slow over coming quarters, an inflation break-out is deemed here to be unlikely.

The earlier post suggested that solid economic growth and 1960s redux concerns would cause the Fed to hike rates by more than the consensus expected in 2018. At the time, the median projection for the three-month Treasury bill rate in the third quarter of 2018 was 1.7%, according to the Philadelphia Fed survey of forecasters. The outturn was 2.1%, with the rate currently at 2.4%.

The first and second charts illustrate the similarity of inflation / unemployment trends in the first half of the 1960s and in recent years. Core inflation remained in a narrow range below 2% despite a multi-year decline in the jobless rate. After the latter moved below 4% in February 1966, however, core inflation surged to more than 3% within a year. In econo-speak, the Phillips curve was flat at unemployment rates above 4% but steepened sharply once this level was crossed.

The unemployment rate fell below 4% in April 2018. While core inflation has firmed, this partly reflects the dropping-out of last year’s large cut in wireless phone charges and a break-out of the range of recent years has yet to occur – September’s 2.0% reading was below a post-recession peak of 2.1% in 2012.

One possible explanation for the difference is that monetary trends have been much weaker than in the 1960s. The third and fourth charts superimpose annual broad money growth, as measured by non-financial M3, derived from data in the Fed’s quarterly financial accounts. Money growth was robust – 8% plus – for several years ahead of the 1966 inflation break-out. It has averaged 5.0% since 2012, recently falling below this level.

High money growth in the 1960s may have contributed to inflation expectations becoming “unanchored”, resulting in a wage / price spiral. Direct measures of inflation expectations, unfortunately, are unavailable for the period but economists’ inflation forecasts rose sharply in 1965-66, which could be indicative of a broader shift  – the median one-year ahead projection for CPI inflation increased by 1 percentage point between June 1965 and June 1966, the largest change over 12 months since 1954, according to the Livingston survey (which has a longer history than the Philadelphia Fed survey).

Consumer and market inflation expectations have remained stable recently, as have economists’ forecasts – fifth chart.

Broad money growth fell sharply in 1966, foreshadowing a significant economic slowdown in 1967, which arrested the decline in the unemployment rate and stabilised core inflation temporarily – third chart. Recent weaker money trends – narrow as well as broad – suggest a similar scenario for 2019. The window for a break-out in core inflation, therefore, may be closing. A sustained rise remains plausible over the medium term, assuming that a weaker economy in 2019 leads to easier Fed policy and an associated rebound in money growth.