Chinese May money numbers give a moderately positive message for economic prospects, suggesting that recent policy easing is gaining traction. Assuming that pandemic disruption is contained, domestic demand is expected here to recover during H2 2022 and into 2023, partially shielding the economy from export weakness due to G7 recessions.

Six-month broad money growth rose further in May and is around levels reached during previous successful monetary / fiscal stimulus campaigns since the GFC – see chart 1.

Chart 1

Narrow money growth, however, continues to lag*, suggesting that improving monetary conditions will take longer than usual to feed through to the economy.

The likely explanation, of course, is that pandemic disruption is holding back demand both directly and via reduced consumer / business confidence, with restraint reflected in a preference to hold additional money in the form of time / savings deposits (for now) rather than ready-to-spend demand deposits.

Still, narrow money growth has recovered significantly since late 2021.

With Chinese CPI inflation contained within its post-GFC range, real as well as nominal money growth rates have improved – chart 2.

Chart 2

As an aside, the relative quiescence of Chinese CPI inflation blows apart US / European central bankers’ claims that current overshoots mainly reflect supply-side shocks. China has suffered the same shocks but pass-through to CPI inflation has been much smaller because of the PBoC’s monetary orthodoxy in 2020-21.

Information through April on the credit counterparts of broad money indicates that the recent growth pick-up has been driven by stronger net lending to government – consistent with expansionary fiscal policy – as well as banks increasing their reliance on monetary funding. Growth of lending to households and firms has moved sideways.

*”Narrow money “= “true” M1 = official M1 + household demand deposits. The May data point is estimated pending release (next week) of a sector breakdown of demand deposits.

G7 GDP data confirm that stockbuilding gave an unusually large boost to growth in the year to Q1. Stockbuilding is almost certain to fall over coming quarters, implying that the growth impact will turn from positive to (probably large) negative. Prospective weakness in stockbuilding reinforces the recessionary signal from real money contraction.

Japanese and Eurozone GDP details released today showed “surprisingly” large increases in inventories in Q1, mirroring similar surges in the US, UK and Canada. For the G7 group, stockbuilding is estimated here to have reached 1.0% of GDP (real data).

GDP growth is related to the change in stockbuilding. G7 stockbuilding was negative in Q1 2021 – inventories fell by 0.1% of GDP. So stockbuilding as a share of GDP rose by 1.1 percentage points in the year to Q1 2022, i.e. stockbuilding “accounted for” 1.1 pp of GDP growth in the year to Q1 – see chart 1.

Chart 1

Q: Why is stockbuilding almost certain to fall from its Q1 level?

A: Because its estimated 1.0% share of GDP in Q1 is a record in data extending back to the 1960s, matched only in Q2 1974 (which immediately preceded a severe recession).

Its average share over 1965-2019 was 0.2%. If the actual share were to fall to this level in Q1 2023, the contribution of stockbuilding to annual GDP growth would be -0.8 pp in that quarter, representing a huge -1.9 pp swing from Q1 2022.

The annual change in G7 stockbuilding as a share of GDP is used here to date lows in the stockbuilding cycle. The cycle has averaged 3 1/3 years historically and the last low was in Q2 2020, suggesting another trough in H2 2023.

The extreme Q1 reading is consistent with a cycle peak but there is a chance that the annual change in the stockbuilding share will rise even further in Q2, reflecting a positive base effect – inventories fell by 0.4% of GDP in Q2 2021.

The argument that the stockbuilding cycle is about to become a major drag on global growth does not, it should be emphasised, rely on a forecast that firms will reduce inventories from their current level, only that the rate of accumulation will slow. Stockbuilding is often still positive at cycle lows.

Following such extreme accumulation, however, a liquidation of inventories is certainly possible and would, of course, reinforce recessionary dynamics.

Recent economic data have been interpreted as supporting the view that global growth is showing “resilience” in the face of significant shocks, in turn suggesting scope for central banks to continue to dial up hawkishness.

This reading of the data is disputed here while monetary trends continue to signal a high probability of a recession by end-2022 followed by a sharp inflation drop in 2023-24. Central bankers ratcheting up interest rate expectations are as off-beam now as they were when engaging in outsized stimulus in 2020-21.

Additional April monetary data confirm that the six-month change in global real narrow money moved deeper into negative territory and has now undershot a low reached in June 2008 as the financial crisis and associated recession escalated – see chart 1.

Chart 1

The comparison with June 2008 is relevant in other respects. The two-year Treasury yield surged from 1.35% to 3.05% between March and June as the oil price spiked above $140 and markets priced in significant Fed tightening. The next move in the Fed funds rate, then 2.0%, was an October cut, by which time the two-year was back below 1.5%.

The fall in global real money momentum in late 2021 / early 2022 reflected rising inflation. Nominal money weakness has been the driver more recently.

With Canada yet to report, three-month growth of G7 broad money is estimated to have fallen to 1.9% annualised in April – chart 2. Annual expansion is likely to have moved down to around 5% in May, close to the pre-pandemic average, based on weekly US data and a sizeable base effect.

Chart 2

Annual broad money growth peaked in February 2021, suggesting that a fall in CPI inflation will start in 2023-24 rather than later this year, assuming a typical lead time of about two years. An “optimistic” view is that the transmission mechanism has been accelerated by supply-side shocks, implying an earlier but higher inflation peak and a faster subsequent slowdown.

Recent news giving apparent support to the view that the global economy is displaying “resilience” includes May rises in new orders indices in the global PMI and US ISM manufacturing surveys. Both indices, however, are well down on three months earlier and the May recoveries were associated with further strength in stockbuilding – chart 3. A moderation of inventory accumulation – and likely eventual liquidation – will act as a major and sustained drag on order flow.

Chart 3

US payrolls growth beat expectations in May but alternative ADP and household survey employment measures have slowed sharply over the latest three months – chart 4. Meanwhile, weaker labour market responses in the Conference Board consumer survey and a rise in involuntary part-time working suggest that a sideways move in the unemployment rate in May is the precursor to an upturn – chart 5.

Chart 4

Chart 5