Category: Money Moves Markets

The “monetarist” rule of thumb that broad money growth leads inflation by two years suggests a rapid fall in G7 CPI inflation in 2023 and an undershoot of targets by H2 2024.

Annual growth of the G7 broad money measure calculated here is likely to have fallen below 3% in October, based on US and Japanese data. The money stock appears to have stagnated in the latest three months, with a contraction in the US offsetting weak growth elsewhere*.

The monetarist rule worked perfectly in the early 1970s, when a surge in annual money growth to a peak in November 1972 was followed by a spike in annual CPI inflation to a high exactly two years later – see chart 1.

Chart 1

Inflation fell sharply from its 1974 peak, mirroring a big decline in money growth in 1973-74. The difference from now is that annual money growth bottomed above 10%, resulting in inflation stalling at a still-high level.

The money growth surge in 2020-21 was almost complete by June 2020 but a final peak was delayed until February 2021. Consistent with the two-year rule, CPI inflation spiked into June 2022, since moving sideways. It may or may not make a final peak but the rule suggests that a major decline will be delayed until after February 2023.

Broad money growth averaged 4.5% in the five years to end-2019. CPI inflation averaged 1.9% in the five years to end-2021 (i.e. allowing for the two-year lag). Money growth returned to the 2015-19 average in June 2022 (4.4%). The monetarist rule, therefore, suggests that inflation will be back below 2% by mid-2024 and will continue to move lower later in the year, reflecting the further decline in money growth since June.

How fast will inflation fall? A reasonable assumption is that its decline will mirror the rapid drop in money growth two years ago, consistent with the 1970s experience. An illustrative projection is shown in chart 2. Inflation, currently at 7.8% (October estimate), falls to 4% in July 2023 and below 3% by December.

Chart 2

Some monetarist economists expect inflation to be stickier in 2023. They argue that there is still a monetary “overhang” from the growth surge in 2020-21. Inflation, according to this view, will remain high into H2 2023 to “absorb” this excess. The impact of current monetary weakness will be delayed until 2024-25.

The assessment here is that the overhang is much reduced and its removal is consistent with the optimistic inflation projection shown in chart 2 as long as money trends remain as weak as currently, which is likely.

One measure of the monetary overhang is the deviation of the real broad money stock from its 2010-19 trend. This deviation peaked at 16% in May 2021 and has since narrowed to 6% as inflation has overtaken slowing nominal money growth – chart 3. 

Chart 3

The projection in chart 3 is based on the inflation profile in chart 2 and an assumption that broad money grows by 2% pa. The deviation of the real money stock from trend falls below 2% in H2 2023 and is eliminated by mid-2024.

Is the assumption of 2% money growth realistic? As noted, there has been no expansion in the latest three months.

As the chart shows, there was a larger deviation of real money from trend than currently at the end of the GFC in 2009. The adjustment back to trend was driven by nominal money weakness rather than high inflation – the money stock contracted by 1.9% between July 2009 and June 2010.

Bank lending has been supporting money growth but central bank loan officer surveys suggest a sharp slowdown ahead: October Fed survey results released this week echo weakness in earlier ECB and BoE surveys – chart 4.

Chart 4

Continued monetary stagnation – or worse – would confirm that G7 central banks, with the honourable exception of the BoJ, have overtightened policies, compounding their 2020-21 policy error.

G7 monetary gyrations may be contrasted with relative stability around trend in E7** real broad money – chart 5. EM central banks eased policies conventionally in 2020 and were swift to reverse course as economies rebounded and / or inflationary pressures emerged. This has been reflected in lower average inflation than in the G7 and a faster turnaround – chart 6.

Chart 5

Chart 6

*Money measures used: US M2+ (M2 plus large time deposits and institutional money funds), Japan M3, Eurozone non-financial M3, UK non-financial M4, Canada expanded M2+ (M2+ plus non-personal time deposits).

**E7 defined here as BRIC plus Korea, Mexico and Taiwan.

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COMMENT:
AUTHOR: Rob
EMAIL:
IP: 140.228.45.229
URL:
DATE: 11/16/2022 11:11:15 AM

Hi Simon,

Hope you're well!

Was wondering if material LTRO payback could ultimately have a negative impact on your real narrow money measure, all else equal?

Thanks!

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COMMENT:
AUTHOR: Simon Ward
DATE: 11/18/2022 05:54:04 PM

Hi Rob, There’s no direct impact on broad / narrow money because the payback is an interbank transaction. The reduction in reserves would put upward pressure on money rates, resulting in indirect effects, but the magnitude is hard to predict.

UK monetary statistics for September were heavily distorted by cash-raising by LDI funds to meet collateral requirements for derivative contracts. 

The headline M4ex broad money aggregate surged by £91 billion, equivalent to 2.7% after seasonal adjustment, between end-August and end-September. Money holdings of non-bank financial corporations* accounted for £71 billion of this increase. 

The long-standing practice here has been to focus on non-financial monetary aggregates, where available, because movements in financial sector money holdings can be erratic and usually have little bearing on near-term economic prospects. 

Non-financial M4, encompassing money holdings of households and private non-financial businesses, rose by £21 billion, or a seasonally adjusted 0.3%, in September. Annual growth eased to 3.5%, with the aggregate expanding at an annualised rate of 3.2% in the latest three months – see chart 1. 

Chart 1

The Bank publishes an industrial breakdown of sterling deposits at commercial banks. The LDI cash-raising is reflected in large monthly increases in deposits of insurance companies, pension funds, fund managers and securities dealers (LDI funds posted margin to dealers, with the dealers placing the funds with banks). This group added a combined £39 billion to sterling deposits in September. 

However, the rise in aggregate deposits of non-financial corporations, according to this table (C1.1), was £46 billion in September – far short of the £71 billion increase in their total M4 holdings (A2.2.3). This represents a record divergence – chart 2. 

Chart 2

The “missing” funds show up on the Bank’s balance sheet: private sector sterling deposits held at the Bank jumped by £28 billion in September (B2.2.1), also a record movement – chart 3. 

Chart 3

Securities dealers and clearing houses have accounts at the Bank, which they appear to have used to deposit a portion of the margin cash received from LDI funds. 

Note that this increase in deposits is not attributable to the Bank’s gilt-buying operation, which started on 28 September: the Bank’s holdings of public sector securities fell by £5 billion during September. 

Sterling cash-raising related to the LDI crisis may have totalled about £67 billion – the sum of the £39 billion increase in commercial bank deposits of insurance companies, pension funds, fund managers and dealers and the £28 billion placed at the Bank. 

LDI funds were also scrambling to raise foreign currency liquidity. The rise in foreign currency deposits of the same group of institutions rose by £25 billion in September. 

Not all the cash-raising represents sales of assets – LDI funds were also borrowing to meet margin requirements. Sterling bank lending to the same group rose by £16 billion in September, with foreign currency lending up by £18 billion. 

Was the Bank involved in facilitating the supply of liquidity to the funds, over and above its gilt-buying operation? It is unlikely to have played a direct role but banks may have borrowed from its discount window to onlend to LDI funds. 

This possibility is suggested by partial data on the Bank’s sterling liabilities and assets – it no longer publishes a full balance sheet on a timely basis. Identified sterling liabilities, including bank reserves and the sterling deposits referred to earlier, rose by £14 billion, while assets – including gilt holdings – fell by £6 billion. The implication is that unpublished items on the balance sheet resulted in the creation of £21 billion of identified sterling liabilities, with discount window lending a candidate explanation. 

*Excluding intermediaries such as central clearing counterparties.

Chinese money trends remain moderately favourable but the economy has been held back by covid disruption and now faces an export threat from global recession. Stocks, meanwhile, have been hit by a ramping up of the Biden administration’s war on Chinese tech along with President Xi’s take-over of economic policy-making, which investors have viewed as negative for longer-term growth prospects. “Excess” money has accumulated in the bond market and has the potential to flow into the economy and equities if the covid drag fades and policy-makers signal a continued commitment to private-led economic expansion. 

Six-month growth rates of nominal narrow and broad money have risen significantly over the past year, with the recovery reflected in a rebound in two-quarter nominal GDP expansion in Q3 despite further covid lockdowns – see chart 1. August / September numbers hint at a peak in money growth but continuing policy support, including directions to banks to expand lending, argues against a relapse – chart 2. 

Chart 1

Chart 2

The faster growth of money than GDP, and of broad money relative to narrow, indicates that the transmission of monetary stimulus is incomplete and “excess” money is currently trapped in the financial system. The key reason for the impaired transmission, of course, is the zero covid policy. With economic activity suppressed, excess money has flowed into the bond market, reflected in a fall in government yields despite the global surge and a tightening of onshore credit spreads – chart 3. 

Chart 3

The economy, nevertheless, has been less weak than many feared, as confirmed by the Q3 GDP number and September monthly activity data, showing a pick-up in industrial output and a stabilisation of new home sales – chart 4. A H1 fall in the interest rate on new mortgages and other easing measures are supporting housing market activity, with secondary sales reportedly growing strongly – chart 5. 

Chart 4

Chart 5

Retail sales remain weak but household money holdings are growing solidly, suggesting fire-power to lift spending if / when covid disruption eases – chart 6. 

Chart 6

Six-month growth of Chinese real narrow money contrasts with contractions in most major economies – chart 7. The level of growth, however, is modest by historical standards, suggesting moderate economic expansion at best: current growth, for example, has been consistent with a manufacturing PMI new orders index of about 50 – chart 8. 

Chart 7

Chart 8

Export weakness due to global recession could drag the PMI lower, as occurred during the GFC. The Chinese reading, however, would be expected to hold up relative to global PMI new orders, which may be heading to 40. 

The moderately positive message for economic prospects from real money trends is supported by a recent recovery in a composite leading indicator calculated here, which attempts to mirror the components of the OECD’s US leading indicator – chart 9. 

Chart 9

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COMMENT:
AUTHOR: David Cotton
EMAIL: mrwbartholomew@gmail.com
IP: 82.132.215.176
URL:
DATE: 10/31/2022 12:40:32 PM

Normal economic analysis is probably quite futile with the government opening and closing swathes of the economy continually due to Covid Zero.

Eurozone money measures are giving mixed signals. Headline broad money M3 rose by a strong 0.7% in September, pushing six-month growth up to 3.3% (6.6% annualised), the highest since December. Narrow money M1, by contrast, contracted on the month, with six-month growth falling further to 1.8% (3.7% annualised) – see chart 1. 

Chart 1

Broad money reacceleration, on the face of it, suggests an economic recovery towards mid-2023 after a sharp winter recession. The judgement here, however, is that broad money numbers have been boosted by technical / temporary factors and intensifying narrow money weakness is a better representation of current monetary conditions and economic prospects. 

The six-month rate of change of real M3, it should be emphasised, remains negative, with consumer prices (ECB seasonally adjusted series) rising by an annualised 8.2% between March and September. 

The sectoral breakdown of the headline M3 / M1 numbers, moreover, shows a significant recent contribution from rising money holdings of financial institutions. This probably reflects cash-raising related to weak markets and is not an expansionary / inflationary signal for the economy. 

The forecasting approach here focuses on non-financial money measures where available, i.e. encompassing holdings of households and non-financial firms only. Six-month growth of non-financial M3 was 2.6% in September versus 3.3% for M3 and has shown a smaller recent recovery – chart 2. 

Chart 2

A further reason for playing down the broad money pick-up is that it is not explained by any of the conventional “credit counterparts” – credit to the private sector and government, net external assets and longer-term liabilities. The counterparts analysis shows a positive contribution from unspecified residual items, which behave erratically, suggesting a future reversal – chart 3. 

Chart 3

Solid growth of lending to the private sector has been the key driver of recent M3 expansion. The October bank lending survey, however, showed a further plunge in credit demand and supply balances, signalling a future lending slowdown or even contraction – chart 4. 

Chart 4

Statistical studies show that real non-financial M1 has the strongest leading indicator properties of the various money and lending measures. Its six-month rate of change remains at the bottom of the historical range, suggesting no economic recovery before H2 2023 – chart 5. 

Chart 5

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COMMENT:
AUTHOR: David Cotton
EMAIL: mrwbartholomew@gmail.com
IP: 78.129.191.50
URL:
DATE: 10/27/2022 04:07:39 PM

The question for me is when severe deterioration in labour markets occurs given a real money contraction on this scale.

A “monetarist” UK recession probability model used here signalled a 70% likelihood of a recession in 2022 back in March. Coincident data suggest that contraction began in the summer. The model now indicates that the recession will last through Q2 2023, at least. 

Monthly GDP figures have been affected by holiday distortions and are often revised significantly but current data show a peak in May and a 0.9% drop by August. 

Employment is a lagging indicator so further growth in the PAYE jobs measure (also subject to large revisions) through September does not preclude a recession having begun*. Job vacancies, by contrast, are coincident. The ONS vacancies series peaked in May, falling steadily through September. 

The published ONS series is a three-month moving average but single-month numbers are available on a non-seasonally-adjusted basis, to which an adjustment procedure can be applied. The resulting total vacancies series peaked in April, falling modestly through July before plunging in August / September– see chart 1. The suggestion is that economic conditions worsened sharply at the end of Q3. 

Chart 1

 

The decline in total vacancies reflects a larger fall in private sector openings, which were down by 13% in September from a May peak, offset by a further rise in the public sector driven by health and social care. 

The official vacancies numbers are from a survey of employers but the ONS also compiles weekly indices of online job adverts from data supplied by Adzuna. These indices have a short history and are not seasonally adjusted but the year-on-year change in total job adverts mirrors that of total vacancies – chart 2. 

Chart 2

Inputs to the recession probability model include real money measures, interest rates, credit spreads, share prices, house prices and the effective exchange rate – see previous post for more details. The model looks out three quarters and the probability estimate stood at 79% at end-Q3, suggesting that the economy will still be in recession in Q2 2023 – chart 3. 

Chart 3

House price strength was a moderating influence on the model reading until recently but coming weakness may contribute to the probability estimate remaining in recession territory. 

*The Labour Force Survey measure of employees in employment fell between May and July but recovered in August.

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COMMENT:
AUTHOR: Emma Wilkinson
EMAIL: ewilkinson@westburyam.co.uk
IP: 82.69.37.168
URL:
DATE: 10/24/2022 09:12:26 AM

Thank you for your valuable content Simon. Out of interest, what is your current data indicating for China; you had early but possibly positive signals for China earlier in the year but would you say that the transmission mechanism is broken due to zero covid policies? There seems no end in sight to this self inflicted downturn!
many thanks
Emma

The “monetarist” rule of thumb that monetary changes feed through to prices with a lag of about two years suggests that G7 consumer price inflation will fall steeply from early 2023. 

G7 headline annual CPI inflation, as calculated here*, moved back up to 7.6% in September, just below a June high of 7.7%. 

A QE-driven surge in G7 annual broad money growth in 2020-21 was similar in magnitude to a bank lending-driven surge in the early 1970s. A peak in money growth in November 1972 was followed by an inflation peak exactly two years later – see chart 1. 

Chart 1

The 2020-21 money growth surge was largely complete by June 2020, although the final peak occurred in February 2021. The expectation here is that the June 2022 peak in CPI inflation will hold but the two-year norm suggests that a big fall will be delayed until after February 2023. 

Annual broad money growth collapsed from February 2021, falling much faster and further than after the 1972 peak. Then, money growth bottomed above 10% in 1975 and rebounded into 1976, remaining in double digits until 1980. Sustained strength allowed high inflation to become entrenched. 

Annual broad money growth is now below 4% (September estimate), with QT plans and a likely credit crunch suggesting further weakness. 

Money growth was relatively stable between 2013 and 2018, averaging 4.3% pa. CPI inflation averaged just 1.2% over 2015-20 (i.e. allowing for a two-year lag). Current monetary weakness suggests similar or lower inflation outturns in 2024. 

While headline probably peaked in June, core inflation continued to rise into September – chart 2. Core strength is feeding pessimism about inflation prospects, but shouldn’t. Contrary to popular mythology, core usually lags headline at turning points. Base effects boosted the G7 core annual rate over July-September but turn more favourable from October through next May (seasonally adjusted, the core index rose by an average 0.44% per month over October 2021-May 2022 versus 0.19% over July-September 2021). 

Chart 2

*GDP-weighted, Japanese September CPI estimated from Tokyo data.

Recent dramatic tightening of UK credit conditions along with Bank of England plans for large-scale QT and a “significant” rate hike could tip current weak broad money growth over into contraction, in turn threatening a deflationary depression. 

To recap, the preferred broad measure here – non-financial M4, comprising sterling money holdings of households and private non-financial firms – grew at an annualised rate of just 0.8% in the three months to August. 

The Bank’s broad measure, M4ex, also includes money holdings of financial institutions, which may rise sharply in September / October, reflecting pension funds’ “dash for cash”. Any such strength is not expansionary / inflationary, increasing the importance of focusing on non-financial money measures. 

In real terms, non-financial M4 has retraced almost back to its pre-pandemic trend as the 2020-21 money surge has passed through to prices – see chart 1. There is no longer a monetary “excess” to support spending or sustain high inflation. 

Chart 1

Current monetary weakness will take time to be reflected in slower price momentum. Prices may continue to outpace nominal money expansion near term, sustaining the real-terms squeeze. 

How likely is it that nominal broad money will begin to contract? 

The “credit counterparts” analysis links movements in broad money to changes in four other components of the banking system’s balance sheet: lending to the public and private sectors, net overseas assets and non-deposit funding. 

Lending to the public sector includes QE / QT. The Bank plans to reduce its gilt holdings by £80 billion over the next 12 months, equivalent to 3.4% of non-financial M4. 

The monetary drag will be smaller to the extent that there is a compensating rise in commercial banks’ gilt holdings. Banks bought £13 billion of gilts in the year to August. Purchases reached a maximum 12-month rate of £50 billion in the wake of the GFC when banks were under strong regulatory pressure to boost their liquid assets. A plausible scenario is that banks will absorb between a third and a half of the QT supply, in which case lending to the public sector would have a contractionary impact on broad money of 1.7-2.2% over the next 12 months. 

Bank lending to the private sector has been supporting broad money growth recently: lending to households and private non-financial firms expanded at a 3.1% annualised rate in the three months to August. The Bank’s Q3 credit conditions survey, released yesterday, signals weakness ahead: future credit demand balances remained soft while availability plunged – chart 2. 

Chart 2

The survey closed on 16 September so does not capture the further surge in market rates and spreads in the wake of the mini-Budget. 

Residential mortgages account for 70% of the stock of lending to households and non-financial firms. The future demand and availability balances for secured credit to households last quarter were comparable with the lows reached at the depths of the GFC – before recent turmoil. Mortgage approvals could halve – chart 3.

Chart 3

 

Bank lending expansion, therefore, could plausibly grind to a halt, as it did in the wake of the GFC. The combined monetary impact of public and private sector lending would then become contractionary.

The other credit counterparts – banks’ net overseas assets and their non-deposit funding – are volatile and difficult to forecast but have had a combined contractionary impact over the last 12 months. The joint influence, however, tends to correlate inversely with lending to the private sector, so could become supportive as lending weakens. 

The “best case” scenario appears to be weak broad money expansion with a significant risk of contraction. 

The warranted policy response is to cancel QT and rate hikes. The Bank, instead, has boxed itself into a restrictive stance in a misguided effort to rebuild its shattered credibility and avoid a charge of “fiscal dominance”. 

The hope is that a government U-turn on the mini-Budget together with an easing of global interest rate pressures result in a reversal of recent market-driven credit tightening. A Bank policy shift is coming but may have to wait for evidence of sharply contracting economic activity.

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COMMENT:
AUTHOR: anon
EMAIL:
IP: 144.2.128.246
URL:
DATE: 10/17/2022 09:35:45 AM

The anti-monetarist policymaking continues

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COMMENT:
AUTHOR: David Cotton
EMAIL: mrwbartholomew@gmail.com
IP: 78.129.191.50
URL:
DATE: 10/17/2022 10:34:38 AM

Seemingly high probability of a house prices falling sharply, panicked rate cuts and deflation on both sides of the Atlantic in the next 12 months..

Bank of England Chief Economist Huw Pill has suggested that fiscal policy easing in the mini-Budget and the reaction in markets warrant a “significant monetary policy response”. Why? 

UK monetary trends continue to weaken and are consistent with a medium-term return of inflation to target, if not below. 

Annual growth of non-financial M4 – the preferred broad aggregate here, comprising holdings of households and private non-financial firms – was unchanged at 3.7% in August, below an average of 4.4% over 2015-19. The three-month rate of expansion fell further to just 0.8% annualised – see chart 1. 

Chart 1

Should the Bank tighten to offset the inflationary impact of exchange rate weakness? The “monetarist” view is that currency movements can delay or speed up the transmission of monetary changes to prices but have no longer-term inflation impact as long as money growth is unaffected. 

The sterling effective rate index was down by 10% on a year before at last week’s low point but the annual change reached -25% during the GFC and -19% after the Brexit referendum. The index hasn’t (yet) broken below its GFC low – chart 2. 

Chart 2

The greater concern here is that increased government borrowing will be financed significantly through the banking system, resulting in another boost to money growth. This could occur via voluntary purchases of gilts by commercial banks in response to higher yields or because the Bank is forced to offer sustained support to a dysfunctional market. 

Such a scenario, however, is possible rather than likely. Any monetary boost from deficit financing could be offset or outweighed by a further weakening of private sector credit trends as banks pass on higher funding costs and widen spreads. 

The Bank would have made better recent decisions if it had paid attention to monetary trends: it wouldn’t have expanded QE in November 2020, would have raised rates earlier in 2021 and wouldn’t have embarked on QT. Current monetary weakness argues against policy tightening. The Bank may judge it necessary to hike rates to bolster its credibility, and that of the wider UK policy-making framework. Bank officials, however, should avoid inflating market expectations and be prepared to reverse increases if markets calm and – as seems likely – money trends remain soft.

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COMMENT:
AUTHOR: David Cotton
EMAIL: mrwbartholomew@gmail.com
IP: 78.129.191.50
URL:
DATE: 10/03/2022 02:24:49 PM

The answer is obviously no and that they should have tightened policy when money growth was surging 12-18 months ago.

My view would be the current UK FX situation is favourable to the UK economy given the global economic backdrop. Certainly much more so than in July 2008 £1 = $2.12, in possibly a similar cyclical position.

Tightening policy now, with nominal global M1 growth below it's pre GFC level, is likely to lead to deflation next year!

Better questions would be, why are central banks basing their policy on what the current level of inflation is?

Why are they ignoring leading data and that there is a long and variable lag to policy changes!

Revised numbers confirm that US GDP fell by 0.6% (1.1% annualised) between Q4 2021 and Q2 2022*. Hours worked in the private sector economy, meanwhile, climbed 1.1% (2.2% annualised) over the same period. What explains this disconnect and how long can it continue? 

The ”explanation” here is that economy-wide productivity was pushed far above trend by the pandemic but has been normalising this year. The reversion to trend appears complete, suggesting that labour market data will reflect output weakness going forward.

Output per hour in the business sector surged in the initial stages of the pandemic in Q2 / Q3 2000, opening up a gap of more than 4% with the prior trend – see chart 1.

Chart 1

Firms responded to economic contraction by laying off lower-productivity workers, boosting the average. Output returned to its pre-pandemic level in Q2 2021, requiring these jobs to be refilled. A fall in participation (due to age demographics) coupled with supply / demand mismatches slowed the rehiring process, resulting in output per hour remaining elevated until recently.

The deviation from trend had narrowed to below 1% as of Q2.

Another way of presenting the data is to compare actual hours worked in the business sector with the number implied by the current level of output, assuming that productivity had continued on its pre-pandemic path – chart 2.

Chart 2

A big deficit had opened up by Q2 2021 but strong employment growth and an output set-back have narrowed the gap. Monthly data through August suggest that hours worked rose solidly again in Q3 and may have converged with the output-warranted level.

With productivity back or close to trend, the GDP / employment divergence is likely ending.

The productivity trend implies that hours worked will fall if GDP rises by less than 0.2% (0.8% annualised) per quarter. Real narrow money has been contracting since January 2022, suggesting further GDP declines in Q4 / H1 2023. Labour market data may be poised for imminent deterioration.

*Gross domestic income – GDP measured from the income side – rose by 0.2% (0.4% annualised) over the same period.

Global six-month real narrow money momentum, the key economic leading indicator in the forecasting approach employed here, is estimated to have moved sideways in deep negative territory in August* – see chart 1. Allowing for an average nine-month lead, the suggestion is that an incipient global recession will extend through Q2 2023, at least. 

Chart 1

More specifically, global six-month industrial output momentum, which crossed below zero in July and is estimated to have weakened further in August, may continue to fall into April / May next year, with no monetary signal yet of a subsequent slowdown in the pace of contraction. 

The lack of recovery in real narrow momentum is disappointing since, as previously discussed, global six-month consumer price momentum pulled back in July / August. This slowdown, however, was offset by a further fall in nominal money expansion – chart 2. 

Chart 2

Nominal money weakness, encompassing broad as well as narrow aggregates, is evidence that monetary policies were already over-restrictive before the latest round of hair-shirt rate hikes. 

What does this monetary backdrop imply for markets? The two measures of global “excess” money calculated here, i.e. the differential between six-month real narrow money and industrial output momentum and the deviation of 12-month real money momentum from a long-term moving average, remained negative in August – chart 3. 

Chart 3

Historically (i.e. over 1970-2021), global equities outperformed cash on average only when both measures were positive, with underperformance greatest when both were negative. 

Previous posts suggested that the first measure would turn positive during H2. This remains possible despite the disappointing August monetary data: the measure has recovered since June as industrial momentum has fallen and output may soon be contracting at a faster pace than real money. 

The second measure, however, is likely to remain negative until well into 2023: 12-month real money momentum weakened further in August and the long-term nature of the moving average implies that it will make little contribution to closing the current wide gap.

The projected development of the measures, i.e. the first crossing back above zero but the second remaining negative, would suggest a slowdown but not reversal in the bear market in late 2023. 

The message for government bond markets is more hopeful. Changes in bond yields have been inversely correlated with changes in the first excess money measure historically, i.e. bonds have, on average, rallied when the measure has risen, even while it has remained negative – chart 4**. 

Chart 4 

The six-month change in the excess money measure turned positive in August, having been negative – implying an unfavourable monetary backdrop for bonds – between November 2021 and July. US 10-year Treasuries have outperformed cash by 4.2% pa on average historically following positive readings. 

*The estimate incorporates monetary data covering two-third of the aggregate and complete CPI results.

**The change in the measure is plotted inverted in the chart.

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COMMENT:
AUTHOR: David Cotton
EMAIL: mrwbartholomew@gmail.com
IP: 82.132.213.243
URL:
DATE: 09/24/2022 12:17:58 PM

Nominal narrow money below the period before the GFC is a major concern given rate hikes.

The rapid raising of interest rates continues to look a significant policy error.

We can probably expect a stampede to cut as this plays out in the real economy next year.