Category: Money Moves Markets

US employment figures for November were disappointing, showing a rise of only 50,000 in private-sector payrolls. Private job openings (i.e. vacancies), however, increased sharply in October, reaching a 26-month high, suggesting that employment growth will pick up in early 2011 – see first chart. (Openings are released a month later than payrolls but lead turning points in the latter by about six months.)

Job openings are rising at a similar pace to 2005, when private payrolls increased by nearly 200,000 a month. Assuming no change in government jobs, such growth would result in a steady decline in unemployment – payrolls need to rise by about 110,000 a month to keep the jobless rate stable, based on the recent rate of expansion of the working-age population and a constant labour-force participation rate.

In further evidence of improving US economic momentum, the six-month rate of change of the OECD’s US leading index stabilised in October while a “leading indicator of the leading index” strengthened for the third consecutive month – second chart. This improvement is occurring on schedule following an acceleration in US real narrow money since the summer, highlighted in numerous previous posts.

The view here remains that the Federal Reserve’s QE2 liquidity boost was unnecessary and is likely to prove counterproductive.

A year ago the consensus expected GDP to grow by 1.2% in 2010, according to the Treasury’s monthly survey of forecasters. The outturn is likely to be between 1.6% and 1.8% (depending on fourth-quarter performance and revisions). The latest Treasury survey shows an average projection for 2011 of 1.9% but this may again prove too low. Three alternative forecasting approaches, described below, all suggest growth of about 2.5%. A stronger performance is possible if global demand remains robust.
 
The first approach is a simple rule-of-thumb that classifies GDP prospects for the coming calendar year as strong, average or weak depending on whether December levels of real (i.e. inflation-adjusted) broad money growth and share prices are higher or lower than a year earlier. The two indicators gave a joint positive signal on 15 occasions between 1965 and 2008; GDP growth averaged 3.8% in the subsequent calendar year. A joint negative signal, meanwhile, occurred in 12 years and was followed, on average, by a GDP rise of only 0.3%. Such a negative reading was given in December 2008 before a 5.0% slump in GDP in 2009. Currently, real broad money growth is lower than in December 2009 while real share prices are higher. This combination occurred 11 times and was associated with average GDP growth of 2.5%.
 
The second approach uses a statistical forecasting model that projects annual GDP growth three quarters ahead based on current and lagged values of interest rates, real narrow and broad money supply growth, the effective exchange rate, the corporate liquidity ratio (i.e. companies’ bank deposits divided by bank borrowing), credit spreads and share prices. The current projection is for GDP to rise by 2.6% in the year to the third quarter of 2011, slightly down on the 2.8% gain in the year to the third quarter of 2010 (according to the latest official estimate). Assuming that the increase is spread evenly across quarters and growth continues at the same pace in the final quarter of 2011, the implied calendar year GDP rise is 2.8%.
 
A third approach is to base a forecast on the progression of GDP in previous recovery phases. The chart compares the fall and rebound in GDP from a high in the first quarter of 2008 with movements following cyclical peaks in the second quarter of 1973, second quarter of 1979 and second quarter of 1990. The recession and recovery to date bear the closest resemblance to the 1979-81 downturn and subsequent revival. The dashed blue line is a “projection” that assumes that the levels of GDP in the fourth quarters of 2011 and 2012 are the equivalent distance from the pre-recession peak as at the same points in the early 1980s recovery. This projection implies calendar year growth of 2.7% in 2011, rising to 3.5% in 2012. (Note that, in addition to the decline in GDP being larger in the early 1980s compared with the mid 1970s and early 1990s, growth was slower at this stage of the recovery. A forecast based on GDP progression in the 1970s or 1990s, therefore, would deliver a stronger number for 2011.)

The Federal Reserve’s QE2 securities purchases have started to lift the US monetary base (i.e. currency in circulation plus bank reserves) but it remains 8% below its February 2010 peak.

US stocks broadly tracked the monetary base between QE1 in late 2008 and this summer but broke to the upside when the Fed signalled QE2 – see first chart. They may need to tread water or correct over the next couple of months, although the base should eventually rise well beyond the level currently implied by the market if the Fed fulfills its intention of buying $600 billion by mid 2011 and fails to sterilise the impact on reserves (i.e. to about $2.5 trillion versus the current $1.98 trillion).

A comparison of the recent recovery in US stocks with an average of performance after six prior big bear markets, discussed in several previous posts, also suggests near-term consolidation – second chart. The market is exactly in line with the “six-bear average”, which meanders around the current level before another advance next spring.

US stocks traded above the six-bear average during the first year of the rally from March 2009 but have been mostly in line or below since G7 real narrow money growth fell beneath industrial output expansion in early 2010. As previously discussed, however, a positive “liquidity cross-over” could occur in early 2011. (Caveat: the range spanned by the historical recoveries widens as the distance from the 2009 low extends, suggesting that the average will become less useful for “anchoring” a forecast.)

Last week’s purchasing managers’ surveys for November were respectable but weighted-average G7 new orders failed to follow through on October’s strong gain – see first chart. The message is that industrial output expansion is reviving after a recent slowdown but should remain well below its pace in the first year of the recovery.

Country surveys show considerable divergence, with strength in China and the UK contrasting with notable weakness in Japan, partly reflecting this year’s surge in the yen – second chart. Chinese buoyancy, however, is no longer “good news” for the world economy and equity markets, since associated overheating pressures guarantee further significant policy tightening.

The small fall in the G7 new orders measure reflected slippage in the US component, which continues to follow the pattern of previous cycles – third chart. This comparison suggests further easing into early 2011, a prospect consistent with some slowdown in stockbuilding from its recent rapid pace.

As previously noted, G7 real narrow money continues to grow moderately, offering a reassuring message about the sustainability of the economic recovery, at least through mid 2011.

US monetary trends continue to strengthen, supporting hopes of faster economic growth in the first half of 2011.

The monetary pick-up is evident in both narrow and broad measures – see first chart – and began in the summer before QE2 was under serious discussion. By injecting further liquidity, the Fed may again be acting in a destabilising fashion, in a mirror-image of its withdrawal of liquidity in early 2010 when money supply trends were worryingly weak.

The current contrast between real M1 strength in the US and a sharp slowdown in the Eurozone is unusual, last occurring in 1991 – second chart. US equities outperformed continental Europe by 17% in 1991 and 13% in 1992, partly reflecting a stronger dollar. As of the end of November, US stocks are 15% ahead of continental Europe this year (MSCI indices).

Higher global crude oil costs, a fall in sterling against the US dollar and coming hikes in VAT and fuel duty suggest that the average price of unleaded petrol will rise from £1.191 a litre in November to more than £1.25 in early 2011, well above the May peak of £1.215. The average diesel price is already above its spring high.

Based on the spot market price, adjusted for current VAT and fuel duty rates, the retail unleaded price looks on course to rise to about £1.23 – see chart. The VAT increase and fuel duty hike of 0.76 pence a litre from January will add a further 3.3 pence, suggesting a retail price of about £1.26 barring a spot market slide.

Such an increase would not provide a further boost to annual CPI inflation because petrol prices rose similarly steeply a year ago. Forecasters’ previous assumption, however, that a slowdown in petrol inflation would partially offset upward pressures on the headline CPI rate is no valid. The view here remains that CPI inflation is likely to reach 4% or more early next year, a prospect endorsed by the MPC’s Andrew Sentance in a recent article.

In further evidence that Chinese inflationary pressure is spreading from food to “core”, output and input price balances in November’s purchasing managers surveys (official and private) reached new highs in their 5-6 year histories. Current readings suggest that producer price inflation will accelerate from an annual 5.0% in October to more than 10% in early 2011 – see chart. Faster PPI rises, in turn, should lift CPI ex. food inflation from 1.6% towards 3% – see previous post for a chart of this relationship. (Official CPI numbers, of course, understate on-the-ground inflation.)

Chinese policy-makers aim to quell inflation by clamping down on credit and money growth via hikes in reserve requirements and lower lending quotas, avoiding a big rise in interest rates. The strategy is flawed because any slowdown in monetary expansion is likely to be offset by a pick-up in the velocity of circulation as real interest rates fall deeper into negative territory, encouraging more spending and financial speculation. By delaying a significant rate hike, the authorities risk having to slam on the brakes in early 2011, with adverse implications for the economy later next year. 

Eurozone real narrow money, M1, has stagnated over the last six months, suggesting that economic growth will slow sharply in early 2011 – see previous post.

M1 comprises currency in circulation and overnight deposits. The first chart shows the six-month change in real overnight deposits broken between the “core” and “periphery” (currency figures are not available by country).

The pace of contraction in the peripheral group eased in October but still signals economic stagnation, at best, in early 2011. The further fall in Eurozone-wide growth last month reflected a loss of momentum in the core, casting doubt on the ability of these economies to continue to decouple from peripheral weakness.

The second and third charts show a country breakdown. Real M1 deposits have contracted over the last six months in all five peripheral economies and also in Belgium and the Netherlands.

The ECB may have contributed to this weakness: its decision to withdraw 12- and six-month lending facilities has resulted in a 20% fall in the monetary base since June, in turn pushing up EONIA and increasing funding pressures on struggling banks. A reinjection of liquidity is urgently required but policy-makers are reluctant to reopen the lending window for fear of being swamped by demand from weaker sovereigns seeking back-door support via local banks.

The Office for Budget Responsibility under its new leadership today issued a 152-page report that makes rounding error changes to the economic and fiscal forecasts presented at the time of the June Budget. One of the few significant amendments is a downward revision to the loss of general government jobs over the next four years, from 490,000 to 330,000, although – like all the numbers in the report – this is “subject to a large degree of uncertainty”.

The basic story is that a below-par but sustained economic recovery combined with the coalition’s tax and spending plans will return the public finances to sustainability by 2015-16. Growth will be constrained, according to the OBR, by tight credit conditions, desired private sector debt reduction and the fiscal consolidation itself.

The OBR, like the consensus, is probably too downbeat about economic prospects. Forecast GDP growth of 2.4% per annum over the five years 2010-14 compares with 3.4% achieved over 1994-98 despite fiscal retrenchment on a similar scale. Claims that the private sector is in a weaker position to take up the baton than in the early 1990s are unconvincing: corporate finances are in better shape and households have been insulated from the consequences of higher debt by low interest rates, resulting in fewer arrears cases and repossessions. There were similar concerns about credit supply in the 1990s, following a large hit to banks’ capital from residential and commercial property busts.

Rather than a growth shortfall, the key risks to the fiscal outlook are that, first, the coalition fails to implement planned spending cuts and / or tax increases yield less revenue than expected and, secondly, higher interest rates boost debt servicing costs. A useful ready-reckoner table on page 117 of the report shows that each 1 percentage point rise in interest rates and inflation raises debt interest spending in 2015-16 by £10.7 billion, or 0.6% of GDP.

The net percentage of UK consumers expecting prices to rise at a faster pace over the next year is at its highest level since July 2008, according to the November EU Commission consumer survey – see chart.

The net percentage reporting an increase in prices over the last 12 months also rose further and is well above its long-run average.

The forward-looking indicator usually leads swings in inflation and the latest rise is consistent with the forecast here of a pick-up in the headline CPI rate to 4% or more in early 2011, a prospect also mooted by MPC member Andrew Sentance in an article yesterday.