Global growth optimists expect continued solid services sector expansion to offset manufacturing weakness. PMI results for May appear, on first inspection, to support this view: services activity and new business indices rose further to 18- and 22-month highs respectively even as manufacturing new orders remained stalled below 50 – see chart 1. 

Chart 1

Chart 1: Global PMI New Orders /  Business. Chart compares manufacturing new order vs. services new business from 2015 to 2023. Source: Refinitiv Datastream.

There are, however, several reasons for discounting the strong headline services readings. 

First, backlogs of services work fell sharply to a four-month low despite stronger new business – chart 2. This suggests that current output is running ahead of incoming demand, in turn implying a future adjustment lower unless demand picks up further. 

Chart 2

Chart 2: Global PMI Backlogs of Work. This chart compares manufacturing vs. Services from 2015 to 2023. Source: Refinitiv Datastream.

Manufacturing backlogs also fell sharply last month, breaking below their November 2022 low. 

Secondly, the sectoral breakdown of the activity and new business indices shows that May rises were driven by a surge in financial services – chart 3. Consumer services indices eased on the month. Financial services strength is difficult to understand given monetary stagnation, slowing bank lending and flat trading volumes, so may prove short-lived. 

Chart 3

Chart 3: Global Services PMI New Business. This chart compares consumer, financial, and business from 2015 to 2023. Source: Refinitiv Datastream.

Thirdly, the high May readings of the global activity and new business indices reflect strong contributions from the US and Chinese components but national services surveys are significantly weaker. 

The US ISM services activity index fell to a three-year low in May even as the S&P Global equivalent series reached a 13-month high – chart 4. 

Chart 4

Chart 4: US Services PMI Business Activity. This chart compares S&P Global vs ISM from 2015 to 2023. Source: Refinitiv Datastream.

The Chinese NBS non-manufacturing new orders index moved below 50 in April and fell further in May, in puzzling contrast to the S&P Global / Caixin services new business index, which reached its second-highest level since November 2020. 

The global manufacturing new orders and services new business indices have been strongly correlated historically but statistical tests indicate a tendency for manufacturing to lead services rather than vice versa*. With global monetary trends continuing to give a negative economic signal, the current unusually wide gap is more likely to be closed by services weakness than a manufacturing revival. 

*In regressions using monthly data with three lags, lagged manufacturing new orders terms are significant in the regression for services new business, but lagged services new business terms are insignificant in the regression for manufacturing new orders.

Monetary trends continue to give a negative message for global economic prospects, suggesting that European / US weakness will outweigh resilience in major EM economies. 

G7 plus E7 six-month real narrow money momentum fell again in April, extending a move down from a local peak in December and suggesting a decline in economic momentum through late 2023 – see chart 1. 

Chart 1

Chart 1 showing Global Manufacturing PMI New Orders & G7 + E7 Real Narrow / Broad Money (% 6m)

A revival in real narrow money momentum in H2 2022 was reflected in a recovery in global manufacturing PMI new orders between December and March. The recovery stalled in April / May and the forecast here remains for a relapse and possible retest of the December 2022 low during H2 2023. 

Narrow money has outperformed broad money as a leading indicator historically, in terms of reliability in signalling turning points in economic momentum. Narrow money usually weakens relative to broad money when interest rates rise as depositors are incentivised to shift funds to less liquid accounts. This is an important feature of the transmission mechanism and one of the reasons narrow money outperforms as a forecasting indicator. 

An argument, however, has been made that the unusual speed of the rise in interest rates over the past year, coupled with worries about deposit safety following recent bank failures and an associated switch into money market funds, may have exaggerated narrow money weakness relative to “true” economic prospects. This would suggest giving greater weight to broad money trends at present. 

As chart 1 shows, global six-month real broad money momentum recovered more strongly during H2 2002 and has stalled rather than fallen back since December. Still, the message for economic prospects is weak, suggesting no growth revival before 2024. 

A marginal decline in global manufacturing PMI new orders in May reflected a notable weakening of the DM component offset by stronger EM results. EM resilience is consistent with recent stronger E7 real money momentum (broad as well as narrow) – chart 2. 

Chart 2

Chart 2 showing G7 + E7 Real Narrow Money (% 6m)

Charts 3 and 4 show six-month real narrow money momentum and manufacturing PMIs in selected major economies. Russia, China and India top the real money momentum ranking with weakness focused on Europe – particularly Switzerland and Sweden. The latest PMI results mirror the real money ranking (rank correlation coefficient = 0.85), with recessionary readings in the Eurozone, Switzerland and Sweden contrasting with Indian / Russian strength. 

Chart 3

Chart 3 showing Real Narrow Money (% 6m)

Chart 4

Chart 4 showing Manufacturing Purchasing Managers’ Indices

Partial information indicates that global (i.e. G7 plus E7) six-month real narrow money momentum fell for a third month in March, possibly breaching a low reached in June 2022. This increases confidence that a recent recovery in PMIs will reverse into H2. 

The June 2022 low in real narrow money momentum presaged a low in global manufacturing PMI new orders in December – see chart 1. Assuming the same six month lead, the roll-over in real money momentum since December 2022 implies a PMI decline from June. 

Chart 1

Chart 1 showing Global Manufacturing PMI New Orders & G7 + E7 Real Narrow Money (% 6m)

The fall could start earlier. The recovery in real money momentum between June and December 2022 was minor and driven entirely by a slowdown in six-month consumer price inflation. Momentum failed to break into positive territory. Credit tightening due to recent banking stresses may accelerate economic weakness. 

The renewed fall in global real money momentum since December reflects nominal money weakness rather than any inflation rebound: the six-month rate of change of nominal narrow money appears also now to be negative, a feat never achieved during the GFC – chart 2. 

Chart 2

Chart 2 showing G7 + E7 Narrow Money & Consumer Prices (% 6m)

Nominal money contraction is being driven the US and Europe, with momentum positive and stable in the E7 and Japan. 

Global real money momentum will be supported by a further inflation slowdown but a significant recovery is unlikely without a policy reversal that revives nominal money growth. As previously argued, recent reexpansion of the Fed’s balance sheet has no direct – or, probably, indirect – impact on money stock measures. 

The fall in global real money momentum has further delayed the expected cross-over above weakening industrial output momentum, suggesting fading the Q1 equity market rally and favouring defensive sectors, quality and yield.

Eurozone February monetary data were extraordinarily negative, suggesting that interest rates were already at a restrictive level before the 50 bp rate hikes in February / March. 

Economic sentiment has lifted in early 2023 in response to a collapsing gas price and China’s reopening but the impact of monetary restriction has yet to kick in. 

The headline M3 broad money measure was down again in February and has fallen in four of the last five months. The six-month rate of change turned negative and is the weakest since 2010 in the aftermath of the GFC – see chart 1. 

Chart 1

Chart 1 showing Eurozone Broad Money M3 (% 6m)

Bank deposits are contracting at a faster pace than then because of a portfolio switch into money market funds and short-term bank bonds. This switch has been motivated by relative yields but the banking crisis could give a further boost to money fund inflows. 

Corporate money trends are particularly alarming. Bank deposits of non-financial corporations contracted at a 4.0% annualised pace in the latest three months, with the overnight (M1) component down by 16.6% – chart 2. Household deposits fell in February and are barely up over three months, with a shift out of overnight accounts suggesting weak spending intentions. 

Chart 2

Chart 2 showing Eurozone Household & NFC* Deposits (% 3m annualised) *NFCs = Non-Financial Corporations

Talk of households still sitting on substantial spendable “excess” savings is suspect. Allowing for inflation erosion, household M3 deposits are below their pre-pandemic trend – chart 3. 

Chart 3

Chart 3 showing Eurozone Real Household M3 Deposits (January 2003 = 100)

Country deposit data suggest that a core / periphery divergence is opening up, with Spain following Italy into year-on-year contraction – chart 4. 

Chart 4

Chart 4 showing Bank Deposits of Eurozone Residents* (% yoy) *Excluding Central Government

Monetary weakness partly reflects a collapse in credit growth: three-month loan momentum was running at an annualised 7.6% as recently as September but turned negative in February – chart 5. 

Chart 5

Chart 5 showing Eurozone Bank Loans* to Private Sector (% 3m annualised) *Adjusted for Sales, Securitisation & Cash Pooling

Corporations have been repaying short-term loans in size since November, consistent with a downswing in stockbuilding, which reached a record share of GDP in Q4. Numbers could bounce near term as firms draw down credit lines while they still can.

A Eurozone recession can now be ruled out, according to the ECB and a PMI-hugging consensus. 

Someone forgot to tell the monetary data. 

The favoured Eurozone narrow money measure here – non-financial M1 – fell for a fifth consecutive month in January, while broad money – non-financial M3 – was unchanged following marginal gains in November / December. 

With inflation data remaining hot, six-month contraction of real narrow money (i.e. deflated by consumer prices) reached a new record, of 5.4% or 10.5% annualised – see chart 1.

Chart 1

Chart 1 showing Eurozone GDP & Real Narrow Money* (% 6m) *Non-Financial M1 from 2003, M1 before

post last month noted that UK sectoral money trends were displaying a recessionary pattern: corporate broad and narrow money holdings were falling in nominal terms, suggesting a cash flow squeeze, while households were moving large sums out of time deposits into sight deposits, consistent with a shift in consumer behaviour from spending to saving. 

The same trends are now on show in the Eurozone: corporate M2 and M1 deposits fell in the three months to January, as did household M1 deposits – chart 2. 

Chart 2

Chart 2 showing Eurozone Household & NFC* Deposits (% 3m annualised) *NFCs = Non-Financial Corporations

The no-recession bandwagon gained momentum following Eurostat’s flash estimate that Eurozone GDP grew by 0.1% in Q4. Recently released national details paint an uglier picture. 

The Q4 fall in German GDP was revised from 0.2% to 0.4%, which will feed into an updated Eurozone number next week. 

More significantly, expenditure breakdowns show that domestic final demand weakened sharply in Q4 in France, Germany and Spain – at annualised rates of 1.6%, 3.7% and 5.4% respectively. The GDP impact was cushioned by a rise in net exports driven by import weakness and a further increase in stockbuilding – charts 3-5. 

Chart 3

Chart 3 showing France GDP (% qoq saar)

Chart 4

Chart 4 showing Germany GDP (% qoq saar)

Chart 5

Chart 5 showing Spain GDP (% qoq saar)

Eurozone stockbuilding, therefore, appears to have risen further from its record (in data since the mid 1990s) share of GDP in Q3 – chart 6. A violent reversal from lower peaks in 2007 and 2011 was a key driver of the 2008-09 and 2011-12 recessions. 

Chart 6

Chart 6 showing Eurozone Stockbuilding as % of GDP

The no-recession narrative was bolstered by February PMI results showing a pick-up in Eurozone services activity and new business. Manufacturing new orders, however, remained contractionary and are a better guide to the cyclical trend (since the key economic cycles – stockbuilding, business investment and housing – involve goods demand; there is no independent services cycle). 

The move off the lows in manufacturing PMI results has been mirrored in the German Ifo manufacturing survey. Business expectations, however, remain weak by historical standards and an indicator of demand inflow has risen by less, stalling between December and February – chart 7. 

Chart 7

Chart 7 showing Germany Ifo Business Survey

Residential construction expectations, meanwhile, plumbed another record low in February. Survey weakness has been reflected in hard data: housing construction new orders in Q4 were down 35% from Q1 and the lowest since 2014. Dwellings investment was a drag on GDP during H2 2022 but the orders plunge suggests a further big negative impact to come – chart 8.

Chart 8

Chart 8 showing Germany Dwellings Investment as % of GDP & Housing Construction New Orders

Japanese monetary trends continue to argue that current inflation is “transitory” and there is no case for BoJ policy tightening. 

Broad money M3 rose by just 0.1% in January, pulling annual growth down to 2.3%, below a 2010-19 average of 2.6%. Annual M1 growth is also below its corresponding average – see chart 1. 

Chart 1

Chart 1 showing Japan Nominal GDP & Narrow / Broad Money (% yoy)

M3 showed little growth on the month despite BoJ net JGB purchases reaching a record ¥20.3 trillion, equivalent to $155 billion or 1.3% of the stock of M3 – chart 2. The modest M3 increase pushes back against claims that BoJ JGB buying has “pumped liquidity into markets”. 

Chart 2

Chart 2 showing Japan BoJ Net JCB Purchases (¥ trn)

A counterparts analysis of M3 is not yet available for January but the lack of impact of QE is probably explained by the BoJ transacting mainly with commercial banks. A purchase from a bank involves a JGB / reserves swap with no effect on deposits held by non-banks. 

A further technical point is that Japanese money definitions exclude holdings of non-bank financial institutions, so purchases from such institutions also have no direct effect on M3. 

Chart 3 shows the contributions to annual M3 growth of selected credit counterparts through December. A substantial positive contribution from QE (domestic credit to government from BoJ) was offset by weakness in domestic credit to other sectors and negative contributions from commercial bank JGB sales (domestic credit to government from other banks) and net external flows. The latter drag partly reflects BoJ intervention to support the yen in late 2022. 

Chart 3

Chart 3 showing Japan M3 & Credit Counterparts Contributions to M3 % yoy

The weakness of credit expansion to non-government domestic sectors in the M3 counterparts analysis contrasts with a recent pick-up in annual growth of loans and discounts by major, regional and Shinkin banks – chart 4. The explanation for the divergence is that the M3 credit measure encompasses lending to non-bank financial institutions, including by the BoJ. Such lending surged during the pandemic but has contracted recently. 

Chart 4

Chart 4 showing Japan Bank Lending (% yoy)

Annual all-items consumer price inflation rose to 4.0% in December, the highest since 1981, and may have reached 4.5% in January, based on Tokyo data. Core inflation adjusted for the impact of major policy changes was 1.7% in December and may have increased to 2.0-2.1% in January. The recent pick-up partly reflects yen weakness, which may be reversing – chart 5. 

Chart 5

Chart 5 showing Japan Core Consumer Prices & Effective Exchange Rate (% yoy)

Annual cash earnings growth surged to 4.8% in December as winter bonuses reflected recent strong profits. Scheduled earnings growth of 1.8% is a better guide to trend but also represents a multi-decade high. 

The reversal of the 2020-H1 2021 M3 growth surge suggests that inflation and earnings growth are at or near a peak and will return to pre-pandemic levels in 2024-25.

The consensus is gloomy about UK economic prospects but is it gloomy enough? 

The current debate has echoes of mid-2008. Q2 2008 was the first quarter of the most severe post-war recession. The consensus that summer was that the economy would eke out growth with a limited rise in unemployment and no need for significant policy easing. 

A recession is widely acknowledged / expected now but the majority view is that it will be shallow and short-lived, partly reflecting recent energy price relief. Labour market damage is projected to be modest and there is general approval of recent MPC policy tightening. 

Monetary trends warned of worse-than-expected outcomes in 2008 and are giving an equally negative message now. 

The six-month rate of contraction of real narrow money (i.e. non-financial M1 deflated by consumer prices) was unchanged at 5.9% (not annualised) in December, close to a 6.1% peak reached in October 2008 – see chart 1. 

Chart 1

Chart 1 showing UK GDP & Real Narrow Money* (% 6m) *Non-Financial M1 from 1977, M1 before

As in 2008, the real money squeeze reflects both high inflation and nominal money weakness. Sectoral nominal money trends are uncannily similar to mid-2008. Corporate M1 and M4 are contracting rapidly, consistent with a sharp fall in profits and suggesting cuts in employment and investment – chart 2. 

Chart 2

Chart 2 showing UK Household & PNFC* Money (% 3m annualised) *PNFCs = Private Non-Financial Corporations

Household M4 is still growing modestly but there has been a large-scale switch out of sight into time deposits in response to rising rates – a classic signal of a shift in consumer behaviour from spending to saving. 

A continued rise in employee numbers in recent months has fed a narrative of labour market “resilience” that is expected to persist. Data and complacency were similar in mid-2008. The quarterly employee jobs series rose into Q3 2008 but the stock of vacancies in June was already down by 9% from its peak, warning of trouble ahead – chart 3. The level of vacancies is higher now but the fall from the peak has been larger, at 14%. 

Chart 3

Chart 3 showing UK Employee Jobs (mn) & Vacancies* (000s) *Single Month, Own Seasonal Adjustment

Eurozone flash PMIs this week were less bad than expected, bolstering a growing consensus that economic prospects are improving. Monetary trends continue to argue the opposite. 

The preferred narrow money measure here – non-financial M1 – fell for a fourth consecutive month in December in nominal terms. Bank lending also contracted on the month, while the broad non-financial M3 measure grew by just 0.1%. 

The three-month rate of contraction in narrow money is a record in data back to 1970. Three-month growth of non-financial M3 is down to 2.3% annualised, less than half its 2015-19 average. Bank loan growth is also now below its corresponding average – see chart 1. 

Chart 1

Chart 1 showing Eurozone Narrow / Broad Money & Bank Lending (% 3m annualised)

Bank lending weakness is being driven by repayment of short-term corporate loans, consistent with a violent downswing in the stockbuilding cycle – chart 2. 

Chart 2

Chart 2 showing Eurozone Stockbuilding as % of GDP (yoy change) & Short-Term* Bank Loans to Non-Financial Corporations (yoy change in % 3m) *Up to 1y Maturity

The six-month rate of decline of real narrow money was little changed from November’s record despite a sharp drop in six-month CPI momentum – chart 3. 

Chart 3

Chart 3 showing Eurozone GDP & Real Narrow Money* (% 6m) *Non-Financial M1 from 2003, M1 before

The rate of contraction of real M1 deposits remains fastest in Italy, reflecting both weaker nominal money trends and higher inflation. Spanish positive divergence is mainly due to a much sharper recent CPI slowdown. 

Chart 4

Chart 4 showing Real Narrow Money* (% 6m) *Non-Financial M1 Deposits

Echoing the better PMI news, German Ifo manufacturing expectations rose for a third month in January. The new demand index, however, has recovered by less and fell back this month – chart 5. European cyclical equity market sectors have outperformed on soft landing hopes and are vulnerable if business surveys now stall, as suggested by monetary trends. 

Chart 5

Chart 5 showing Germany Ifo Manufacturing Survey & MSCI Europe Cyclical Sectors ex Tech* Price Index Relative to Defensive Sectors *Tech = IT & Communication Services

post in October gave a hopeful view of Chinese prospects, noting that “excess” money had accumulated and could flow into equities and the economy if policy-makers signalled a commitment to expansion.

The consensus is now optimistic, believing that property market support measures and the removal of pandemic control restrictions will result in strong economic acceleration through 2023. Yet the latest money / credit data signal caution.

Globally, Chinese reopening is expected to be reflationary. Reopening, however, will release supply as well as demand. The former effect could dominate, resulting in additional downward pressure on Chinese export prices.

Six-month growth of true M1 peaked in July 2022, falling back to its March level in December – see chart 1. This suggests a slowing of underlying nominal GDP momentum from Q2. The levels of nominal and real narrow money growth are modest by historical standards. 

Chart 1

Chart 1 showing China Nominal GDP & Money / Social Financing (% 6m)

Broad money trends are stronger, with six-month growth of the favoured measure here – M2 excluding deposits of non-bank financial institutions – ending 2022 near the top of its range in recent years. Money, however, needs to shift from time deposits into M1 to signal rising confidence and spending intentions. 

Broad money growth may have been inflated by a switch out of wealth management products and other bank liabilities into deposits. The total stock of bank funding has been growing less strongly, with minimal acceleration since 2021 – chart 1. 

Many analysts follow the “credit impulse” – the rate of change of credit growth, usually expressed relative to GDP. This often gives the same message as narrow money trends (but is judged here to be less reliable) and also suggests a loss of economic momentum – chart 2. 

Chart 2

Chart 2 showing China “Credit Impulse” Change in Rolling TSF Flow as % of GDP

Bulls argue that excess household savings will fuel a consumption boom, drawing parallels with G7 experience following reopenings. Chinese households did not receive stimulus checks or direct wage support and the excess is likely to be considerably smaller, implying less pent-up demand. 

Supporting this view, household real M2 deposits in December were 8% above their pre-pandemic trend (and may have been inflated by the early timing of the Chinese New Year) – chart 3. US household real M3 holdings reached a peak 24% overshoot of the comparable trend in March 2021 – chart 4. 

Chart 3

Chart 3 showing China Household Sector Real M2 Deposits (RMB bn, 2015 consumer prices)

Chart 4

Chart 4 showing US Household Sector Real M3 ($ bn, 1982-84 consumer prices)

Fed policy remained expansionary as pandemic drags faded. The PBoC, by contrast, appears concerned about inflationary risks from rapid reopening and has engineered or at least tolerated a significant rise in term money rates. The increase in late 2022 was universally dismissed by China specialists as a year-end phenomenon unrelated to any policy shift but a minor fall in early January has since given way to another rise – chart 5. 

Chart 5

Chart 5 showing China Interest Rates

The view here is that the reopening boost to domestic demand will be modest and biased towards services. For goods, supply expansion due to reduced disruption may outweigh the lift to demand. 

Global trade moved into contraction in late 2022, partly reflecting an accelerating downswing in the global stockbuilding cycle. With supply constraints easing, Chinese exporters are likely to cut prices to increase market share, especially given the super-competitive level of the RMB – chart 6. 

Chart 6

Chart 6 showing China Broad Effective Exchange Rate (JP Morgan, 2010 = 100)

Gas price relief and Chinese reopening have tempered pessimism about Eurozone economic prospects, contributing to a Q4 rally in equities. Monetary trends, by contrast, suggest a worsening outlook due to the ECB’s scorched earth policy tightening. 

The preferred narrow money measure here – non-financial M1 – contracted for a third straight month in November. The three-month annualised rate of decline of 5.3% compares with a maximum fall of 1.7% during the GFC – see chart 1. 

Chart 1

Chart showing Eurozone Money Measures

Narrow money weakness is being driven by households and firms switching out of overnight deposits into time deposits and notice accounts – a normal pre-recessionary development. Broad money, in addition, is slowing – non-financial M3 rose by only 0.2% in November, pulling three-month annualised growth down to 3.4%, the slowest since 2018. 

The headline M1 and M3 measures are displaying greater weakness, reflecting a fall in money holdings of non-bank financial corporations.

Broad money growth had been supported by solid expansion of bank loans to the private sector but, as expected and signalled by the ECB’s lending survey, momentum is now fading – chart 2. Slumping credit demand and forthcoming QT suggest that broad money will follow narrow into contraction. 

Chart 2

Chart showing Eurozone Bank Loans to Private Sector and ECB Bank Lending Survey Credit Demand Indicator

Corporate loan demand had been boosted by inventory financing but stockbuilding reached a record share of GDP in Q3 – chart 3 – and is probably now being cut back sharply, contributing to a move into recession. Consistent with this story, short-term loans to corporations contracted in both October and November. 

Chart 3

Chart showing Eurozone Stockbuilding as Percent of GDP

A sharp fall in inflation will support real money trends but has yet to arrive. The six-month rate of contraction of real non-financial M1 reached another new record in November – chart 4. 

Chart 4

Eurozone GDP and Real Narrow Money

Monetary tightening in 2007-08 and 2010-11 was associated with a divergence of money trends across countries, reflecting and contributing to financial fragmentation. This is occurring again, with weakness focused on Italy. 

Italian real narrow money deposits contracted by 9.7%, or an annualised 18.4%, in the six months to November, with the larger decline than elsewhere due to both greater nominal weakness and higher CPI inflation – chart 5.

Chart 5

Chart showing Real Narrow Money

In nominal terms, total bank deposits in Italy were unchanged in the year to November – chart 6. Italian banks’ assets grew modestly over this period. The banks funded this expansion by increasing their net borrowing from Banca d’Italia, which in turn accessed additional funding from the Eurosystem, resulting in a further widening of its TARGET2 deficit. The deficit reached a record €715 billion in September following a surge in Italian BTP yields, falling back in October / November – chart 7. Another rise in yields since early December may have been associated with deposit outflows from the banking system and renewed upward pressure on the TARGET2 shortfall. 

Chart 6

Chart showing Bank Deposits of Eurozone Residents

Chart 7

Chart showing TARGET2 Balances