Global and international – CC&L Financial Group Ltd.

Chinese money and credit numbers for December suggest that policy stimulus is becoming effective, warranting an upgraded assessment of economic prospects.

Six-month rates of change of broad / narrow money and broad credit (total social financing) bottomed in June / July but the recovery through November was modest. All three jumped higher in December – see chart 1.

Chart 1

Money measures – particularly narrow money – were negatively distorted last spring by regulatory enforcement of deposit rate ceilings*. The revival in six-month momentum partly reflects the dropping out of this effect. Still, December readings should be undistorted and broad money momentum is close to its 2015-19 average, when nominal GDP grew solidly.

Monetary financing of fiscal easing has been a key driver of the money growth pick-up. Banking system net lending to government (including by the PBoC) contributed 2.0 pp (not annualised) to M2 growth in the six months to December, the most since the 2015-16 stimulus episode.

An apparent weak spot in the December release was a further fall in annual bank loan growth (i.e. excluding lending to government). The numbers, however, are being distorted by debt swap operations, involving repayment of bank loans by government-related organisations. Six-month loan momentum has edged up despite this drag, with household lending weakness abating – chart 2.

Chart 2

Will the money growth recovery continue? Recent renewed pressure on the currency has been associated with a resumption of f/x sales and a firming of money market rates. The increase in term rates has so far been modest and may be offset by ongoing support from money-financed fiscal easing.

*Lower interest rates on demand deposits resulted in enterprises moving money into time deposits and non-monetary instruments while repaying bank loans.

Chinese money trends are normalising after weakness, suggesting modest economic improvement.

A previous post argued that a recovery in money growth was under way but the extent of reacceleration was uncertain. A revival remains on track but has so far proved lacklustre.

Money numbers were distorted in the spring by regulatory enforcement of deposit rate ceilings, which led to corporations switching out of demand deposits into time deposits and non-monetary instruments. Broader money measures were less affected, resulting in a focus here on the “M2ex” aggregate (i.e. official M2 minus deposits of financial institutions, which are volatile and less correlated with future activity / prices).

Six-month M2ex momentum bottomed in June and recovered further in November, though remains below its 2015-19 average – see chart 1.

Chart 1

Narrow money momentum is much weaker but has started to normalise as the spring distortion drops out of the six-month comparison. (The “true M1” measure shown approximates to a new official M1 definition to be adopted from January.)

Chinese money momentum has led nominal GDP momentum by two quarters on average historically, so monetary reacceleration since mid-year suggests better economic data from early 2025.

November activity numbers were positive on balance. Six-month rates of change of industrial output, fixed asset investment and home sales rose further but retail sales disappointed – chart 2. Output strength could reflect front-loading ahead of tariffs.

Chart 2

The suggestion from monetary trends of improving prospects is supported by the OECD’s composite leading indicator, six-month momentum of which has turned positive, suggesting above-trend growth – chart 3.

Chart 3

Real money momentum has led leading indicator momentum by four months on average historically but the low in the latter occurred earlier on this occasion, perhaps reflecting the regulatory distortion to monetary data mentioned above.

Sectoral numbers show that recent US money growth has been focused on the household and financial sectors, with business holdings falling.

A recent post noted that US six-month narrow money momentum fell back in September / October, casting doubt on post-election economic optimism. Sectoral money trends revealed in the Fed’s Q3 financial accounts give further grounds for caution.

Chart 1 compares the six-month rate of change of the monthly broad measure calculated here – M2+, which adds large time deposits at commercial banks and institutional money funds to the official M2 series – with the two-quarter change in a domestic money aggregate derived from the financial accounts. The series are closely correlated with end-Q3 readings similar.

Chart 1

An advantage of the financial accounts data set is that it allows a breakdown of broad / narrow money between the household, non-financial business and financial sectors. Broad money growth in the two quarters to end-Q3 was driven by households and financial firms, with business money falling – chart 2. The narrow money decomposition (not shown) mirrors this pattern.

Chart 2

Business money trends have exhibited a stronger and more consistent relationship with future economic activity than household / financial sector developments historically. Changes in business liquidity can influence decisions about investment and hiring, with employment consequences feeding through to household incomes and money holdings.

The approach here, therefore, is to interpret the signal from a given level of aggregate money growth as more positive – or less negative – when the business component is outperforming (and vice versa).

Chart 3 shows that real business money – on both broad and narrow definitions – is falling on a year-ago basis, suggesting that a slowdown in investment will continue in 2025.

Chart 3

The Q3 financial accounts numbers also support an earlier proposition here that asset prices and nominal GDP have – in combination – moved above levels implied by the current broad money stock, i.e. there is no longer an “excess” money tailwind for the economy and markets.

To recap, the “quantity theory of wealth” is a suggested modification of the traditional quantity theory recognising that (broad) money demand depends on wealth as well as income and proposing equal elasticities. Nominal income is replaced on the right-hand side of the equation of exchange MV = PY by a geometric mean of income and wealth.

Using Q4 2014 as a base, the measure of gross wealth used here – the market value of public equities, debt securities (excluding Fed holdings) and the housing stock – had risen by 107% as of end-Q3 versus a 64% increase in nominal GDP. Implied growth of 84% in the geometric average compares with an increase of 80% in broad money over the same period – chart 4.

Chart 4

Equity / house price gains, debt issuance / QT and expected respectable nominal GDP expansion suggest that the overshoot will have widened in Q4.

Monthly UK money growth was boosted by households scrambling to dispose of assets ahead of the Budget, with a reversal likely and corporate liquidity trends worryingly weak.

The narrow and broad money measures tracked here – non-financial M1 / M4 – rose by 0.9% in October, in both cases representing the largest monthly increase since 2021, when the Bank of England was still conducting QE.

Strength was focused on the household sector, with a monthly rise in M4 holdings of £20.2 billion (1.1%) versus a £7.6 billion average over the previous half-year – see chart 1.

Chart 1

Six-month momentum of household real narrow money, which had edged into positive territory in September, rose to a three-year high. Corporate real narrow money momentum, by contrast, was the most negative since March, suggesting that firms were facing a financial squeeze before the Budget national insurance grab – chart 2.

Chart 2

Corporate broad money holdings contracted at a 1.7% annualised rate in nominal terms in the six months to October, while M4 lending to the sector grew by 5.6%. The corporate liquidity ratio, therefore, fell at a 6.9% pace.

Households crystallised capital gains, accelerated property transactions and withdrew cash from pension funds to avoid mooted Budget tax hikes. Retail savers sold £5.9 billion of investment funds in October, the most since September 2022, according to the Investment Association. The number of residential property transactions rose by 10% on the month, with non-residential deals jumping 40% to a record.

An increase in asset turnover has no monetary impact where transactions are between UK residents and involve offsetting changes in the bank balances of buyers / sellers. A monetary boost occurs when UK-owned assets are sold to overseas residents and / or when transactions are associated with an increase in bank lending.

Non-financial M4 lending (i.e. to households and private non-financial corporations) rose by £7.2 billion in October versus a prior six-month average of £4.1 billion.

UK buyers of assets, moreover, may have made room for purchases by reducing demand for gilts, requiring an offsetting rise in bank lending to the public sector. Gilt sales to the UK non-bank private sector slowed to £6.1 billion in October versus a prior six-month average of £12.3 billion. The credit counterparts analysis shows a positive public sector contribution to the change in M4 of £11.0 billion (0.4%).

Sales of assets to overseas investors, meanwhile, may have been significant, judging from a £9.1 billion monthly fall in non-resident net sterling deposits.

Sellers of assets for tax reasons are unlikely to wish to retain permanently higher money balances. “Excess” funds may be used to repay bank lending, increase gilt purchases and buy assets from non-residents, resulting in a reversal of the monetary boost.

The suggestion is that the pick-up in household money momentum should be discounted, with greater weight given to deteriorating corporate trends.

Eurozone services price momentum is “unsticking” as expected, supporting the forecast of sub-2% 2025 inflation.

A post in September suggested that the ECB staff’s latest inflation forecast – like earlier projections – would be undershot.

With November’s favourable surprise, annual headline and core (i.e. ex. energy and food) consumer price inflation are on course to average 2.2% and 2.7% respectively in Q4, versus ECB September central projections of 2.6% and 2.9%.

Six-month headline / core momentum is still loosely tracking the profile of broad money growth two years earlier, a relationship suggesting a further decline and undershoot of the 2% target – see chart 1.

Chart 1

A fall in six-month core momentum to 2.1% annualised in November was driven by a sharp slowdown in services prices, which fell marginally on the month (ECB seasonally adjusted series).

Previous posts questioned central banks’ focus on “sticky” services inflation. Monetary conditions determine aggregate inflation, with the component breakdown partly shaped by “exogenous” factors. Earlier weakness in energy / food and core goods prices suppressed headline inflation while allowing consumers to spend more on services, delaying price deceleration in that sector. The suggestion was that services disinflation would speed up as downward pressure on goods prices eased.

This appears to be playing out: six-month goods momentum has recovered, mainly reflecting food price reacceleration and a slower fall in energy costs, with the headline impact neutralised by a “surprise” services slowdown – chart 2.

Chart 2

The “monetarist” relationship, taken at face value, implies a period of falling prices in 2025. The judgement here is to downplay this possibility and regard the monetary signal as directional rather than giving strong guidance about the level of price momentum.

The stock of money could still be above “equilibrium”, implying a cushion against deflation. This question can be addressed using the “quantity theory of wealth” – the idea that asset prices and incomes adjust such that a geometric average of wealth and nominal GDP rises in line with broad money over the medium term.

Chart 3 shows that, using Q4 2018 as a base, nominal GDP has lagged broad money significantly while wealth has slightly outpaced it. The nominal GDP / wealth average was still 2% short of the level implied by the money stock as of Q2 2024.

Chart 3

A small “excess” money cushion, along with recent currency weakness, may head off an extreme scenario but money trends still suggest a sustained inflation undershoot and a need for further policy easing to achieve medium-term realignment.

November results confirm a September low in global manufacturing PMI new orders, with money trends suggesting a further rise through spring 2025, subject to tariff distortions.

The baseline scenario here has been that global industrial momentum – proxied by the manufacturing PMI new orders index – would bottom out in late 2024 and recover weakly into H1 2025. A manufacturing upturn was expected to be offset by loss of services momentum, with associated labour market weakness combining with favourable inflation news to support faster monetary policy easing.

The manufacturing part of the story is on track. The forecast of a late 2024 PMI new orders low was based on a recovery in global six-month real narrow money momentum from a trough in September 2023, taking into account a recent average interval of about a year between turning points in the two series. The new orders index reached a 22-month low on schedule in September, recovering solidly in October / November – see chart 1.

Chart 1

The turnaround has been mirrored by an alternative indicator based on national business surveys, although this bottomed one month earlier in August and has recovered by slightly less – chart 2.

Chart 2

Chart 3 highlights the recent relationship between swings in six-month real narrow money momentum and directional changes in the alternative indicator. Real money momentum recovered between September 2023 and April 2024 but has since stalled at a weak level by historical standards, falling back in September / October.

Chart 3

Assuming that the lead time remains at about a year, the suggestion is that a rise in the survey indicator / PMI new orders will level off in spring 2025, falling short of prior historical peaks.

Forecast uncertainty is higher than normal because tariff threats are distorting behaviour. Accelerated stockbuilding could result in a stronger near-term pick-up and earlier peak with a subsequent normalisation – or worse if threats crystallise.

Eurozone money trends are improving but remain too weak to support economic optimism, while country details highlight French stress.

A post in June noted that six-month real narrow money momentum was still significantly negative, suggesting that a minor economic recovery in H1 2024 would give way to a H2 “double dip”. The PMI composite output index fell from 50.9 in June to a flash reading of 48.1 in November.

Six-month real money momentum has risen further since June but was still barely positive in October. It has, however, crossed above Japan and narrowed a shortfall with the US, implying improving relative prospects – chart 1.

Chart 1

Consensus gloom about Germany may be overdone. Six-month nominal narrow money momentum has swung into positive territory since mid-year, catching up with Spain / Italy – chart 2.

Chart 2

French momentum, by contrast, remains negative, with a recovery stalling in September / October.

French narrow money weakness appears to reflect low confidence and spending intentions rather than deposit flight (so far). Annual growth of all bank deposits slowed sharply in September / October but is still on a par with in Germany – chart 3.

Chart 3

France’s deficit in the TARGET system rose by €34 billion in September to a record €175 billion, which could signal a capital outflow related to the political / fiscal crisis. There has, however, been no corresponding increase in Germany’s surplus, for which an October number is available – chart 4.

Chart 4

A pull-back in US narrow money momentum casts doubt on post-election economic optimism.

Six-month growth of M1A (comprising currency in circulation and demand deposits) eased to 5.7% annualised in October, down from an August peak of 10.0% – see chart 1.

Chart 1

Growth of the broad M2+ measure, by contrast, rose to 5.1% annualised, the fastest since March 2022. (M2+ adds large time deposits at commercial banks and institutional money funds to the official M2 measure.) Narrow money, however, has a better record of signalling turning points in economic momentum.

Six-month expansion of official M1 is weaker, at 2.9%. M1 is no longer a narrow money measure, following its redefinition in 2020 to include savings accounts.

A post in September expressed doubt that a pick-up in M1A growth would be sustained, partly because it had occurred before any rate cuts. In addition, the rise had been driven solely by the demand deposit component, with currency momentum unusually weak.

Six-month growth of currency has recovered but was still only 1.7% annualised in October – chart 1.

A further consideration, noted in a post last month, is that narrow money growth has tended to rise ahead of presidential elections but reverse shortly before or after the poll date – chart 2. (1984 and 2000 were notable exceptions.)

Chart 2

The pull-back to date has been modest but could become more serious, especially if the Fed delays further rate cuts.

Broad money growth, however, could be supported by increased monetary financing of the fiscal deficit, based on Treasury plans for higher bill issuance in Q4 and Q1 (given that these are mostly purchased by money funds and banks).

Narrow / broad money divergences can reflect shifts in confidence and spending intentions affecting broad money velocity. (Such shifts are associated with movements between low-velocity broad money components and high-velocity narrow money.) Relative narrow money strength into the summer was a positive signal for the economy; the reversal suggests fading prospects.

The current stockbuilding cycle may be approaching its mid-point, which typically marks a shift from “risk-on” to a neutral or negative market environment.

The stockbuilding (or inventory or Kitchin) cycle is usually described as ranging between 3 and 5 years. The dating here suggests a normal band of 2.5 to 4.5 years, with an average of about 3.5.

A key indicator used to inform judgements about cycle dates is the annual change in G7 stockbuilding, expressed as a percentage of GDP. Chart 1 shows a long history of this indicator, along with suggested cycle low dates.

Chart 1

There were 16 complete cycles, measured from low to low, between Q2 1967 and Q1 2023, a period of 55.75 years. This implies an average cycle length of 3.5 years or 42 months.

The cycle described in a 1923 article by Joseph Kitchin averaged 40 months. Kitchin analysed data on bank clearings, commodity prices and interest rates and did not explicitly link his cycle with inventory fluctuations. His average was based on 9 cycles spanning 30 years, i.e. a smaller data set than shown in chart 1.

An average of about 3.5 years harmonises with the longer-term housing cycle, with an accepted average length of 18 years. Five stockbuilding cycles “nest” within each complete housing cycle, implying an average length of 3.6 years (43 months).

The most recent stockbuilding cycle trough is judged to have been reached in Q1 2023. Assuming a starting point in the middle of the quarter, November 2024 is month 21 of the current cycle.

The annual change in G7 stockbuilding was still negative in Q3 and usually becomes significantly positive at peaks, suggesting that the cycle remains an expansionary influence on economic momentum currently.

The cycle is as important for markets as the economy (as shown by Kitchin’s reliance on commodity price and interest rate data). The first half of the cycle (starting from a trough) is typically favourable for risk assets and cyclical exposure. Bear markets and crises have historically been concentrated in cycle downswings.

Table 1 compares movements in various assets since the Q1 2023 trough – third column – with average performance in the first 21 months of the prior 8 cycles (stretching back to the mid 1990s) – first column. The second column shows average performance over the remainder of those 8 cycles.

Table 1

The current cycle has so far largely conformed to the historical pattern, with strong performance of equities, cyclical sectors, precious metals and credit. The suggestion is that remaining upside potential is limited in these areas, with weakness likely over the next 1-2 years as a cycle downswing unfolds.

Could the current cycle prove to be longer than average, extending the risk-on phase? A longer cycle is plausible both because the previous one was short (2.75 years) and to align with the business investment cycle, for which the dating here implies a low in 2027 or later.

A delayed entry to the downswing phase could imply catch-up potential for areas that have lagged relative to history, including non-US / EM equities and commodities.

Cycle timings, however, could be affected by accelerated stockbuilding in anticipation of tariff wars, which could bring forward the cycle peak, although this would not necessarily imply an earlier trough.

The overall message is cautionary. A previous post argued that the “excess” money backdrop for markets is now neutral / negative in stock as well as flow terms. Cyclical considerations reinforce the monetary message.

Japanese money trends remain ominously weak, suggesting poor economic / market prospects and a return of inflation to unacceptably low levels.

Annual growth rates of broad money M3 and narrow money M1 fell to 0.7% and 1.5% respectively in October, well below 2010-19 averages of 2.6% / 5.1% and the lowest since the GFC – see chart 1.

Chart 1

Record f/x intervention resulted in monetary contraction in Q2 but a subsequent recovery has been minor, partly reflecting BoJ policy tightening. M3 and M1 grew at annualised rates of 0.5% and 0.1% in the three months to October – chart 2.

Chart 2

Japanese economic prospects represent another test of “monetarist” vs. consensus forecasting approaches. The BoJ / consensus view is that above-potential economic growth, a tight labour market and a gradual rise in adaptive inflationary expectations will result in annual CPI inflation – on both the targeted ex. fresh food measure and the BoJ’s core index also excluding energy – remaining close to the 2% target in FY 2025 and FY 2026. The BoJ views risks as skewed to the upside, warranting a tightening bias.

The “monetarist” view, by contrast, is that 2022-23 inflation resulted from a temporary spike in money growth in 2020, with the effects extended by a big fall in the yen. With money growth well below the 2010-19 average, CPI inflation is heading back to, or beneath, its corresponding average of 0.5%, unless the exchange rate suffers a further collapse.

Headline CPI numbers have been affected by changes in energy and travel subsidies but six-month core momentum (on the standard international definition excluding all food as well as energy) has fallen back below 2% annualised, consistent directionally with the earlier slowdown in money growth – chart 3. The level of core momentum still incorporates the effects of yen weakness.

Chart 3

Chart 4 shows the contributions of the “credit counterparts” to annual M3 growth, with data available through September. Comparing with growth a year earlier, the largest drag has been a shift in domestic credit to government from expansion to slight contraction, reflecting the impact of f/x sales (which reduce government borrowing needs) and the BoJ moving from QE to QT.

Chart 4

A slowdown in domestic credit to other sectors has also exerted a negative influence. The measure shown is significantly broader than the BoJ’s series for loans and discounts by commercial banks but growth in the latter has also moderated recently, while the latest senior loan officer survey reported weaker expectations for credit demand – chart 5.

Chart 5

Is there still an overhang of money from the 2020 surge sufficient to sustain nominal economic expansion despite current low M3 growth? This can be answered using the “quantity theory of wealth” – the idea that asset prices and incomes adjust such that a geometric average of wealth and nominal GDP rises in line with broad money over the medium term.

Chart 6 shows that, using Q4 2018 as a base, a nominal GDP undershoot relative to broad money (i.e. a fall in conventionally defined velocity) has been offset by a wealth overshoot, resulting in the average moving slightly ahead of the level implied by the money stock in Q2 2024.

Chart 6

The suggestion is that an “excess” money reserve has been exhausted and, unless asset prices fall, current low money growth will be reflected in nominal economic weakness.