3rd March 2016 by Simon Ward
Narrow money growth in the E7 large emerging economies rose further in January, suggesting improving economic and equity market prospects.
With January data available for six of the seven countries, the six-month change in real (i.e. consumer price-adjusted) narrow money* is estimated to have risen to more than 5%, or nearly 11% annualised, representing the fastest growth since October 2010 – see first chart. The six-month change turned negative in December 2014 ahead of economic weakness in 2015.
The pick-up in growth since mid-2015 reflects a combination of stronger nominal money expansion and a slowdown in inflation, with the former dominating.
By country, China has been the key driver but additional boosts have come from a resumption of real money growth in Russia and a slowdown in the rate of contraction in Brazil. Real money expansion remains strong in Korea (latest data point December) and respectable in other E7 countries, although has slowed notably in Mexico – second chart.
Key concerns for emerging market investors are that the US economy will either enter a recession in 2016 or reaccelerate strongly, prompting the Fed to press ahead with interest rate hikes. Current evidence suggests that a middle course of sub-par expansion is more likely.
A recession is not the main case scenario here because 1) US real narrow money has yet to contract, as it has before most prior recessions, and 2) consumer expectations are holding up, suggesting that consumption growth will continue to offset weakness in business spending. Expectations usually fall sharply at the onset of recessions – third chart. Energy price declines have provided important support recently, so an early, large oil price rebound would be concerning.
Strong economic reacceleration is deemed unlikely because 1) US narrow money trends remain weak and 2) the Kitchin inventory cycle is in a downswing. According to revised national accounts data released last week, the ratio of real non-farm inventories to sales of final goods and structures rose to an 18-quarter high at the end of 2015, with the deviation from the long-term downward trend the largest since the second quarter of 2009 – fourth chart. Assuming that final sales grow at a 2% annualised rate, and stockbuilding adjusts smoothly, a return to the long-term trend by end-2016 would imply a drag of 0.5-0.75 percentage points on GDP growth in the year to the fourth quarter.
Emerging market investors are also concerned about Chinese economic weakness. February purchasing managers’ survey headline numbers were modestly disappointing from the perspective of the optimistic view of Chinese near-term prospects here but upcoming “hard” data for January / February will be more important for assessing developments. There were some promising signs in the details of the surveys: for example, order backlogs in the official manufacturing survey rose to a four-month high while activity expectations improved sharply – fifth chart**.
*Narrow money = “true” M1 for China, M1 for other countries.
**Own seasonal adjustment applied to official data.