US narrow money trends remain worryingly weak, suggesting that monetary policy is already restrictive and a significant economic slowdown lies immediately ahead.
The Fed last week released sector financial accounts for the third quarter, permitting the calculation of an end-September number for non-financial M1, the preferred narrow money measure here*. The two-quarter change in real (i.e. deflated by consumer prices) non-financial M1 moved into negative territory, reaching its lowest level since 2008. The leading relationship with two-quarter GDP momentum suggests that the latter will fall sharply from a third-quarter peak – see first chart.
Narrow money trends appear to have remained weak so far in the fourth quarter, judging from the headline M1 measure – the chart incorporates a November estimate of the six-month change in real M1 based on weekly data through 26 November.
The weakness of real non-financial M1 was initially focused on the business sector but household holdings also contracted over the latest two quarters – second chart. Previous posts suggested that the fall in business holdings would be reflected in a slowdown in investment and hiring – recent data (e.g. capital goods orders, aggregate hours worked) lend support to this forecast. With household holdings also now weakening, consumer spending could be next to disappoint.
The fall in business money holdings, which extends to the broad M3 measure, has occurred despite foreign earnings repatriation, which might have been expected to swell domestically-held corporate deposits. The financial accounts show that the repatriation flow has been offset by a rise in net equity retirement (i.e. buy-backs and cash takeovers), a slowdown in debt issuance and faster accumulation of “miscellaneous assets”. The flow peaked in the first quarter and fell further in the third quarter, with a corresponding slowdown in net equity retirement – third chart.
The negative signal for economic prospects from money trends is receiving confirmation from the OECD’s US composite leading indicator. As previewed in a post last week, this indicator continued to decline in October, signalling below-trend GDP growth – fourth chart.
*Non-financial M1 comprises holdings of currency and checkable deposits by households and non-financial businesses. Headline M1 also includes holdings of insurance companies, pension / retirement funds, money market funds, government-sponsored enterprises, finance companies, REITs, brokers / dealers and foreign non-banks (excluding official institutions). These holdings account for more than 30% of M1 (dominated by the foreign component, mainly currency) but are unlikely to be of relevance for assessing near-term prospects for spending on goods and services.