As discussed in Tuesday’s post, global narrow money trends suggest that economic momentum will bottom out in the third quarter of 2019 but remain weak into early 2020.
The monetary signal has been confirmed by a global non-monetary leading indicator based on the OECD’s country leading indicators. The six-month rate of change of this indicator appears to have bottomed in early 2019 and typically leads by 4-5 months – see first chart.
Neither money trends nor the leading indicator are yet suggesting an economic recovery, in the sense of a return to trend growth.
A further reason for expecting economic momentum to bottom out around the third quarter, discussed in previous posts, relates to the global stockbuilding or inventory cycle, which averages 3.5 years in length, i.e. measured from trough to trough.
The second chart shows the contribution of stockbuilding to annual G7 GDP growth. The last trough occurred in the first quarter of 2016, suggesting another low in the third quarter of 2019, assuming that the current cycle is of average length.
The growth contribution was still significantly positive in the first quarter of 2019 – the last data point in the chart – raising the possibility that the current cycle will be longer than average, implying a later trough.
However, two pieces of evidence suggest a rapid weakening in recent months – a third-quarter low, in other words, remains plausible.
First, an indicator derived from G7 business survey responses about inventories correlates with the GDP stockbuilding data but is more timely and sometimes leads, and this indicator turned significantly negative in early 2019, though has yet to reach an extreme suggestive of a cycle low – third chart.
Secondly, global retail sales volumes have rebounded strongly since end-2018, far outpacing industrial output – fourth chart. This suggests a significant drawdown in inventories unless spending on capital goods has collapsed.
Retail sales strength is likely to fizzle. It partly reflects a US bounce-back after weakness associated with the government shutdown. In addition, a fall in sequential inflation was a tailwind during the first half but is now reversing. Softening labour markets, meanwhile, are starting to erode consumer confidence.
The forecast of a trough in global industrial momentum in the third quarter suggests that the global manufacturing PMI – a coincident indicator – is at or near a low. The forthcoming July flash results, moreover, could reflect some hope engendered by the Trump-Xi trade truce in late June – this may have influenced yesterday’s stronger Philadelphia Fed manufacturing survey.
The danger is that markets and policy-makers wrongly interpret a bottoming of the manufacturing PMI as a precursor to an economic recovery in late 2019 / early 2019 – ignoring evidence from monetary trends and other leading indicators that prospects remain worryingly weak.
A rebound in bond yields as expectations of central bank policy easing are reined back would risk aborting the recent tentative monetary recovery. It could also trigger another sell-off in equities, which have displayed a strong inverse correlation with real yields in recent months – fifth chart.