M1's decline as severe as during the Great Depression

 Here, I showed a chart of real (= inflation-adjusted) US M1.  The unadjusted version is as interesting.

As you can see, nominal (i.e., not adjusted for inflation) M1 is falling as fast as it did during the Great Depression (1929-1933).  It fell then because banks failed, and when that happened, their deposits were written off, causing money supply to fall.  It's happening now because The Fed is allowing its book of government bonds bought during the Covid Crash to run off without replacing them.   When that happens, the money it receives is extinguished (central banking is complicated to explain!) and so the money supply is reduced.  

The huge surge in money supply during Covid led to an economic boom (though fiscal stimulus exacerbated the boom) and a jump in inflation to 40-year highs.  Of course, there's never just one factor---inflation was worsened by the invasion of Ukraine, by a surge in commodity prices, and by supply chain hiccoughs.  However, there is no doubt in my mind that massive monetary stimulus in the form of zero interest rates plus quantitative easing helped overstimulate the economy and worsened inflation.   

Now the situation is reversed.  Interest rates have risen the fastest in 40 years, and money supply is falling as fast as it did in the Great Depression.  It is of course possible that neither of these two factors will lead to recession.  But, alas, it seems very unlikely.  

We must be alert to the possibility that the Fed's redefinition of money supply to include liquid interest-bearing deposits has changed its behaviour, but you would have expected the effect to be the other way, as precautionary motives and rising interest rates led to an increase in interest-bearing liquid assets.  But M2, which includes money market funds, is also falling faster than at any time in the last 60 years, though not as fast as M1.

US real M1 falling fastest in 100 years

 US real M1, i.e., M1 deflated by the CPI, is falling faster than at any time in the last 100 years.   The post WW2 decline in the inflation-adjusted time series was because war-time price controls were lifted and published inflation jumped to 20%, before falling back.  In fact, it went negative---businesses had in fact raised prices too enthusiastically, which I suspect is happening again.

The Fed instituted a policy of "quantitative easing" during the Covid crash, which caused a big jump in money supply.  Since it became concerned about inflation, it has reversed this policy, and this has reduced money supply.  There was also a change in definition of money supply, but I have adjusted my data to reflect this.

If you argue that quantitative easing expanded the economy, leading to low unemployment, high growth and surging inflation, you must accept that "quantitative tightening" will lead to the reverse outcomes. There is no sign that real M1 has started to rise.  If anything, its absolute decline is accelerating.

I think this is a major blunder on the part of the Fed, and will lead to a sharp decline in economic activity.  The lags are long, but we should be starting to feel the effects of this singular plunge in real money supply from now on.

US PMI up; big 3 PMI falls in September

In September, the preliminary US PMIs for both services and manufacturing rose a little.  The average for them both is shown below.  This is the first time, month on month, that they've risen in over a year.  Is this the end of the slowdown?  Perhaps, though I would have said it's a few months too soon based on both my leading and my longer-leading US indices.  Perhaps it is the end of the decline in the PMIs, but not yet the beginning of a sustained rise.

The "flash" manufacturing PMIs for both Europe and Japan fell (there isn't a preliminary estimate made for China, and its PMIs for September will only be out early next month) .  So the weighted average for the big three declined again.

This divergence between the US and Europe will have implications for markets.

• The Fed seems to me unlikely to cut the fed funds rate again.  They will wait to see whether the cuts already made have their effect.  This easing cycle, for the time being, is ended.
• Since because of Germany's intransigence, Europe can't do the obvious—increase deficit spending to turn the economy around—the ECB will be obliged to turn to QE (quantitative easing) which is a fancy term for saying that the ECB will buy bonds with "printed" money, to drive down bond yields.  However, as bond yields in Germany, France and The Netherlands are already negative, and they're sub 1% in the rest of Europe, this is unlikely to make any difference.  Except .... to the exchange rate.  Expect the Euro to keep on weakening, and watch for Trump's trade wars to spread to Europe as that happens.
• Expect in contrast the US$ to keep on rising.
• Thus already anaemic share markets in Europe will look even worse in US$ terms.  The US share market will remain the most attractive of all developed markets (in US$)
• US bond yields have prolly troughed for the time being.  Europe's prolly haven't.  The spread between the two regions will widen.
• Commodity prices on average will prolly continue to slide, though supply/demand considerations in some commodities will make them exceptions.  If China begins a sustained recovery, then commods will bottom.  Until then, be cautious.  

Entrepôt economy points to recession

I've talked before about entrepôt economies or cities.  They're trading cities which depend on trade in their surrounding regions and around the world.  Cities like Vienna, Hong Kong and Singapore these days and Venice, Dar-es-Salaam in the past.  (I talked about them here and here).  This makes them especially sensitive to economic conditions in the regions they serve.  The PMI (purchasing managers index) for Austria comes out a few days before the final pan-Europe PMI, and correlates well with it.  It fell below 50 for the first time since 2012 this month, which would signal the onset of a recession.  (I explain about diffusion indices and PMIs here)

A recession now in Europe would be difficult to stop.  The ECB's (European Central Bank) discount rate is already at zero, deficit spending is constrained by the "stability pact", and with other large world economies slumping (China, the USA, Japan) it's hard to see what will reverse this downtrend.  As indeed, this article points out.  For obvious reasons, I remain bearish on equities.

US econ slumps

The various regional branches of the US Federal Reserve Bank (the Fed) do surveys of business conditions in their region.  If you add 5 of them together (unweighted) you get an indicator which closely follows the year on year change in real GDP,  but leads it by 3-5 months.  We now have data for January.  This is perfectly consistent with my longer-leading index which points to an at best slowdown in 2019 and 2020 and at worst recession.  Of which more anon.

Moral of the story: economic growth in the US, as measured by real GDP,  is about to plunge.  Which is prolly why the Fed has backed away from further rate increases, and is muttering about slowing the unwinding of QE.

An impending US recession?

Total car sales tend to lead the overall economic cycle at the peak (see the chart below; double-click to enlarge).  There are reasons proffered for this current downshift: people are holding on to their cars longer; millennials aren't buying cars.  Yet varying explanations for falling car sales are produced every cycle.  As you can see from the chart, it's a big decline.

Add in the rising cash rate from the Fed; an impending reversal of QE (quantitative easing) to QT (quantitative tightening) as the Fed starts to sell down its bloated holdings of long term-debt bought to provide stimulus over the last 7 years; and consumer weariness, and it's looks quite likely there will be a recession.  When?  Can't tell yet.  But it does raise some question marks over the boom on Wall Street. 

No sign US is slowing

The PMI and ISM indices for December for the US remained at a reasonable level, not yet boom but very far from bust.

My guess is that QE will go on being "tapered" but that this won't have any effect on growth though bond yields are likely to continue to rise albeit more slowly than they have done over the last 8 or 9 months.  This will be a moderate headwind for the market (I mean the share market)  Though the US recovery is far from boom territory, the US bull market is very long in the tooth.  But until the Fed starts raising the Fed Funds target rate, which won't happen for many many months, the bull market will be intact.  All the same, it's had a good run.  Caution.

"Surprise" ISM May slide

In the US, the ISM index (what used to be called the NAPM index) has had a very close correlation with economic activity over the last 75 years.  Even though manufacturing is now just 12% of GDP, still, it is well correlated.

It fell, surprising the markets, in May.  What's happening seems clear enough to me.  The economy had finally started to accelerate into a sustained economic recovery.  And then the "fiscal cliff" started to bite, and it slowed again.   This dynamic has played out again and again over the last 5 years, right across the world.  Fiscal tightening causes economic slowdown.  Is anybody listening?

QE is safe.  But the share market may not be -- the market is well correlated to economic "surprises" (i.e., what surprises the assembled gurus en masse)  And the surprises have all been negative over the recent period.

Japan starts a genuine reflation

Finally.  The new govt in Japan is forcing the BoJ to target positive inflation.  The yen is (rightly) plumetting as a result.  And the wash of new money will force others to follow suit, or their currencies will rise against the yen.

The yen has made a MAJOR technical down break.

Spain bank audit paves way for bailout

The Age article here.

We're coming to the end of the GFC-related disasters (though note how the article points out that the current Spanish crisis has been made more severe by previous austerity; maybe the same will happen again).  No convincing signs yet that Europe has bottomed.  The usual suspects among the brokers have been wheeling out the champagne ("the worst is over") at a very modest rise in the European PMI.  I hae me doots.

Meanwhile the Spanish 10 year  bond yield has drifted up a tad (Chart from Bloomberg)  Personally, I would be extremely careful not to short Spanish or Italian bonds.  You'd be on a hiding to nothing -- if yields rise any more, a rescue will be announced and the ECB will then be empowered to buy unlimited quantities of bonds.  In other words:  if things improve by themselves, bond yields will fall, and if they don't, the ECB will open its purse, and bond yields will fall.

Jackson's Hole

Yep.  It really is called that.  Every year at about this time, the heads and support staff of the world's major Central Banks retreat here to discuss the problems facing the world economy and what they should do about it.  Ben Bernanke said a day or so ago that he was very concerned about the unemployment rate in the US and how slowly it's fallen this year.  And he said that the Fed would if it was necessary do something about it.  On the strength of this, share markets rallied, and the bulls swished around all excited.  Delicious animals.

The problems with o'erweening optimism are these:

• Major markets are at previous highs (see charts).  To rise through these highs will require either much better economic data and/or serious, credible stimulatory measures in the US and China and Europe. Comforting words from Ben are not enough. Not any more.
• The Chinese share market, though, isn't at previous highs.  It's slumped.  And that's because the Chinese leadership is embrangled in a leadership struggle, one that happens every five years, but which has had the bad taste to happen now when the Chinese economy is slowing sharply.  No one wants to make key decisions until they know who's going to be boss.  This is complicated by a shift in the Chinese growth model from export-led growth.  Lots of big decisions and no one to make them, probably until November.
• The US (20% of the world economy) is still facing a "fiscal cliff" in January, when the rolling back of previous tax cuts and mandatory expenditure cuts will slice 4 or 5% from GDP.  We've all seen the result of swingeing austerity in Europe.
• And, talking of Europe, even though a dim awareness that deep expenditure cuts and tax increases are counterproductive seems to be percolating through even to the Germans, so much needs to happen to generate a recovery -- an end to fiscal austerity; a common bank oversight model for the whole Euro zone; massive quantitative easing; and rate cuts.  They will happen in time, but while we await, markets could get very skittish.  Not so good, kitty malloona.  

I'm taking some money off the table and watching sectoral swings like a ... fund manager should.   Perhaps share markets will just go sideways for a while and then resume their uptrends.  And perhaps not.