Review and outlook of liquidity trends

Monetary trends continue to suggest a slowdown in global industrial momentum in H2 2021, with a rising probability that weakness will be sustained into H1 2022.

EM equities would normally underperform in such a scenario but the asset class has already lagged, probably reflecting restrictive Chinese monetary policy and covid developments. We prefer EM equities to cyclical sectors of developed markets and expect support from a Chinese policy reversal as economic data continue to disappoint.

Global six-month real narrow money growth – the “best” monetary leading indicator of the economy – peaked in July 2020 and extended its fall in May, dashing a previous hope here of a Q2 stabilisation / recovery. This measure typically leads turning points in the global manufacturing PMI new orders index by 6-7 months but a PMI peak was delayed on this occasion by a combination of US fiscal stimulus and economic reopening. A June fall in new orders, however, is expected to mark the start of a sustained decline, confirming May as a significant top – see chart 1.

Chart 1

The magnitude of the fall in global real narrow money growth and its current level suggest a move in the manufacturing new orders index at least back to its long-run average of 52.5 during H2 (May peak = 57.3, June = 55.8).

Cyclical sectors of developed equity markets lost momentum during Q2 but have outperformed year-to-date, suggesting that an economic slowdown has yet to be discounted. By contrast, EM equities – which have correlated with DM cyclical sectors historically – have underperformed; moreover, cyclical sectors within EM have lagged – chart 2. EM equities, therefore, appear already to have embraced a more sombre economic outlook and may accordingly be less at risk from a PMI slide.
 

Chart 2

EM underperformance partly reflects restrictive Chinese monetary policy. A strong recovery in activity through 2020 prompted the PBoC to withdraw stimulus in H2, resulting in a money / credit slowdown that has fed through to weaker H1 2021 economic data. The central bank, however, has been reluctant to change course, partly to avoid fuelling house and commodity price speculation, and six-month real narrow money growth has fallen to a worryingly low level – chart 3.

Chart 3

There are signs that policy has started to shift – three-month SHIBOR was allowed to drift lower during Q2 while survey evidence suggests a slight improvement in corporate access to credit – and the forecast here is that the PBoC will accelerate easing in Q3. The adjustment has come too late to prevent a further economic slowdown in H2 but could stabilise or boost expectations for H1 2022.

Covid developments may also have acted as a drag on EM equities in H1 – in particular, the perception that vaccine rollouts would permit much earlier economic normalisation in developed markets. A recent pick-up in new cases in the UK despite high vaccine deployment, coupled with an unexpectedly rapid slowdown following a devastating second wave in India, casts doubt on this judgement.

Chinese monetary / economic weakness has been reflected in relative stock market performance – MSCI China rose by 1.1% in US dollar terms in H1 versus a 9.9% gain for the rest of the EM index. We anticipate raising our current underweight 4 rating (on a 1-5 scale) if PBoC policy easing is confirmed by stronger monetary data in Q3.

Charts 4 and 5 show six-month real narrow money growth across a selection of EM economies. Growth remains relatively high in Korea and Taiwan but both markets have a cyclical bias so could be held back by a H2 global industrial slowdown. 

Chart 4

Chart 5

Brazil was the best-performing market in Q2 following an awful Q1 but is also pro-cyclical, while an aggressive tightening of monetary policy has resulted in a sharp weakening of narrow money trends – we are considering a downgrade.
 

Our previous quarterly commentary noted solid real narrow money growth in the CE3 / Greece and these markets also outperformed in Q2. The monetary signal has weakened in the CE3, partly reflecting a sharp pick-up in inflation and associated policy responses, but remains positive in Greece.

The Indian market held up in Q2 despite the covid tragedy. Real narrow money growth is in the middle of the EM range and the economy is usually less sensitive to global developments – we maintain an overweight 2 rating. Narrow money trends are relatively weak in Mexico and South Africa, which have benefited from US economic optimism and strong commodity prices respectively – both could be peaking. ASEAN markets are candidates for an upgrade – they are often counter-cyclical and could benefit if market expectations of Fed tightening are reined back. Real narrow money growth, however, is currently weak across these economies.