"Soft" June - Noise Or Signal?
Paul Kasriel
From retail sales to industrial production, June was a "soft" month with regard to real economic activity. Was the softness just a fluke or the sign of something more significant? The behavior of the nominal and real M2 money supply is suggesting that the June weakness was not a fluke, at least for consumer spending.

Chart 1 shows the year-over-year percent change in monthly real retail sales - i.e., nominal retail sales deflated by the CPI for consumer goods. In this current expansion, real retail sales growth peaked in March of this year at 8.29%, and has been in a downtrend since, slowing precipitously to 2.62% in June.

Chart 1

Chart 2 shows what has been happening to the M2 money supply - both in nominal and real, or CPI-adjusted (CPI for consumer goods) terms. Both nominal and real M2 growth have been in a downtrend since March of 2003. In June, year-over-year real M2 growth was only 0.79% -- the weakest growth since April 1995. Nominal M2 growth has been weaker, in large part, because of the slowdown in mortgage activity (see Chart 3). With business credit demand weak, growth in banks' earning assets has been concentrated in mortgage-related loans and securities. Now that mortgage activity has fallen off, bank credit growth - the flip-side of money growth, has weakened too. In addition to the slowdown in nominal M2 growth, real M2 growth has been weakened further by the rise in consumer inflation.

Chart 2

Chart 3

So, what does real M2 growth have to do with real retail sales growth? Plenty, as can be seen in Chart 4. Year-over-year real M2 growth tends to lead year-over-year real retail sales growth by about two months. The correlation coefficient between the two series (with real M2 growth advanced two months) is 0.66 out of a possible 1.00. So, the continued slowing in year-over-year real M2 growth in the past two months does not bode well for year-over-year growth in real retail sales going forward. Chart 4

Chart 4

Now, with long-term interest rates falling of late, households might start withdrawing money from their home ATMs again (i.e., step up cash-out refinancings), which would boost nominal money supply growth and consumer spending. But keep an eye on the trend in real M2 growth. If it does not turn up soon, get ready for some downward revisions to real GDP growth forecasts.


July 26, 2004

Paul L. Kasriel, Director of Economic Research (plk1@ntrs.com)

The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.