FT : Please continue to not mind the Chinese M1-M2 gap

Please continue to not mind the Chinese M1-M2 gap
China’s money supply growth narrows and widens… much as the seasons change and the tides turn.
But for those who seek insight in any of those things, here’s a tale in a few brief paragraphs of why differences between narrow and broader money supply growth in China still don’t tell us very much, from Bank of America Merrill Lynch analysts.
As they say, the M1-M2 growth gap — M1 is basically cash plus demand deposits, while M2 equals M1 plus a broader array of deposits such as time deposits — in China has widened and narrowed over the past but that hasn’t actually supplied any predictive power:

After much debate about the widening gap of M1-M2 growth in 1H2016, the story shifts to this gap narrowing again since last July.
  • 1H2016: When the M1-M2 gap widened since Mar 2015, many argued it indicated more funding was moving into short-term investment, likely to push up the domestic A-share equity market instantly. Some believed it was a sign of severe liquidity trap, and, as a result, monetary expansion would fail to reflate the economy.
  • 2H2016-2017: After the gap peaked in July 2016, a new theory emerged, claiming the narrowing gap was due to capital being channeled into the real economy, which would lead to an imminent investment boom.
Limited prediction power on growth or stock market
In our view, the M1-M2 growth gap has shown limited prediction power over future investment demand and equity market performance.
  • Despite the widening in M1-M2 growth gap in 1H16, there is no evidence of a liquidity trap or an A-share rally afterward. Government bond yields rose notably since August, and our BofAML China ACT index rebounded in March and improved slightly by July 2016. The SHCOMP index first corrected 28% to 2,688 in Feb 2016), and then came back by 11% to 2,979 in July 2016.
  • The narrowing M1-M2 growth gap since 2H2016 did not lead to an investment boom either. FAI growth only picked up to 8.9% yoy in January-February from 7.8% in 4Q and 7.0% in 3Q16, due to higher infrastructure investment.
Now, back in 2016 the assumption was that the widening gap between the two measures was down to the deleveraging mindset of private corporates. So, what’s behind the narrowing gap this time? From BofAML again:
  1. Slower home sales growth: Home purchases effectively shift money from households’ deposits (part of M2, but not M1), into home presale proceeds in developers’ demand deposit. As home sales growth slowed down from peak levels in spring 2016 due to tighter property policies and a higher comparison base, it becomes much less supportive for M1 growth.
  2. Potentially a small improvement in capex demand in some areas: Real borrowing costs for some up-to-mid stream corporates came down with a rapid rise in PPI inflation, while expected investment-returns may rebound on better growth expectation and supply-side reform. As such, capex demand may be encouraged in some areas even though an overall boom is absent. [The idea here being that when M1 growth starts to decline and M2 growth rises, it means some cash has found its way into some specific projects and is no longer housed in demand deposits account waiting for immediate financial transactions.]
  3. Tapered fiscal easing: In our view, the strong fiscal easing from 2015 to early 2016 mobilized funds from time to demand deposits at public organizations (POs), ready for spending. But as funds were allocated to projects while fiscal easing tapered, POs’ demand deposit growth has started to ease gradually.
All of which suggests that the gap could continue to narrow, even if, to repeat a repeated point, that doesn’t actually tell you very much about future investment demand or stock market performance:
It’s all more nuanced than that.