A post in late March argued that the global monetary backdrop remained consistent with a solid economic recovery but no longer supported further market gains. The escalation of the Eurozone sovereign debt crisis and the recent set-back in equities may be symptoms of deficient liquidity.

One reason for caution was a fall in G7 annual real M1 expansion below industrial output growth – equities have tended to underperform cash following such cross-overs. The US Federal Reserve, meanwhile, has engaged in "stealth" tightening since February, using Treasury bill sales to drain $174 billion from banks' reserve accounts. The Fed may partly reverse this withdrawal if markets continue to deteriorate.

The latest monetary statistics confirm the earlier assessment. The charts show six-month growth rates of G7 and E7 output and real M1. G7 real M1 expansion appears to be stabilising following a slowdown while E7 real M1 continues to boom. Combined growth looks consistent with an ongoing economic recovery.

Six-month G7 real M1 expansion, however, remains below industrial growth, suggesting insufficient liquidity to push markets higher. This relationship bears monitoring – output momentum is moderating and central bank responses to current turbulence could cause real M1 to reaccelerate. A positive cross-over of annual growth rates, however, is unlikely until late summer at the earliest.