“Amber warnings in EA?”

Leading, coincident and lagging indicators have peaked

The key chart

Watch this space – leading (real M1), coincident (real HH) and lagging (real NFC) indicators have all peaked, but remain well above the levels associated with recessions risks (% YoY, real terms).
Source: ECB; Haver; CMMP analysis

The key message

January’s monetary developments data for the euro area (EA) presented no surprises. Monetary aggregates are still growing well above the levels associated with heightened recession risks.

Broad money (M3) growth increased to 5.2% from 4.9% in December 2019. Narrow money (M1) remains the main component, contributing 5.3% to this growth (other ST deposits being the negative balancing item) and accounting for 69% of the outstanding stock of M3. There is now just under €9trillion residing in (cash and) overnight deposits despite negative real rates, indicating an enduring debt overhang in the region.

Private sector credit grew 3.8% YoY, a new high in nominal terms in the current credit cycle, but lags the growth in the supply of money, reflecting the on-going deficiency in credit demand.

However, an early warning sign is flashing within the context of my money, credit and business cycle framework. Growth rates in real M1 (a leading indicator), real HH credit (a coincident indicator) and real NFC credit (normally a lagging indicator) have all peaked at the aggregate level and in Germany and France, the two markets that have driven loan growth in the region. None of these indicators imply recession risks, but they do point to a slowdown in economic activity across the euro area. Watch this space…

The charts that matter

No headline surprises – broad money (M3) grew 5.2% in January versus 4.9% in December (% YoY, nominal terms)
Source: ECB; Haver; CMMP analysis
Growth trends and breakdown of M3 by component – overnight deposits (red bars) remain the key driver of money supply growth. M1 contributed 5.3% of the total 5.2% M3 growth, other ST deposits were the negative balancing item (% YoY, nominal terms)
Source: ECB; Haver; CMMP analysis
Confirmation of the enduring debt overhang – c Euro 9 trillion sitting in (cash and) overnight deposits despite negative real returns (Euro billions)
Source: ECB; Haver; CMMP analysis

M3 = credit to EA residents + net external assets – LT financial liabilities + other counterparts

From a counterparts perspective, and on a positive note, credit to other EA residents (the purple bars) has replaced credit to central government (the green bars, QE impact) as the main driver of M3 (%YoY, nominal terms)
Source: ECB; Haver; CMMP analysis
Early warnings #1 – real growth in M1 (leading indicator) has fallen from recent peak of 7.3% in November 2019 to 6.8% in January (% YoY, 3m MVA)
Source: ECB; Haver; CMMP analysis
Early warnings #2 – real growth in HH credit (co-incident indicator) has also fallen from recent peak of 2.6% in November 2019 to 2.3% in January (% YoY, 3m MVA)
Source: ECB; Haver; CMMP analysis
Early warnings #3 – real growth in NFC credit (typically a lagging indicator) peaked at 3.0% in October 2019 and has fallen to 2.0% in January (% YoY, 3m MVA)
Source: ECB; Haver; CMMP analysis
Germany is the second largest contributor to EA HH credit growth after France – growth hit a new peak of 4.5% in January in nominal terms, but has fallen from 3.4% in October 2019 to 2.9% in January in real terms (% YoY)
Source: ECB; Haver; CMMP analysis
Germany is the largest contributor to EA NFC credit growth. Nominal growth rates peaked at 7.0% in June 2019 and have fallen to 5.0% in January. Real growth rates peaked at 5.6% in August 2019 and have fallen to 3.3% in January (% YoY)
Source: ECB; Haver; CMMP analysis
France is the largest contributor to EA HH credit growth – in nominal terms, growth hit a new high of 6.5% in January, but peaked in real terms at 5.4% in October 2019 and has fallen to 4.7% in January
Source: ECB; Haver; CMMP analysis
France is the second largest contributor to EA NFC credit growth after Germany – nominal growth rates have fallen from 8.3% in August 2019 to 5.7% in January and real rates have fallen from 6.9% to 3.9% over the same period
Source: ECB; Haver; CMMP analysis

Please note that the summary comments above are extracts from more detailed analysis that is available separately

chris@cmmacroperspectives.com

“Are we there yet?”

Eight key charts and why they matter

The key chart

Time for a policy reboot – does it make sense to run tight fiscal policy (1) at this point in the cycle, and (2) when the private sector is running persistent financial surpluses? (4Q sums, % GDP)
Source: ECB; Haver; CMMP analysis

Introduction

In my previous post, “Policy reboot 2020?” I suggested that, “progress towards dealing with the debt overhang in Europe remains gradual and incomplete”. This prompted two follow-up questions:

  • How do I monitor this progress within the Macro Perspectives framework?
  • Why does it matter?

In this post, I present eight graphs that are key to monitoring this progress:

  1. Private sector debt ratios (PSDRs)
  2. Costs of borrowing
  3. Lending spreads versus policy rates
  4. Growth in broad money (M3)
  5. Growth in private sector credit
  6. Money supply vs demand for credit dynamic
  7. Inflation
  8. Private sector net financial balances

Summary and implications

The eight graphs confirm that the EA is still dealing with the legacy of a debt overhang. Private sector debt levels are still too high, money, credit and business cycles are significantly weaker than in past cycles and inflation remains well below target.

In spite of this, the collective fiscal policy of EA nations is (1) about as tight as any period in the past twenty years and (2) is so at a time when the private sector is running persistent net financial surpluses (largely above 3% GDP since the GFC).

An important lesson from Japan’s experience of a balance sheet recession is that the deflationary gap in economies facing debt overhangs is equal to the amount of private unborrowed savings. These savings (at a time of zero rates) are responsible for weakness in the economy, and it is because the economy is so weak that fiscal stimulus is necessary (Koo, R. 2019).

Ironically, the EA is positioned better to ease fiscal policy than the UK (where both the private and public sector are running simultaneous financial deficits) but we are more likely to see fiscal stimulus in the latter (March 2020) than in the former.

It’s time for a policy reboot in the EA for 2020 and beyond.

Eight key charts

Key chart 1: Private sector debt ratios

Too little, too late? Private sector deleveraging in the EA began later and has been more gradual than in the UK and the US (private sector debt as % GDP)
Source: BIS; Haver; CMMP analysis

The first chart illustrates twenty-year trends in private sector debt ratios (PSDR) – private sector debt as a percentage of GDP – for the UK, EA and US. The three vertical, dotted lines mark the point of peak PSDR for each economy. This is the standard starting point for analysing debt overhangs.

Private sector deleveraging began much later and has been more gradual in the EA than in both the US and the UK. The PSDR in the EA is now the highest among these three economies.

  • The US PSDR peaked first at 170% GDP in 3Q08, fell to a post-GFC low of 147% GDP in 3Q15 (co-incidentally the point when the EA PSDR peaked) and is currently 150% GDP
  • The UK PSDR peaked one quarter later (4Q08) at 194% GDP, fell to 160% GDP in 2Q15 and is currently 163%
  • The EA PSDR continued to rise after the GFC before peaking at 172% in 2Q15 and declining slightly to 166% currently

For reference, but not shown here, household (HH) and corporate (NFC) debt ratios (the two sub-sets behind these totals) differ across the three economies. In the EA, the NFC PSDR is 108% (above the BIS’ maximum threshold of 90%) but the HH PSDR is only 58%. In the UK and US these splits are 79%:84% (see “Poised to disappoint”) and 75%:75% respectively. In other words, the risks lie in different places in each economy.

Key chart 2: Cost of borrowing

The cost of borrowing for HH and NFCs has fallen sharply, reflecting relatively weak credit demand (composite costs %, nominal terms)
Source: ECB; Haver; CMMP analysis

The second chart illustrates the ECB’s composite measures for HH and NFC cost of borrowing (in nominal terms). The cost of borrowing typically falls in periods of debt overhang, reflecting weak demand for credit.

Weak credit demand is reflected in the cost of borrowing for EA HHs and NFCs falling sharply.

  • HH and NFC costs of borrowing both peaked in 3Q08 at 5.6% and 6.0% respectively
  • The HH cost of borrowing hit a new low in December 2019 of 1.41%
  • The NFC cost of borrowing hit a low of 1.52% in August 2019 and is currently 1.55%

For reference, costs of borrowing in real terms (shown here) remain low at 0.11% for HH and 0.25% for NFCs but above their October 2018 lows of -0.49% and -0.65% respectively.

Key chart 3: Spreads vs policy rates

Lending spreads at, or close to, post-GFC lows (composite cost minus MRR, ppt)
Source: ECB, Haver, CMMP analysis

The third chart illustrates the spread between composite borrowing rates and the ECB’s main refinancing rate (MRR). These spreads typically narrow during periods of debt overhang.

Spreads between borrowing costs and the ECB’s main policy rate are at, or slightly above, post-GFC lows.

  • HH spreads have declined from 2.97% in May 2009 to a new post-GFC low of 1.41%
  • NFC spreads have declined from 2.76% in May 2014 to 1.55% currently, slightly above their post-GFC low of 1.55%

Key chart 4: Growth in broad money (M3)

Growth in M3 has been steady since 2014 easing, but subdued in relation to past trends (% YoY)
Source: ECB; Haver; CMMP analysis

The fourth chart illustrates the twenty-year trend in the growth of broad money (M3). Broad money reflects the interaction between the banking sector and the money-holding/real sector.

Growth rates in broad money have been stable since ECB easing in 2014 but subdued in comparison with previous cycles.

  • In December 2019, M3 grew by 5.0% YoY
  • Narrow money (M1) contributed growth of 5.3% which was offset by negative growth in short term marketable securities

For reference, the share of M1 within M3 has risen from 42% in December 2008 to a new high of 68%, despite the fact that HH overnight deposit rates are -1.25% in real terms.

Key chart 5: Private sector loan growth

Private sector credit growing at the fastest rate in the current cycle, but growth is subdued in relation to past cycles (% YoY)
Source: ECB; Haver; CMMP analysis

The fifth chart illustrates YoY growth in private sector credit, the main counterpart to M3.

Private sector credit is growing at the fastest rate in the current cycle but also remains subdued in relation to past cycles and highly concentrated geographically (Germany and France).

  • Private sector credit grew 3.7% YoY in December 2019 (3m MVA) above the average growth rate of 3.5%
  • Germany and France together contributed 2.8% of the 3.7% growth in HH credit and 2.6% of the 3.2% growth in NFC credit in 2019

Key chart 6: Money supply vs credit demand

The gap between the supply of money and the demand for credit has started to widen again, indicating an on-going deficiency in credit demand
Source: ECB; Haver; CMMP analysis

The sixth chart – one of my favourite charts – illustrates the gap between the supply of money (M3) and the demand for credit by the private sector. In typical cycles, monetary aggregates and their counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.

The gap between the growth in the supply of money and the demand for credit indicates on-going deficiency in credit demand in the EA.

  • Since 4Q11, broad money and private sector credit trends have diverged with gaps peaking in 3Q12 and 1Q15
  • The gap narrowed up to September 2018 but has widened out again recently

Key chart 7: Inflation

Inflation persistently below the ECB 2% target during 2019 (% YoY)
Source: ECB; Haver; CMMP analysis

The seventh chart ilustrates the twenty-year trend in inflation (HICP) plotted against the ECB’s current inflation target. Again, inflation rates tend to much lower in periods of debt overhang.

Inflation remained below the ECB’s target throughout 2019 and finished the year at 1.3%

  • Inflation ended 2019 at 1.3%, below the ECB’s target of 2%

Key chart 8: Private sector financial balance

The private sector is running a net financial surplus in spite of negative/low rates (4Q sums, % GDP)
Source: ECB; Haver; CMMP analysis

The eighth, and final chart, illustrates trends in the private sector’s net financial surplus. In this analysis, 4Q sums are compared with GDP.

Finally, the private sector (in aggregate) is running a financial surplus in spite of negative/very low policy rates – a very strong indication that the economy is still suffering from a debt overhang

  • In aggregate, the EA private sector is running a net financial surplus equivalent to 3.1% of GDP (3Q19) at a time when deposit rates are negative (average -0.9% during 3Q19)

Why does this matter?

…Fiscal rules should be designed to favor counter-cyclical fiscal policies. Nevertheless, despite various amendments to strengthen the counter-cyclical features of the [EA] rules, the outcomes have been mainly pro-cyclical.

IMF, Fiscal rules in the euro area and lessons from other monetary unions, 2019

The EA is still dealing with the legacy of a debt overhang. Private sector debt levels are still too high, money, credit and business cycles are significantly weaker than in past cycles and inflation remains well below target.

Does this make sense #1? Collective fiscal policy is about as tight as at any point in past twenty years (Government net financial deficit, 4Q sum, % GDP)
Source: ECB; Haver; CMMP analysis

In spite of all of this, the nations of the EA are collectively running a fiscal policy that is about as tight as at any period in the past twenty years. They are also doing this at a time when the private sector is running persistent net financial surpluses. Clearly, these developments fail a basic “common sense test”.

Does this make sense #2. The key chart again – what is the logic of running a tight policy when the private sector is running persistent surpluses (largely above 3% GDP)
Source: ECB; Haver; CMMP analysis

Its worth noting that fiscal policy rules in the EA, including the Stability and Growth Pact, were created without reference to the private saving and for an economic environment that no longer exists (eg, positive rates, high inflation, government mismanagement etc.).

Are current rules still fit for purpose – government deficit/surplus as % GDP (y axis) plotted against government debt as % GDP (x axis)? Red lines indicate current SGP rules, green line indicates a balanced budget. These rules were designed for a different type of recession and constrain appropriate policy responses today
Source: ECB; Haver; CMMP analysis

Leaving aside, the weak track record of adherence to these rules by member states, the obvious question is whether these rules remain relevant and whether the current policy mix is appropriate?

An important lesson from the experience of Japan’s balance sheet recession is that the deflationary gap in economies facing debt overhangs is equal to the amount of private unborrowed savings. Balance sheet recession theorists, such as Richard Koo, argue that these, “unborrowed savings (at a time of zero interest rates) are responsible for the weakness in the economy, and it is because the economy is so weak that fiscal stimulus is necessary”.

Relating the same argument to inflation targets, when inflation and inflation expectations are below target and rates are zero or negative, fiscal policy should lead with an expansionary stance and monetary policy should cooperate by focusing on guaranteeing low interest rates for as long as needed.

The UK is not as well positioned as the EA to relax fiscal policy – the UK private and public sectors are running simultanous deficits – but we are more likely to see UK fiscal easing first, in the March 2020 budget (4Q sums, % GDP)
Source: ONS; Haver; CMMP analysis

Ironically, the EU is positioned better to relax fiscal policy than the UK (where both the private and public sector are running simultaneous deficits) but we are more likely to see fiscal easing in the latter (March 20202 budget) before the former.

In short, it is time for a policy reboot in the EA for 2020 and beyond.

Please note that the summary comments above are extracts from more detailed analysis that is available separately.

“Policy reboot 2020?”

The EA remains trapped by PS debt levels and outdated policy rules

The key chart

Slowing GDP growth confirms the need for a major policy reboot (% YoY)
Source: ECB; Haver; CMMP analysis

Summary

Today’s 4Q19 GDP data confirms that the euro area (EA) is growing at its slowest rate since the ECB introduced expansionary measures in June 2014 (0.1% QoQ, 0.9% YoY).

The region remains trapped by its debt overhang and out-dated policy rules – a major policy reboot is long overdue.

The root causes are captured clearly by my Macro Perspectives analysis that incorporates (1) global debt dynamics, (2) money, credit and business cycles, and (3) financial sector balances in a consistent analytical framework.

Progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The EA continues to display the characteristics of a “private sector balance sheet-driven” slowdown rather than a “structural slowdown”. In this context, it is unsurprising that unorthodox monetary policy measures (1) have been only partially successful, at best, and (2) have unintended, negative consequences for growth, leverage, financial stability and income inequality.

Financial sector balances send clear message about the causes of the slowdown (4Q sum, % GDP)
Source: ECB; Haver; CMMP analysis

Last month, I introduced my balance sheet framework and applied it to the UK economy. There are two key messages from this framework that are applicable to the current EA situation:

  • When the private sector is running a financial surplus in spite of negative/very low policy and deposit rates (see graph above), this is a strong indication that the economy is still suffering from a debt overhang
  • Fiscal space, like debt sustainability, is at its core a flow concept, not a stock concept (see graph below)

Following from this (and deliberately simplifying a complex policy debate), when growth, inflation and inflation expectations are below target and when interest rates are already zero or negative, fiscal policy should lead with an expansionary stance and monetary policy should cooperate by guaranteeing low interest rates for as long as needed. In short, this is a very different economic context to the one that existed when the current fiscal policy rules were chosen.

Germany’s private and public sectors are running simultaneous net financial surpluses in the face of slowing economic growth – does this make sense for Germany and/or the EA?
Source: ECB; Haver; CMMP analysis

Unfortunately, despite strong and repeated calls for fiscal stimulus by the ECB, fiscal policy is only expected to be moderately supportive in 2020. Rules, designed to address different challenges at different times, are preventing stimulus in counties where policy makers would like to spend more (Italy, Spain) and national policy choices are limiting policy expansion in countries that have room for further stimulus (German, Netherlands). This is compounded by the lack of a central fiscal capacity at the euro area level that could strengthen the ability to deploy fiscal policy, complementing monetary policy, in case of significant euro area-wide downside dynamics (see https://www.imf.org/en/News/Articles/2020/01/28/sp012820-vitor-gaspar-fiscal-rules-in-europe ).

Are current fiscal rules still fit for purpose – government deficit/surplus as % GDP (y axis) plotted against government debt as % GDP (x axis)? These rules were designed for a different typ of recession and constrain required policy responses today. (Red lines indicate current rules)
Source: ECB; Haver, CMMP analysis

Conclusion

Marco Perspectives frameworks illustrate why a major policy review that begins with differentiating between different types of recessions is required if the EA is to escape from the current debt and policy trap. The ECB has announced a review of monetary policy in the EA, but the need for a wider fiscal policy review/reboot appears more urgent, in my view.

I presented the investment implications of this analysis at “The 5th Global Independent Research Conference” in London earlier this month. Please contact me to dicusss these implications and for access to the detailed analysis behind the summary comments above.

chris@cmmacroperspectives.com

“Tacking into the wind”

EA banks battle against the headwinds

The key chart

The cost of borrowing for EA households (HH) and corporates (NFC) ended 2019 at, or close to, historic lows (%, nominal terms)
Source: ECB; Haver; CMMP analysis

Gusting force 9-10

The latest ECB bank interest rate statistics for the euro area (EA) show rates on household (HH) and corporate (NFC) lending at, or close to, new lows at the end of 2019.

In the HH sector, rates fell the most in 2019 (absolute bp terms) in Germany, Italy and the Netherlands, although France and Portugal also saw noticeable declines despite starting the year with rates well below the EA average. In the NFC sector, rates fell the most in Portugal, Spain, France and Italy but rose in Ireland, the Netherlands and Austria. Spreads (versus 3m Euribor) also hit new lows in the HH sector and were close to lows in the NFC sector.

Negative rate and spread developments are offsetting subdued loan growth and present an on-going challenge in terms of delivering sustainable top-line revenue growth. As noted in “Power to the borrowers“, QE has shifted the balance of power firmly from lenders to borrowers.

With the exception of the Spanish, Portuguese and Irish HH sectors, rates on new loans are also below rates on the outstanding stock of loans, indicating that downward pressures will continue.

Strong margin/spread headwinds remain for EA banks, compounding negative trends in the basic macro building blocks that are required to support sustained improvements in profitability and share price performance.

For more details, please contact me at chris@cmmacroperspectives.com.

The charts that matter

In real terms, the cost of borrowing remains low but above the 2018 lows of negative real borrowing costs. The ECB has been successful in achieving its goal to “ensure that HHs and NFCs should be able to borrow more and spend less to repay their debts” (%, real terms)
Source: ECB; Haver; CMMP analysis
In the HH sector, rates fell the most in Germany, Italy and the Netherlands during 2019 (YoY change in basis points).
Source: ECB; Haver; CMMP analysis
France and Portugal also saw noticeable declines in HH lending rates despite starting 2019 with rates well below the EA average
Source: ECB; Haver, CMMP analysis
In the NFC sector, rates fell the most in Portugal, Spain, France and Italy but rose in Austria (slightly), the Netherlands and Ireland (YoY change in basis points)
Source: ECB; Haver; CMMP analysis
Average HH spreads on new loans hit a new post-GFC low (versus 3m Euribor)
Source: ECB; Haver; CMMP analysis
Shifting the balance of power to HHs – lending rates have fallen further than 3m Euribor and the MRR since May 2014 in all economies except Ireland. The biggest falls have been in Portugal, France, Italy and Belgium (change in bp since May 2014)
Source: ECB; Haver; CMMP analysis
Shifting the power to NFCs – most pronounced shifts in NFC lending rates seen in Portugal, Spain, Italy, France and Germany (change in bp since May 2014).
Source: ECB; Haver; CMMP analysis
Exceptions to the rule – rates on new Spanish HH loans are above the rates on the outstanding stock. Along with the Irish and Portuguese HH sectors, this is an outlier – elsewhere in the EA, rates on new loans are below the rates on the outstanding stock (%, nominal terms)
Source: ECB; Haver; CMMP analysis
Where are we now? Lending rates in Germany and France, the two economies driving growth in PSC in the EA, remain well below average (%, nominal terms)
Source: ECB; Haver; CMMP analysis

Please note that the summary comments above are extracts from more detailed analysis that is available separately.