Money growth peaked, but the message remains unchanged
The key chart
What are the messages from the money sector as money growth peaks? (Source: ECB; CMMP)
The key message
At the end of 1Q21, the cyclical and structural messages from the EA money sector remain unchanged. In terms of ST tactical trends and the outlook for 2021, we are looking for evidence of: (1) a moderation in HH deposit flows; (2) a resynchronisation of money and credit cycles; and (3) recovery in consumer credit. In terms of LT secular trends, we focus on the split between more productive COCO-based and less productive FIRE-based lending and the hidden risks of QE.
HH deposit flows remain almost double the levels seen pre-COVID and the enduring preference for holding highly liquid assets (despite their negative real returns) indicates persistently high levels of HH uncertainty. The gap between the money and credit cycles (evidenced in banks’ 1Q21 earnings) has stopped widening but remains very significant. Finally, consumer credit is still falling (and HHs repaid credit again in March) but at a slower rate than earlier in the quarter. In short, investors positioned for a sustained upturn in EA inflation will need to be patient still.
Resilient mortgage demand has been a key feature in an otherwise lacklustre retail banking sector (as in the UK). The 5.0% YoY increase in EA mortgages in March was the fastest rate of growth since May 2008. Mortgages are the largest segment of FIRE-based lending, which reached a new high of €5,891bn at the end of March, up 28% from its January 2009 level, and represented almost 52% of total lending. More productive COCO-based lending totalled €5,478bn, lower than its January 2009 peak of €5,517bn. COCO-based lending’s share of total lending has fallen from 55% to 48% of total lending over this period. The ECB is correct to highlight the positive impact of unorthodox monetary policy in terms of keeping borrowing affordable and supporting access to credit for NFCs and HHs. That said, the hidden risks of QE in “fuelling the fire” and their negative implications for leverage, growth, financial stability and income inequality in the EA should not be overlooked.
Money growth may have peaked, but the core messages from the money sector remain unchanged.
The core messages in six key charts
Key signals for 2021
Persistent HH uncertainty reflected in monthy deposit flows (Source: ECB; CMMP)The gap between the money and credit cycles has narrowed slightly, but remains significant (Source: ECB; CMMP)HHs are repaying consumer credit but YoY declines are slowing (Source: ECB; CMMP)
FIRE-based lending and the hidden risks of QE
FIRE-based lending hits a new high at the end of 1Q21 (Source: ECB; CMMP)COCO-based lending is still lower than its 2009 peak (Source: ECB; CMMP)By fuelling the fire, QE brings hidden risks that investors should not forget (Source: ECB; CMMP)
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What do 1Q21 results say about 2021’s investment themes?
The key chart
YoY changes (%) in customer lending and customer accounts by region (Source: HSBC; CMMP)
The key message
As a shareholder, I was relieved to see the 4% bounce in HSBC’s share price today, but as a global investor I was far more interested in what this morning’s 1Q21 results said about wider investment themes.
The results clearly illustrate the desynchronization of global money and credit cycles with customer accounts growing 15% YoY while customer lending was flat. The same trend was seen across all regions on an annual basis and across HSBC’s wealth and personal banking (WPB) and commercial banking (CMB) divisions. Asia bucked the trend over the most recent quarter, however, as customer lending rose 2% QoQ while customer accounts fell marginally, but lending fell QoQ in Europe and the UK.
1Q21 change ($bn) in customer lending and customer accounts by region (Source: HSBC; CMMP)
Credit investors may welcome HSBC’s strong capital position (CET1 15.9%) and abundant liquidity (LDR 63%) but other investors should note the broader message with respect to the so-called “reflation trade”.
1Q20 and 1Q21 loan-deposit ratios by region (Source: HSBC; CMMP)
The top-down and bottom-up messages from the money sector remain the same: (1) money and credit cycles remain out of synch with each other, and (2) money sitting idly in deposit accounts contributes to neither GDP nor inflation.
Investment narratives are like endurance athletes…
The week ahead…
Like endurance athletes, investment narratives require consistent refuelling to maintain performance.
This week represents an important, potential refuelling period for three popular 2021 trades: long reflation, value and financials/banks.
Losing momentum, part 1 – 10Y bond yields (Source: Koyfin; CMMP)
Despite delivering positive performance YTD, each of these trades have lost momentum over the past month. US and UK 10Y bond yields are 12bp and 8bp lower over the past month, while German 10Y yields are essentially unchanged.
Losing momentum, part II – US value versus growth and momentum (Source: Koyfin; CMMP)
In the US, value has underperformed growth and momentum by 3% and 4% over the past month and US and EA financials have underperformed by 1% and 4% respectively. Given the downbeat messages from the money sector so far YTD, this loss of momentum comes as little surprise.
Losing momentum, part III – relative performance of US and EA banks (Source: Koyfin; FT; CMMP)
Looking forward, the ECB and the Bank of England publish monetary statistics for March 2021 on Thursday (29 April) to complete the top-down picture for 1Q21.
It is too early, in my view, to expect much “refuelling” in terms of the three key signals for 2021: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit.
Instead, look to see whether each signal has stopped getting worse! Attention may focus more, therefore, on the bottom-up perspectives and outlooks provided by leading European FIs as they report their latest results – HSBC and UBS (Tuesday), Deutsche Bank (Wednesday), Barclays and BNP Paribas (Friday) and Soc Gen next week. Watch this space…
Total debt levels and cumulative market share as at the end of 3Q20 (Source: BIS; CMMP)
The key message – seven perspectives
First, the US has the highest outstanding stock of debt in the world but deeper analysis is required to determine whether it has a “debt problem”
Second, in terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies across the government, household (HH) and corporate (NFC) sectors
Third, the US is also one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds
Fourth, the current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH to government debt
Fifth, this changing structure reduces associated risks since the government faces different financial constraints to the HH and NFC sectors and cannot, as a currency issuer, become insolvent
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms
Seventh, risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US.
In short, risks associated with US debt are concentrated rather than systemic. Moreelevated risks exist in other developed and emerging economies where some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are rising despite the low interest rate environment. Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie elsewhere.
Does the US have a debt problem?
Outstanding US debt and market share by sector (Source: BIS; CMMP)
The US has the highest outstanding stock of total, government, HH and NFC debt in the world but deeper analysis is required to determine whether it has a “debt problem”.
The US has outstanding total, government, NFC, and HH debt of $61tr, $27tr, $18tr and $16tr respectively (as at end 3Q20). The US accounts for 29% of global debt alone and almost 50% together with China (see key chart above) and has market shares of 34%, 22% and 32% of global government, NFC and HH debt respectively (see chart above).
To understand the implications here and consider whether the US has a debt problem, CMMP analysis considers the stock of debt in the context of the level of GDP (debt ratios), its structure, its rate of growth and affordability.
Ranking of BIS reporting economies by total debt/GDP (Source: BIS; CMMP)
In terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies in all sub-sectors. It is ranked only #18 in terms of total debt ratio for example (see chart above), and #22 and #12 in terms of NFC and HH debt ratios. In the case of government debt (129% GDP), the US is ranked higher, however, at #10 after Japan (235%), Greece (212%), Italy (172%), Portugal (146%), Belgium (137%), France (134%), UK (133%) and Spain (132%).
NFC and HH debt ratios plotted against BIS maximum threshold levels (Source: BIS; CMMP)
The US is one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds. The BIS considers HH and NFC debt ratios of 85% and 90% GDP to be threshold levels above which debt becomes a constraint on future growth. The BIS provides debt ratios for 22 developed and 21 emerging economies. As can be seen in the scatter diagram above, the US sits in the lower LH quadrant with a HH debt ratio of 78% and a NFC debt ratio of 84%. Germany, Greece and Italy are the only other developed economies to sit within the same quadrant.
Breakdown of outstanding US debt by sector (Source: BIS; CMMP)
The current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH debt to government debt. The share of HH debt peaked at 44% total debt in 2Q07 and fell to 27% by end 3Q20. In contrast, the share of government has risen from 26% to 44% over the same period.
As the Federal Reserve Bank of St Louis noted back in 2018, “The fall in household debt was primarily driven by the fall in mortgage debt that followed the housing crash. The surge in public debt, on the other hand, was partly driven by the large fiscal stimulus packages that were deployed to fight the Great Recession.”
The changing structure of US debt reduces associated risks since the government faces different financial constraints and cannot, as a currency issuer, become insolvent. HHs, NFCs and financial institutions are all “currency users” who face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020). In contrast, the US government, as a currency issuer, cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
In the seventh lesson from the money sector, I highlighted an article published by David Andolfatto of the Federal Reserve Bank of St Louis (4 December 2020). In line with my preferred financial sector balances approach, Andolfatto questions the “government as a household” analogy and notes that, “to the extent that government debt is held domestically, it constitutes wealth for the private sector.” From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Trend in HH debt/GDP ratio over past 20 years (Source: BIS; CMMP)
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms. High levels of household indebtedness were an important contributing factor to the GFC and subsequent recession. The HH debt ratio rose to a peak of 99% GDP in 1Q08 well above the 85% BIS threshold level. This ratio is 78% GDP today. Not only was the level of HH debt a matter of concern, but the pace of growth was sending clear warning signals too.
Rolling 3-year RGF for US HH sector over past 20 years (Source: BIS; CMMP)
CMMP analysis uses a relative growth factor to analyse the rate of growth in debt. This compares the 3-year CAGR of debt with the 3-year CAGR in nominal GDP. As can be seen in the chart above, the RGF for the US HH sector peaked at 7% in 1Q04, fell and then remained negative for 41 consecutive quarters from 2Q10 until the last reporting quarter (3Q20).
HH RGFs plotted against HH debt ratios for advanced BIS economies (Source: BIS; CMMP)
In the context of other developed economies, the risks of excess HH credit growth are much lower in the US than in Norway, Sweden, Canada, Switzerland, New Zealand and the UK. Each of these economies are experiencing excess HH credit growth (ie, RGF > 1) despite relatively high debt ratios that exceed the BIS threshold level of 85% GDP.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
In terms of affordability risk, the debt service ratio for the US HH sectors is low in absolute terms (7.6%) and in relative terms against its own 10Y average of 8.3% and against other developed economies.
Trend in NFC debt ratio over past 20 years (Source: BIS; CMMP)
Risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US. The NFC sector experienced 33 consecutive quarters of a rising debt ratio since 1Q12 and at 84% GDP is very marginally below the recent peak in 2Q20. Note however, that while the current NFC debt ratio is high in the context of the US, it remains below the 90% BIS threshold.
Rolling 3-year RGF for US NFC sector over past 20 years (Source: BIS; CMMP)
Of more concern is the current 4ppt rate of excess NFC credit growth. As can be seen, the current RGF is close to previous peaks. This is despite fact that the absolute level of NFC debt is higher than at previous peaks in excess growth. The current RGF places the US among a group of seven developed economies experiencing excess NFC credit growth of more than 4ppt. Within this sample, Sweden, France, Canada, Switzerland and Japan are experiencing higher rates of excess growth despite having higher levels of NFC debt that exceed the BIS maximum threshold level of 90%.
NFC RGFs plotted against NFC debt ratios for advanced BIS economies (Source: BIS; CMMP)
Finally, the highest level of concern relates to the affordability of NFC debt. The current NFC debt service ratio of 47% is only marginally below its all-time high and is 8ppt above its 10-year average of 39%. Among developed economies, this places the US NFC sector among the higher risk sectors, albeit it below the NFC sectors in France, Canada and Sweden.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
Conclusion
The risks associated with US debt are more concentrated than systemic and relate mainly to the rate of excess NFC credit growth and its affordability.(Further incentive for the Federal Reserve to keep rates lower for longer?) From a global perspective, debt risks are more elevated in other developed and emerging economies. Some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are increasing within and outside this sub-set despite the low interest rate environment.
Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie eslewhere.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available seperately.
