I posted a comment on LinkedIn last week about a so-called “basket-case” currency that is currently trading above its five-year average levels despite a host of negative economic, political and market-related factors.
The currency in question was the pound sterling and the graph illustrated the narrow version of the sterling exchange rate index (ERI) as calculated and published daily by the Bank of England (see key chart above).
The “tongue-in-cheek” post reflected an increasing frustration with excessive USD dollar-centricity in current financial and economic reporting.
USD – Sterling exchange rate (Source: BoE; CMMP)
Trends in bilateral exchange rates such as USD to sterling are important, of course, The US is the UK’s largest individual trading partner after all, and sterling is currently trading 7% below its five-year average versus the USD (see chart above). This is noteworthy in itself.
Sterling ERI weights (Source: BoE; CMMP)
That said, the UK economy is affected by (and reflected in) movements in sterling against many different currencies. As a bloc, the EU is the UK’s largest trading partner, for example. The region accounts for roughly double the US’s share of UK trade (see chart above). Sterling is currently trading 2% ABOVE is five-year average versus the EURO (see chart below), which helps to explain the trend in sterling’s ERI illustrated above (see key chart).
EURO – Sterling exchange rate (Source: BoE; CMMP)
This is not to deny that sterling is trending weaker, increasing the risk of imported inflation in the process. The sterling ERI has fallen 4% YTD. But, for a UK-audience at least, it is helpful to explore the extent to which reported trends in the bilateral exchange rate with the US are a reflection of USD strength as opposed to sterling weakness.
Perhaps the more important question, is why is sterling actually not trading much weaker than it is now?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is availability separately.
Look beyond the headlines with this week’s UK macro data
The key chart
UK HH savings ratio (%, SA) (Source: ONS; CMMP)
The key message
Surprise and sensational headlines may follow the release of two UK data points this week – the 1Q22 household savings ratio (ONS, Thursday) and consumer credit growth for May 2022 (BoE, Friday). Neither would be justified.
Official UK forecasts already assume (1) that real household disposable income will fall in 2022 and 2023, and (2) that the savings ratio will fall to a record low at the start of 2023, in response. In practice, this means that some UK HHs will run down the c£166bn of excess savings built up during the pandemics while others take on more debt.
We know from the “messages from the UK money sector” that HH monthly money flows (savings) are already trending back towards pre-pandemic levels and that monthly consumer credit flows have recovered to exceed pre-pandemic levels over the past three months. Nothing surprising nor sensational so far. Indeed both trends reflect an important return to normality after the pandemic.
That said, current trends are not all “good news.” There are negative implications here for both financial equality and economic sustainability.
Excess savings have typically accrued to HHs that already have sizable savings, have higher incomes, and are much older. These HHs typically spend less from any extra savings they accumulate. In contrast, lower-income HHs, with higher marginal propensities to consume, are more likely to borrow more to support consumption. The result? Greater financial inequality in the UK.
The OBR’s forecasts also assume that the UK HH sector ultimately moves from its traditional role as a net lender to the rest of the economy to being a sustained net borrower. Such a transition would involve remarkable role reversals from the pandemic period when the government took exceptional measures to protect HH incomes from the full effect of the crisis. More concerning here is the fact that the implied shift to replace public borrowing with more private borrowing reflects the flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing government debt as a problem rather than as a solution.
Unfortunately, this is neither new nor surprising news either.
“Don’t be surprised”
Surprise and sensational headlines may follow the release of two UK data points this week – the household savings ratio (ONS, Thursday) and consumer credit growth (BoE, Friday). Neither would be justified.
Latest (March 2022) OBR forecasts for real HH disposable income (% YoY) (Source: OBR; CMMP)
Recall that in March 2022, the OBR’s “Economic and fiscal outlook” forecast that real household (HH) disposable income will fall by 1.5% this calendar year and by 0.2% in 2023, before recovering steadily to average 1.7% from 2024 onwards (see chart above).
OBR forecasts for UK savings ratio (Source: OBR; CMMP)
In the face of weaker real income growth, the OBR already expects HHs to save less than previously forecast and for the savings ratio to reach a record low of 2.8% by the start of 2023. In practice, “the lower saving ratio will reflect some HHs running down excess savings while others take on more debt” (Economic and Fiscal Outlook, March 2022).
CMMP estimates for build up of excess savings (£m) (Source: BoE; CMMP)
Since the start of the COVID-19 pandemic, UK HHs have accumulated excess savings of c£166bn in the form of bank deposits (see chart above). We know from the “messages from the money sector”, however, that monthly HH money flows have moderated back towards pre-pandemic levels during 2022. In April 2022, these flows totalled £5.7bn, 1.2x the average pre-pandemic flows. At their peak in May 2020, these monthly flows had reached £26bn, 5.5x pre-pandemic levels (see chart below).
Monthly HH money flows as a multiple of pre-pandemic flows (Source: BoE; CMMP)
We also know that consumer credit borrowings over the past three months have been higher than the average pre-pandemic monthly borrowings. In February, March and April 2022, HHs borrowed £2.0bn, £1.3bn and £1.4bn respectively. These flows compare with the pre-pandemic average of £1.0bn. The annual growth rate of consumer credit also increased to 5.7% YoY in April 2022 from 5.2% in March 2022, the highest YoY growth rate since February 2020 (see chart below).
Monthly flows (£bn) and YoY growth rates in consumer credit (Source: BoE; CMMP)
Nothing surprising nor sensational so far. Indeed both trends reflect an important return to normality after the pandemic. That said, these current trends are not all “good news.” There are negative implications here for both financial inequality and economic sustainability.
Excess savings have typically accrued to HHs that already have sizable savings, have higher incomes, and are much older. These HHs typically spend less from any extra savings they accumulate. In contrast, lower-income HHs, with higher marginal propensities to consume, are more likely to borrow more to support consumption. The result? Greater financial inequality in the UK.
Trends and forecasts for HH net lending/borrowing as % GDP (Source: OBR; CMMP)
The OBR’s forecasts also assume that the UK HH sector ultimately moves from its traditional role as a net lender to the rest of the economy to being a sustained net borrower (see chart above).
Such a transition would involve remarkable role reversals from the pandemic period when the government took exceptional measures to protect HH incomes from the full effect of the crisis. More concerning here is the fact that the implied shift to replace public borrowing with more private borrowing reflects the flaw in conventional macro thinking that typically ignores the risks associated with private debt while seeing government debt as a problem rather than as a solution.
Unfortunately, this is neither new nor surprising news either.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Aggregate monthly card payments versus pre-pandemic levels (Source: ONS; CMMP)
Two-thirds of the way through 2Q22, and the message from the UK money sector is still one of resilient consumer spending. But what are households (HHs) spending their money on and why does it matter?
According to the latest ONS data (9 June 2022), monthly spending on credit and debit cards was 104% of its pre-pandemic, February 2020 level. This is 18ppt higher than in January 2022 and 6ppt higher than in May 2021 (see chart above).
All spending categories rose in the week to 1 June according to the shorter-term, daily CHAPS-based indicator. While the overall message from the shorter-data remains the same, it is important to note that spending is concentrated on getting to work and on staples ie, spending more on basic items (see chart below).
Card payments (seven-day rolling average) to 1 June 2020 by type (Source: ONS; CMMP)
In contrast, while spending on delayable goods such as clothing and furniture is recovering, it remains 8ppt below pre-pandemic levels.
This matters, because spending on delayables is a key indicator of whether the excess savings built up during the pandemic are returning to the economy in a sustained manner.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Time for new solutions to Italy’s structural problems
The key chart
Trends in private and public sector net lending/borrowing over the past decade (Source: ECB; CMMP)
The key message
With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing again on the net borrowing of the Italian government and the government debt ratio (172% GDP).
This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.
A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has household (HH) and corporate (NFC) debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth.
Not only does Italy not have a private sector debt problem, some of the economy’s key challenges stem from a lack of private sector borrowing and investment, not from too much. Consider:
The Italian private sector has been a consistent (and growing) net lender over the past decade. Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting. The outstanding stock of NFC debt at end 3Q21 was below the level recorded in 3Q09, for example.
The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.
“Austerity” and future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses. The structural challenges of excess savings and insufficient private sector investment remain.
The fact that un-borrowed savings in countries experiencing private sector deleveraging are able to leak into other bond markets, restricting governments from funding stimulus measures, reflects a structural flaw in the Eurozone. In 2012, Richard Koo, the Japanese economist and global expert on balance sheet recessions, proposed applying different risk weights to domestic and foreign government bonds as a partial solution.
Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…
Attenzione!
Top 10 government debt ratios, ranked by size (Source: BIS; CMMP)
With the yield on Italian 10Y government bonds rising to 3.37% (+251bp YTD), attention is focusing once again on the net borrowing of the Italian government and the government debt ratio (which is the third highest in the world at 172% GDP). This is entirely consistent with conventional macroeconomic thinking that continues to ignore private debt while seeing public debt as a problem. It is also mistaken.
HH and NFC debt ratios for BIS advanced economies (Source: BIS; CMMP)
A key theme of CMMP analysis is that, “private debt causes crisis – public debt (to some extent) ends them” (Professor Steve Keen, June 2021). Italy, of course, stands out as being one of only four developed market economies that has HH and NFC debt ratios well below the maximum threshold levels above which the BIS believes that debt becomes a constraint on future growth (see chart above).
According to the latest BIS statistics, Italy’s HH and NFC debt ratios are only 44% GDP and 73% GDP respectively. This compares with average debt ratios in the euro area of 61% GDP and 111% GDP (EA in the chart above) and BIS threshold levels of 85% GDP and 90% GDP respectively (red lines in chart above).
Not only does Italy not have a private sector debt problem, some of the economy’s key problems stem from a lack of private sector borrowing and investment, not from too much.
Net lending of Italy’s private sector over the past decade (Source: ECB; CMMP)
The Italian private sector been a consistent (and growing) net lender over the past decade (see chart above). Instead of borrowing money to invest, HHs and NFCs have been saving/disinvesting (see chart below). NFC debt of €1,277bn at the end of 3Q21 was below the €1,305bn recorded at the end of 3Q2009, for example. Over the same period, HH debt has increased by only 1.3% CAGR from €660bn to €764bn.
Trends in HH and NFC debt and debt ratios since 2009 (Source: BIS; CMMP)
The net savings of the private sector have been running at 1.5-3.0x the size of the net borrowings of the government. Instead of funding the fiscal stimulus required to close Italy’s deflationary gap, un-borrowed private sector savings have leaked out of the economy.
Trend in private sector net lending versus public sector net borrowing (Source: ECB; CMMP)
“Austerity” and potential future fiscal consolidation have not/will not solve either of these fundamental challenges. Domestic sector imbalances leave the Italian economy increasingly reliant of running current account surpluses with the RoW (see chart below). The structural challenges of excess savings and insufficient private sector investment remain.
Trends in Italian net sector balances (EURbn) (Source: ECB; CMMP)
In “The escape from balance sheet recession and the QE trap”, Richard Koo, the Japanese economist and leading authority on balance sheet recessions, highlighted the structural flaw in the Eurozone that allowed un-borrowed savings in countries experiencing private sector deleveraging to flee to other bond markets, preventing domestic governments from issuing debt to fund stimulus measures.
As far back as 2012, Koo proposed applying different risk weights to domestic and foreign government bonds. He suggested that, “The relatively minor regulatory change of attaching different risk weights to holdings of domestic versus foreign government bonds would go a long way toward reducing pro-cyclical and destabilising flows among government bond markets.”
Perhaps the time for new and imaginative solutions to Italy’s sector imbalances is at hand, once again…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
The sharp and co-ordinated slowdown in EA money and private sector credit (% YoY, real) (Source: ECB; CMMP)
The key message
What are the implications of the re-synching of euro area money and credit cycles for asset allocation and what are the current messages from the money sector telling us?
Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore.
The recovery in money and credit cycles in the post-GFC period broadly followed this stylised pattern. Other macro-factors complicated the wider interpretation of these trends, however. Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example. At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.
That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.
With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector.
Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits, and will be encouraged by the resilient HH and recovering NFC credit demand (in nominal terms).
In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms with be a far more alarming message, especially for those positioned for economic recovery.
Euro area re-synching – part 2
As a macro strategist, economist and global investor, I have always been interested in the relationship between money, credit and business cycles and the implications for asset allocation.
Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore. Note that these relationships tend to be stronger with reference to turning points than to the amplitude of growth.
The recovery in money and credit followed the stylised pattern post-GFC (% YoY, real) (Source: ECB; CMMP)
The recovery in money and credit cycles followed this stylised pattern in the post-GFC period (see chart above). Real M1 bottomed in July 2011 (-1.4%) and turned positive in May 2012. Real HH credit bottomed next in September in 2012 (-2.3%) and turned positive in December 2014. Finally, real NFC credit bottomed in June 2013 (-4.6%) and turned positive in November 2015. Other macro-factors complicated the wider interpretation of these trends, however.
Trends (% YoY) in real GDP and real M1 (Source: ECB; CMMP)
Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example (see chart above).
Interest rate and cyclical effects are typically the main factors affecting trends in narrow money, with the latter being more relevant for asset allocation purposes.
While real M1 continued to exhibit leading indicator qualities, strong demand for overnight deposits (within M1), driven by their increasing low opportunity cost, suggest that interest rate effects had a greater impact than cyclical factors over much of the past decade. The COVID-19 pandemic also resulted in dramatic increases in forced and precautionary savings, again largely in the form of overnight deposits. This compounded the challenges of interpreting these dynamics (see “Don’t confuse the message”).
Trends (% YoY) in real GDP and real HH credit (Source: ECB; CMMP)
At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.
The chart above illustrates how real HH credit has enjoyed a broadly coincident relationship with GDP for most of the period. That said, it also shows that the EA HH sector was engaged in an extended period of passive deleveraging between March 2010 and March 2019 with real growth in HH credit lagging real growth in GDP.
Similarly, the chart below illustrates how NFC credit has also enjoyed a broadly lagging relationship with real GDP growth. Again, the analysis and interpretation is challenged by an extended period of NFC deleveraging. Growth in NFC credit lagged behind real GDP growth from December 2009 to May 2016 and to July 2018, in a more sustained fashion.
Trends (% YoY) in real GDP and real NFC credit (Source: ECB; CMMP)
That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.
Monthly HH deposit flows as a multiple of pre-pandemic levels (Source: ECB; CMMP)
With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector. Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits (see chart above), and will be encouraged by the resilient HH and recovering NFC credit demand, in nominal terms (see chart below).
Growth trends (% YoY, nominal) in HH and NFC credit (Source: ECB; CMMP)
In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms (see chart below) will be a far more alarming message, especially for those positioned for economic recovery.
The alarming and coordinate slowdown in real money and credit growth (Source: ECB; CMMP)
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
YoY growth rates in M3 and private sector credit and trends in excess liquidity (Source: ECB; CMMP)
The key message
Growth rates in euro area (EA) money supply and private sector credit continue to converge and re-align. This matters because the de-synchronisation of money and credit cycles over the past decade, which peaked during the COVID-19 pandemic, created major challenges for policy makers, banks and investors alike.
On a positive note, this reflects a combination of slowing (excess) money supply growth and rising demand for private sector credit. Recall that narrow money (M1), and within that overnight deposits, drove the expansion of broad money (M3) during the pandemic. The contribution of productive COCO-based lending is also increasing, led by a recovery in corporate credit. Importantly, COCO-based lending supports both production AND income formation.
That said, less-productive FIRE-based lending continues to be the more important driver of private sector credit in the EA, driven by resilient mortgage demand. FIRE-based lending, which accounts for more than half of the outstanding stock of credit, supports capital gains through higher asset prices but does not lead directly to income generation. This has negative implications for leverage, future growth, financial stability and income inequality.
In short, the message from the money sector here is broadly positive, albeit with the “hidden-risks” that are associated with higher levels of FIRE-based lending. In the second part of this analysis, I analyse money and credit trends in real terms to consider the implications here for the outlook for growth and business-cycle approaches to asset allocation. The conclusions here are less positive…
Euro area re-synching – part 1
Growth rates in EA money supply and private sector credit continue to converge and re-align (see key chart above). This matters because the de-synchronisation of these cycles over the past decade, which peaked during the COVID-19 pandemic, created major challenges for policy makers, banks and investors alike. The effectiveness of monetary policy, the dominant macro policy during this period, diminished dramatically as a result, and banks and investors had to deal with the consequences of excess liquidity for balance sheet management and the (mis-)pricing of both real and financial assets.
What is driving the re-synching of money and credit cycles? (Source: ECB; CMMP)
On a positive note, this reflects a combination of slowing (excess) money supply growth and rising demand for private sector credit (see chart above). Broad money (M3) growth has slowed from its January 2021 peak of 12.5% YoY to 6.0% YoY in April 2022. Growth in private sector credit has recovered from its May 2921 low of 2.7% YoY to 5.3% YoY, the highest nominal rate of growth since May 2020. The gap between the two growth rates (the green line in the chart above) has narrowed from 8ppt in January 2021 to 0.7ppt in April 2022, the narrowest gap since November 2018.
Contribution (ppt) of COCO-based lending to total private sector credit (Source: ECB; CMMP)
The contribution of productive COCO-based lending is also increasing (see chart above), led by a recovery in corporate credit. COCO-based lending, which includes lending to corporates (NFCs) and household (HH) consumer credit, contributed 1.9ppt towards to total PSC growth of 4.9% YoY in April 2022. This compares with only 0.4ppt to the total PSC growth of 3.0% in August 2021.
Note that COCO-based lending supports both production and income formation. Loans to NFCs are used to finance production, which leads to sales revenues, wages paid, profits realised and economic expansions. So while an increase in NFC debt will increase debt in the economy, it also increases the income required to finance it. Consumer debt also supports productive enterprise since it drives demand for goods and services, helping NFCs to generate sales, profits and wages. It differs from NFC debt to the extent that HHs take on an additional liability since the debt does not generate income.
Contributions (ppt) of FIRE-based and COCO-based lending to total private sector credit (Source: ECB; CMMP)
That said, less-productive FIRE-based lending continues to be the more important driver of private sector credit (see chart above), driven by resilient mortgage demand (see also chart below).
FIRE-based lending, which accounts for more than half of the outstanding stock of credit, supports capital gains through higher asset prices but does not lead directly to income generation. Loans to NBFIs are used primarily to finance transactions in financial assets rather than to produce, sell or buy actual output. Such credit may lead to an increase in the price of financial assets but does not lead (directly) to income generation. Mortgage or real estate lending is used to finance transactions in pre-existing assets. It typically generates asset gains as opposed to income (at least directly). As noted in previous posts, the shift towards FIRE-based lending has negative implications for leverage, future growth, financial stability and income inequality.
In short, the message from the money sector here is broadly positive, albeit with the “hidden-risks” that are associated with higher levels of FIRE-based lending.
YoY real growth trends in M1, household and corporate credit (Source: ECB; CMMP)
In the second part of this analysis, I analyse money and credit trends in real terms to consider the implications here for the outlook for growth and business-cycle approaches to asset allocation. The conclusions here are less positive…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
