Positive 2022 euro area PSC trends proved unsustainable in 4Q22
The key chart
Trends in PSC (% YoY) and contribution (ppt) of COCO-based lending (Source: ECB; CMMP)
The key message
The positive private sector credit (PSC) dynamics that supported a more optimistic outlook for euro area (EA) economic activity proved unsustainable in 4Q22.
The context for this week’s ECB policy announcement remains a challenging one with coincident and lagging monetary indicators slowing sharply.
The “Coco is cooling” at the start of the new year…
Is the Coco cooling?
PSC dynamics supported a more optimistic outlook for EA economic activity through 2022. PSC growth accelerated and productive COCO-based lending made an increasing contribution to this growth (see key chart above). A recovery in corporate (NFC) credit demand led this process. Both factors were positive for the EA growth outlook. Unfortunately, neither proved sustainable in 4Q22.
PSC growth peaked at 6.7% YoY in September. At this point COCO-based and less-productive, FIRE-based lending both contributed 3.3ppt to total PSC growth. By the end of 4Q22, PSC growth had slowed to 5.0% YoY, with the COCO-based and FIRE-based lending contributing 2.4ppt and 2.7ppt respectively. The key driver here was the peaking of NFC credit, the largest segment of COCO-based lending. NFC credit growth has slowed from 8.1% in October 2022 to 5.5% in December 2022.
Trends (EUR bn) and breakdown (% total) of euro area PSC since 2004 (Source: ECB; CMMP)
Recall that unorthodox monetary policy (QE) had fuelled the wrong type of lending in the EA. At the time of the GFC, the outstanding stock of COCO-based lending peaked at €5,517bn in January 2009, and contributed 55% of total PSC. This level was not reached again until December 2021. At this point COCO-based lending contributed only 48% of total PSC. In other words, nearly all of the aggregate growth in EA lending between these dates was in the form of lending to support capital gains through rising asset prices (see chart above). This explains why last year’s dynamics were so important – demand for productive lending was recovering again.
Unfortunately, annual growth rates in mortgages (the largest contributor to FIRE-based lending) and NFC credit (the largest contributor to COCO-based lending) fell -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart below).
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
As noted in my previous post, these variables typically display coincident and lagging relationships with real GDP growth. Both are suggesting rising risks to the economic outlook in the euro area. This is the context for the latest policy announcement from the ECB on Thursday.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Atypical foundations for a bull market in European equities
The key chart
Trends in YoY growth rates in real M1, real HH credit and real NFC credit (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) present atypical foundations for a bull market in European equities.
The good news is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Two (of three) key signals from the money sector suggesting a normalisation of economic activity.
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. This matters because these three variables (real M1, HH credit and NFC credit) typically display leading, co-incident and lagging relationships with real GDP over time. If historic relationships continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
The key question for asset allocators, therefore, is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Cold water therapy or cold shower?
Trends in broad (M3) and narrow (M1) money (% YoY, nominal terms) (Source: ECB; CMMP)
Monetary developments in the EA present atypical foundations for a bull market in European equities. Growth in broad money (M3) fell to 4.1% in December 2022, down from 4.8% in November 2022. This represents the slowest rate of growth since January 2019 (see chart above). Growth in narrow money (M1) slowed sharply to 0.6% in December 2022, down from 2.4% in November 2022. This represents the slowest rate of growth since August 2008. At the same time, the SXXE index closed at 449.17 on Friday 27 January 2023, up 26% from its early 4Q22 low.
Growth rate in M3 (% YoY) and contributions from ON deposits and other sources (ppt) (Source: ECB; CMMP)
The good news from the money sector is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Recall that cash hoarding by HHs and NFCs in the form of overnight deposits was the key driver of the rapid expansion in broad money during the pandemic – a combination of forced and precautionary savings (see light blue columns in the chart above).
In the 4Q22, the flow of HH deposits fell to €26bn, the lowest quarterly flow since the pandemic began and well below the 2Q20 peak of €190bn and the pre-pandemic average flow of €91bn (see chart above). Recall also that a moderation in HH deposit flows was one of our three key signals for a normalisation of economic activity post-COVID. A second was a re-synching of money and credit cycles (see below).
Trends in M3 and PSC (% YoY) (Source: ECB; CMMP)
Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike. The gap between the growth in money supply and the growth in private sector credit (PSC) hit a historic high during the COVID-pandemic (see chart above). As the region emerged from the pandemic, these growth rates have converged as the build-up in excess savings has slowed and the demand for credit has recovered (at least in nominal terms). A positive sign.
Trends in M3 and PSC (% YoY) since December 2017 (Source: ECB; CMMP)
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. Growth in adjusted PSC, for example, slowed to 5.3% in December 2022, down from 6.2% in November 2022 and down from the recent September 2022 peak of 7.0% (see chart above).
Trends in monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
The monthly flow of mortgages, for example, fell to €4.5bn in December 2022, down from €8.9bn in November 2022 and down from the recent peak of €30.1bn in June 2022. The latest monthly flow was the lowest recorded since March 2020 (see chart above). The YoY growth rate in mortgages also fell to 4.4% in December 2020 down from 5.8% YoY in August 2021.
Monthly consumer credit flows also remain subdued in absolute terms and in relation to trends seen in the US and the UK. The monthly flow fell to €0.5bn in December 2022 from €2.1bn in November 2022 and €2.4bn in October 2022. As noted in “Clues from consumer credit”, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP over time. Each indicator has peaked and is falling in real terms – -7.9% YoY, -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart above). If historic relationships between these variables continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
In short, the key question for asset allocators is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
What if China’s private sector turns to debt minimisation/savings maximisation instead?
The key chart
Trends in Japanese, Spanish and Chinese private sector debt ratios (% GDP) (Source: BIS; CMMP)
The key message
The “China re-opening” story that suggests that the easing of COVID restrictions will unleash pent-up demand for commodities, consumer goods and travel has received a great deal of attention at the start of 2023.
A key element of this narrative is the $836bn of excess savings that Chinese consumers are reported to have built up during the pandemic. Will these savings be unleashed in a consumption and travel boom? Quite possibly, but what are the wider risks to this positive narrative?
The biggest, unspoken (so far) risks are the level of private sector debt, the growth of household debt and the affordability of private sector debt. What happens, for example, if rather than seeking to maximise profit/utility as traditional economics assumes, the Chinese private sector turns to minimizing debt or maximising savings instead? What if China experiences a balance sheet recession?
Recall that China is one of five economies where (1) private sector indebtedness (220% GDP) exceeds the “peak-bubble” level seen in Japan (214% GDP, 4Q94) and (2) the debt service ratio is not only high in absolute terms, but is also elevated in relation to its 10-year average. China’s debt dynamic has shifted from excess growth in corporate debt (well-known) to excess credit growth in household debt (less well-known). With recent re-intermediation, the banking sector is also relatively exposed to the risks associated with current debt dynamics. Bank sector debt ratios exceed the levels reached at the height of the Spanish private sector debt bubble, for example.
In short, China’s debt dynamics point to potential demand (debt minimisation) and supply side (bank sector debt) constraints to future consumption. At the very least, these factors need to be included in the investment narrative.
Do not forget the lessons from both Japan and Spain’s balance sheet recessions…
Please note that the summary comments and chart above are abstracts from more detailed analysis that is available separately.
Assessing the state of the US consumer balance sheet
The key chart
Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FED; CMMP)
The key message
What are the implications of buoyant US consumer credit flows for the state of household balance sheets?
Consumer credit is the second largest financial liability for US households (24% total) after mortgages (64% total). This structure has changed little over the past 20 years, although the relative importance of mortgages (up then down) and consumer credit (down then up) fluctuated in the interim period.
Consumer credit displays a relatively stable relationship with disposable personal income (DPI). The recent moderation in monthly credit flows is consistent with the consumer credit to DPI ratio being at high end of its narrow, historic range (at the end of 3Q22).
Mortgage debt, in contrast, displays a more volatile relationship with DPI. Importantly, the deleveraging of the US HH sector in the post-GFC period is due almost exclusively to a reduction in excess mortgage indebtedness. Consumer credit indebtedness is largely unchanged.
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Risky US consumer credit dynamics?
In my previous post, I noted that US consumers were doing their level best to counter the “US slowdown” narrative. While consumer credit demand has moderated from its recent highs, monthly flows in November 2022 were still almost double their pre-pandemic average flow. In response, I was asked what this means for the state of consumer balance sheets. This post provides a summary response.
How important is consumer credit?
Trends in stock of consumer credit broken down by type (Source: FED; CMMP)
Consumer credit is the second largest financial liability for US households (24% total), after mortgage debt (64% total). The structure of financial liabilities has changed little over the past 20 years, although there has been important variations in the relative importance of mortgages (up then down) and consumer credit (down then up) during the interim period (see charts above and below).
Structure of US consumer credit (% total) over past 20 years (Source: FED; CMMP)
What is the relationship with disposable personal income?
Trend in consumer credit / disposable personal income ratio (%) (Source: FED; CMMP)
Consumer credit has also displayed a relative stable relationship with disposable personal income (DPI) over this period. The recent moderation in demand is consistent with the fact that the ratio was close to the upper end of its historic range at the end of 3Q22 (see chart above).
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Mortgage demand, in contrast, has displayed a more volatile relationship with DPI over the period (see chart above). Indeed, the deleveraging of the HH sector in the post-GFC period is due almost exclusively to a reduction in mortgage indebtedness (see chart below). Consumer credit indebtedness is largely unchanged since the GFC.
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Conclusion
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Consumer credit flows remain c.2x pre-pandemic average flows
The key chart
Trends in monthly US consumer credit demand (US$ bn) (Source: FED; CMMP)
The key message
In the face of pressures on real household disposable income, consumers have the option to borrow more, save less and/or consumer less – or various combinations of all three. In terms of borrowing more, monthly flows of consumer credit continue to highlight the relative resilience of US consumers in relation to their UK and euro area (EA) peers. US consumers are doing their “level best” to counter the slowdown narrative (at least so far!).
US consumer credit demand and the slowdown narrative
The US has seen 27 consecutive months of positive monthly consumer credit flows since August 2020 (see key chart above). The latest FED data point for November 2022 (published yesterday, 9 January 2023) showed a monthly flow of $27bn (3m MVA). This was up on the $26bn flow in September 2022 but well below April 2022’s peak of $37bn. The key message here is that while demand for consumer credit is moderating it still remains almost double the average pre-pandemic flow of just under $15bn.
US, UK and EA consumer credit flows expressed as a multiple of pre-pandemic average flows (Source: FED; BoE; ECB; CMMP)
Monthly consumer credit flows also rebounded in the UK and the euro area between October and November 2022 but, in contrast to US trends, their respective flows were only 0.8x and 0.6x their pre-pandemic levels (see chart above). Note that in the EA, flows of consumer credit have still to recover to their pre-pandemic levels.
Conclusion
US consumers repaid less consumer credit in the pandemic period and have borrowed more in the post-pandemic period in relation to their UK and EA peers. While momentum is slowing in each region, the US is the only one where consumer credit remains above, indeed comfortably above, pre-pandemic levels.
US consumers are doing their “level best” to counter the slowdown narrative (at least so far!).
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Mortgage flows slowing at a faster rate in the EA than in the UK
The key chart
Monthly mortgage flows (3m MVA) expressed as a multiple of pre-pandemic average flows (Source: BoE, ECB; CMMP)
The key message
November 2022 monthly mortgage flows point to a synchronised slowdown in mortgage demand in the UK and EA, but with a sharper rate of decline in the EA (driven by German and French dynamics). Mortgage demand typically displays a co-incident relationship with GDP growth. In this context, turning points are more significant than the rate of change. The key message here relates more to a synchronised slowdown in economic activity in both regions, therefore, rather than “point-scoring” between them!
Synchronised slowdowns?
Trends in UK monthly mortgage flow (£bn, LHS) and annual growth (% YoY, RHS) (Source: BoE; CMMP)
Monthly UK mortgage flows rose to £4.4bn in November 2022, up from £3.6bn in October 2022. While this is well below the recent peak flow of £17bn in June 2021, it is above the pre-pandemic average flow of £3.9bn.
According to the latest, Bank of England data release (4 January 2022), approvals for house purchase, an indicator of future borrowing, decreased from 57,900 in October 2022 to 46,100 in November 2022, the lowest level since June 2020. It is reasonable, therefore, to expect lower UK flows in coming months.
Mortgage flows are slowing at a faster rate in the EA than in the UK. The 3m MVA of monthly mortgage flows in the EA has fallen from 2.1x pre-pandemic flows in July 2022 to 0.9x pre-pandemic flows in November 2022 (see key chart above). In contrast, UK monthly flows remain above pre-pandemic levels on a monthly basis (1.1x) and a smoothed basis (1.2x).
Mortgage demand typically displays a co-incident relationship with GDP growth. In this context, turning points are more significant than the rate of change. So, as above, the key message here relates more to a synchronised slowdown in economic activity in both regions rather than “point-scoring” between them!
Please note that the summary comments above are abstracts from more detailed analysis that is available separately.
Slowing EA mortgage demand is more positive for financial stability
The key chart
Trends in EA monthly mortgage flow (EUR bn, LHS) and annual growth (% YoY, RHS) (Source: ECB; CMMP)
The key message
The euro area (EA) money sector continues to send a clear message of slowing mortgage demand in 4Q22, reflecting sharp slowdowns in Germany and France, the region’s two most important markets. While this may be disappointing for the EA growth outlook, it is more welcome from a financial stability perspective, given the vulnerabilities flagged in both markets in CMMP analysis over the past two years.
Negative for growth, but…
Trends in monthly EA mortgage flows (EUR bn) (Source: ECB; CMMP)
The monthly EA mortgage flow was €9.3bn in November 2022, up from €8.4bn in October 2022 but well below the recent peak of €30.1bn in June 2022. The 3-month moving average fell to €11bn, the lowest level since May 2020 (see chart above).
Country drivers (in ppt) of EA mortgage growth (% YoY) (Source: ECB; CMMP)
The annual growth rate in the outstanding stock of EA mortgages has slowed from the recent peak of 5.8% YoY in August 2021 to 4.6% YoY in November 2022. German and French mortgage demand are the main drivers of aggregate EA demand (see chart above). They contributed 1.8ppt and 1.2ppt of the total 4.6% YoY growth, for example.
Trends in EA, German and French mortgages (% YoY) (Source: ECB; CMMP)
German mortgage growth has slowed from 7.2% YoY in August 2021 (2.0ppt contribution) to 5.9% YoY in November 2022, however. French mortgage growth has slowed even faster from 8.2% YoY in August 2021 (2.1ppt contribution) to 4.9% YoY in November 2022 (see chart above). In contrast, annual growth rates in the Netherlands and Italy, the third and fourth largest contributors, was higher in November 2022 (4.8% and 4.7% YoY respectively) than in August 2021 (3.4% and 4.3% respectively).
While this may be disappointing news for the growth outlook, it is more welcome from a financial stability perspective, given the vulnerabilities flagged in both markets.
CMMP analysis highlighted RRE vulnerabilities in Germany based on the combination of house price and lending dynamics, the extent of overvaluation and the lack of appropriate macroprudential measures back in November 2021 and warned of the risks associated with the rate of growth and affordability of French household sector debt in January 2022.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
