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.
The UK and EA may be in disharmony over COVID vaccinations, but the messages from their respective money sectors remain far more consistent.
Neither last week’s ECB data release nor today’s (29 March 2021) Bank of England money credit statistics for February 2021 provide support for inflation hawks. Three things need to happen for this to change: (1) a moderation in monthly household (HH) deposit flows; (2) a re-synching of money and credit cycles; and (3) a recovery in consumer credit.
What have we learned today from the UK?
UK HHs’ flows into deposit-like accounts remained strong in February with a net flow of £17bn. This is below December 2020’s recent peak of £21bn and January’s £19bn but still 3.7x the average monthly flows seen during 2019. HHs continue to maintain large cash holdings despite the fact that the effective interest rate paid on new time deposits fell to a new series low of 0.34%.
The gap between the growth in money supply (15.2%) and the growth in private sector lending (3.8%) hit a new record of 11.4ppt from 10.6ppt in January. Rather than re-synching, the UK money and credit cycles are moving out-of-synch at an even greater pace.
UK HHs repaid £1.2bn in consumer credit during February, following repayments of £2.7bn in January and £0.9bn in December. This marks five consecutive months of net repayments of consumer credit bringing the YoY growth rate to another new series low of -9.9% in February.
As in the EA last week, there is no change yet in the subdued message from the UK money sector for inflation hawks. HH uncertainty and liquidity preference remain very elevated, money and credit cycles are de-synchronising at a record rate and consumer credit is also declining at a record rate.
Broad money (M3) rose 12.3% YoY across the euro area (EA) in February 2021, down slightly from the 12.5% and 12.4% growth rates recorded in January 2021 and December 2020 respectively. Narrow money (M1) grew 16.4% YoY, versus 16.5% in January, and contributed 11.3ppt to overall money growth. Overnight deposits, the key component of M1, rose 17.0% YoY and contributed 10.1ppt to overall money growth alone.
In relation to three key signals framework introduced early this year that look for (1) a moderation in monthly deposit flows, (2) a re-synching of money and credit cycles, and (3) a recovery in consumer credit – there is little change to report in these numbers:
Households placed €53bn in deposits in February, down from €61bn in January but in-line with the €54bn deposited in January. February’s monthly flow is still 1.6x the average monthly flows recorded in 2019 indicating that the preference for holding highly-liquid assets and household uncertainty levels remain high
Money and credit cycles remain out-of-synch. Private sector credit grew 4.5% YoY in February, unchanged from January, but 7.8ppt slower than the 12.3% growth in broad money. This is the second highest gap between credit growth and money growth after last month’s 8ppt. Note that from a counterparts perspective, credit to the private sector contributed only 5.3ppt to broad money growth versus 8.6ppt from credit to general government.
Consumer credit remains weak. While the monthly flow of consumer credit was a positive €2bn, versus net repayments of €3bn in January, the YoY grow rate fell to a new low of -2.8%.
So no change in the messages from the money sector. Household uncertainty and liquidity preference remains elevated, money and credit cycles remain out-of-synch and consumer credit continues to weaken.
Little cheer yet for investors positioned for an upturn in EA inflation.
Are the risks associated with excess growth re-emerging? Excess credit growth versus penetration rates (Source: BIS; CMMP)
The key message
Risks associated with “excess credit growth”, which had been declining in the pre-Covid period, have re-emerged during the pandemic.
Some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed maximum threshold levels (Singapore, France, Hong Kong, South Korea, Japan, Canada).
Affordability risks are also increasing within and outside (Sweden, Switzerland, Norway) this sub-set despite the low interest rate environment.
Risks are more elevated in the corporate (NFC) sector than in the household (HH) sector but are not unique to either the developed market (DM) or emerging market (EM) worlds – one more reason to question the relevance of the current DM v EM distinction
Much of the debate relating to global debt focuses exclusively on the level of debt and, to a lesser extent, on the debt ratio (debt as a percentage of GDP). This analysis highlights how the addition of growth and affordability factors provides a more complete picture of the risks associated with current trends and their investment implications.
Introduction
As noted above, much of the recent debate about global debt has been restricted to its level in absolute terms or as a percentage of GDP. The addition of other factors – the rate of growth in debt, its affordability and, in the case of many EMs, its structure – provides a more complete picture, however.
In this post, I add condsideration of the rate of growth in global debt to my previous analysis in “D…E…B…T, Part II.” The approach is based on the simple relative growth factor (RGF) concept which I have used since the early 1990s as a first step in analysing the sustainability of debt dynamics. I also link both to the affordability of debt as measured by debt service ratios (DSRs).
In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. The three-year CAGR in debt is compared with the three-year CAGR in nominal GDP to derive a RGF. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).
The concept is simple – one would expect relative high levels of excess credit growth in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage or when excess credit growth continues beyond previously observed levels.
The key trends
Rolling private sector RGF for all BIS reporting, developed and emerging economies (Source: BIS; CMMP)
In the pre-COVID period, the risks associated with excess credit growth had been declining in developed (DM) and emerging (EM) economies (see chart above illustrating rolling RGF trends). In response to the pandemic, however, credit demand has risen while nominal GDP has fallen sharply. As a result, the RGF (as at the end of 3Q20) for all economies, DM and EM have risen to 3%, 2% and 4% respectively. As can be seen, these levels are elevated but remain below those seen in previous cycles during the past 15 years.
Private sector credit snapshots
Excess PS credit growth versus PS debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of private sector RGF by country (Source: BIS; CMMP)
Importantly, out of the top-ten economies experiencing the highest rates of excess private sector credit, six have private sector debt ratios higher than the threshold levels above which debt is considered a constraint to future growth – Singapore, France, Hong Kong, South Korea, Japan and Canada. In the graph above, and in similar ones below, the orange bar indicates where debt ratios exceed the threshold level.
Excess PS credit growth versus PS debt ratios as at end 3Q20 in LATEMEA (Source: BIS; CMMP)
Argentina and Chile have the highest private sector RGFs among the sample of LATEMEA economies. The associated risks are higher in the case of Chile than in Argentina given the two economies debt ratios of 169% GDP and 24% GDP respectively. As highlighted below, the risks in Chile relate primarily to excess growth in the NFC sector.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are also relatively high in France, Hong Kong, South Korea, Japan and Canada despite the low interest rate environment. Outside this subset, affordability risks are relatively high in Sweden, Switzerland and Norway where DSR’s are relatively high in absolute terms and in relation to each economy’s history.
NFC credit snapshots
Excess NFC credit growth versus NFC debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of NFC RGF by country (Source: BIS; CMMP)
Similarly, out of the top-ten economies experiencing the highest rates of excess NFC credit, seven have NFC debt ratios above the threshold level (90% GDP) – Singapore, Chile, France, Canada, Japan, South Korea and Switzerland.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this second subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are relatively high in France, Canada, Japan and South Korea. Despite lower rates of excess NFC credit growth affordability risks are also relatively high in Sweden, Norway and the US. (Note that the availability of sector DSRs is more restricted than overall private sector DSRs).
HH credit snapshots
Excess HH credit growth versus HH debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of HH RGF by country (Source: BIS; CMMP)
In contrast, out of the top-ten economies experiencing the highest rates of excess HH credit, only two have HH debt ratios above the threshold level – Hong Kong and Singapore. This is not surprising given that HH debt ratios are lower than NFC debt levels in general. Of the 42 BIS reporting countries, 11 have HH debt ratios above the 85% GDP HH threshold level whereas 20 have NFC debt ratios above the 90% GDP NFC threshold level.
Rolling HH RGFs for China and Russia (Source: BIS; CMMP)
That said, experience suggests that the current levels of excess HH credit growth in China and Russia indicate elevated risks, especially in the former economy. In “Too much, too soon?“, posted in November 2019, I highlighted the PBOC’s concerns over HH-sector debt risks – “the debt risks in the HH sector and some low income HHs in some regions are relatively prominent and should be paid attention to.” (PBOC, Financial Stability Report 2019). Excess credit growth remains a key feature nonetheless.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this third subset, the debt service ratio in absolute terms and in relation to respective 10-year averages is relatively high in South Korea. Again, despite lower rates of excess HH credit growth, affordability risks are also relatively high in Sweden and Norway.
Conclusion
This summary post extends the analysis of the level of global debt and debt ratios to include an assessment of the rate of growth in debt and its affordability. Together, these factors provide a more complete picture of the sustainability of current debt trends.
Risks associated with excess credit growth are re-emerging and will be a feature of the post-COVID environment going forward. The two key risks here are: (1) some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed threshold levels; and (2) affordability risks are increasing within (and outside) this sub-set despite the low interest rate environment.
To some extent, little of this is new news – I have been flagging the same risks in an Asia context for some time – and the implications are the same. Despite recent market moves, the secular support for rates remaining “lower-for-longer” remains, albeit with more elevated sustainability risks in the NFC sector.
Revisiting the level and structure of global debt six months on
The key chart
What are the implications of new highs in global debt and debt ratios? (Source: BIS; CMMP)
The key message
Global debt hit new highs in absolute terms ($211tr) and as a percentage of GDP (277%) at the end of 3Q20, driven largely by government ($79tr) and NFC debt ($81tr).
Public sector and NFC debt ratios both hit new highs above the maximum threshold level that the BIS considers detrimental to future growth.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability risks in the NFC sector.
The US and China account for nearly 50% of global debt alone and more than 75% with Japan, France, the UK, Germany, Canada and Italy – but only Japan and France are included in the top-ten most indebted global economies.
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio increased to 179% GDP.
China’s accumulation of debt has eclipsed the “EM catch-up story”. Chinese debt now accounts for just under 70% of EM debt and EM x China’s share of global debt has remained unchanged over the past decade.
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics.
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. From this more appropriate foundation, further analysis can be made of the growth and affordability of debt…
D…E…B…T, Part II
Breakdown of global debt and trend in debt ratio since 2008 (Source: BIS; CMMP)
Global debt hit new highs in absolute terms and as a percentage of GDP at the end of 3Q20, driven largely by public sector debt and NFC debt. According to the BIS, total debt rose from $193tr at the end of 1Q20 to a new high of $211tr. Within this:
Government, NFC and HH debt all hit new absolute highs of $79tr, $81tr and $51tr respectively
The global debt ratio increased from 246% GDP in 1Q20 to a new high of 278% GDP
The public sector debt ratio increased from 88% GDP to 104% GDP and the NFC debt ratio increased from 96% GDP to 107% GDP over the same period. In both cases, the debt ratio was a new high and above the maximum threshold level of 90% above which the BIS considers the level of debt to become a constraint on future growth
The HH debt ratio also increased from 61% GDP to 67% but remains below its historic peak of 69% (3Q09) and the respective BIS threshold level of 85% GDP.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability especially in the NFC sector.
3Q20 ranking of BIS reporting economies by total debt and cumulative market share (Source: BIS; CMMP)
The US and China account for nearly 50% of global debt, but neither is ranked in the top-15 most indebted economies. At the end of 3Q20, total debt reached $61tr (29% global debt) in the US and $42tr in China (20% global debt). In absolute terms, these two economies are followed by Japan $21tr, France $10tr, UK $8tr, Germany $8tr, Canada $6tr and Italy $tr. In other words, the US and China account for almost a half of global debt and together with the other six economies account for over three-quarters of global debt. Note, however, that only two of these eight economies rank among the top-ten most indebted global economies (% GDP).
3Q20 ranking of BIS reporting economies by total debt as % GDP (Source: BIS; CMMP)
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio rose to 179% GDP, close to its all-time-high. Following the GFC, the private sector debt ratio in advanced economies had fallen from a peak of 181% GDP in 3Q09 to 151% in 1Q15. It had then stabilised at around the 160% of GDP level.
Private sector debt in advanced economies in absolute terms and as % GDP (Source: BIS; CMMP)
As discussed in “Are we there yet?”, this had direct implications for the duration and amplitude of money, credit and business cycles, inflation, policy options and the level of global interest rates. In subsequent posts, I will examine the implications of these recent trends on the sustainability and affordability of private sector debt in advanced economies.
Trends in China’s private sector debt and share of EM private sector debt (Source: BIS; CMMP)
China’s accumulation of debt has eclipsed the “EM catch-up story”. Fifteen years ago, China’s debt was just under $3tr and accounted for 35% of total EM debt. At the end of 3Q20, China’s debt had increased to $33tr to account for 67% of total EM debt. The so-called EM catch-up story is in effect, the story of China’s debt accumulation. Excluding China, EM’s share of global debt in unchanged (12%) over the past decade.
China and EMx China’s share of global debt (Source: BIS; CMMP)
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics. The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and NZ) and eight emerging economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).
Asian NFC and HH debt ratios (Source: BIS; CMMP)
The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to NFC (Japan) and HH (Australian and New Zealand) debt dynamics.
The remaining grouping is more troublesome as it ignores the wide variations in market structure, growth opportunities, risks and secular challenges. I prefer to consider China, Korea, Hong Kong and Singapore as unique markets. China is unique in terms of the level, structure and drivers of debt and in terms of the PBOC’s policy responses. Korea and Hong Kong stand out for having NFC and HH debt ratios that exceed BIS maximum thresholds. Hong Kong and Singapore are distinguished by their roles as regional financial centres but have different HH debt dynamics. Malaysia and Thailand can be considered intermediate markets which leaves India and Indonesia as genuine emerging markets among Asian reporting countries (see “Sustainable debt dynamics – Asia private sector credit”).
Global NFC and HH debt ratios (Source: BIS; CMMP)
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. In this case, excess refers to levels that are above the BIS thresholds. Among the BIS reporting economies (and excluding Luxembourg) there are:
Eight economies with excess HH and NFC debt levels: Hong Kong, Sweden, the Netherlands, Norway, Denmark, Switzerland, Canada and South Korea
Eleven economies with excess NFC debt levels: Ireland, France, China, Belgium, Singapore, Chile, Finland, Japan, Spain, Portugal, and Austria
Three economies with excess HH debt levels: Australia, New Zealand, the UK
The RoW with HH and NFC debt levels below the BIS thresholds
These classifications provide a more appropriate foundation for further analysis of the other, key features of global debt – its rate of growth and its affordability. These will be addressed in subsequent posts.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Historic and forecast trends in HH net savings (% GDP, rolling annual average) (Source: OBR; CMMP)
The key message
UK households (HHs) play a vital role in the UK economy and in the demand for credit. Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again?
Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open. If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c.6% to consumption in 2021 and 2020. Such a bullish scenario is unlikely for three reasons:
HHs typically save most unanticipated sources of wealth rather than spend them
The rise in savings is skewed towards high-income households who typically have lower marginal propensities to consume;
History suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock.
That said, the scale of accumulated HH savings provides support for a more rapid re-adjustment than after the GFC (the central OBR forecasts is consistent with HHs on average spending 5% of the extra deposits) and suggests that the UK has a higher level of gearing to a recovery than the euro area (EA). Potentially good news for suppliers of consumer durables…
Riding to the rescue
HHs matter
UK households (HHs) play a vital role in the UK economy and in the demand for credit. HH consumption accounts for 65p in every pound of UK GDP and lending to HHs accounts for 66p in every pound of M4 Lending. HHs are important investors in financial and non-financial assets (mainly property), with balance sheets skewed towards financial assets. The sector is typically a net saver/net lender in the UK (and other developed economies). However, notable shifts in the HH net financial balances have occurred in the post-GFC period and during the COVID-19 pandemic. A key theme in the analysis below it that the unwinding of HH savings built up during the pandemic will play an important role in determining the scale, pace and sustainability of any economic recovery.
Disappoint or ride to the rescue?
Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again? The sector was poised to disappoint at the start of 2020 with risks to official forecasts tilted clearly to the downside.
HH debt (LHS, £bn) and debt/GDP ratio (RHS, %) (Source: BIS; CMMP)HH gross savings (LHS, £bn) and savings rate (RHS, %) (Source: ONS; CMMP)
HH debt levels peaked at 96% GDP in 1Q10 and, after a period of “passive deleveraging”, stabilised at c.85% GDP from 2Q14 onwards (note that 85% GDP is the maximum threshold level above which the BIS assumes that debt becomes a constraint on future growth). Despite low debt servicing costs, HHs chose to fund consumption by slowing their rate of savings (and accumulation of net financial assets) rather than by increasing their debt levels. With real growth in disposable income slowing, however, and with the savings rates still close to historic lows, the risks to HH consumption and GDP growth were tilted clearly to the downside before COVID-19 hit.
2019
2020e
2021e
2022e
2023e
2024e
2025e
GDP (%)
1.4
-9.9
4.0
7.3
1.7
1.6
1.7
HH cons. (ppt)
0.7
-7.1
1.8
7.0
0.8
1.1
0.8
Forecasts for GDP growth and contribution from HH consumption (Source: OBR; CMMP analysis)
Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open (see table above). After falling 11% in 2020, HH consumption is forecast to recover 2.9% in 2021, contributing 1.8ppt to GDP growth of 4.0% and then to grow 11.1% in 2022 contributing 7.0ppt to GDP growth of 7.3% (OBR, March 2021 forecasts).
What if?
If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c6% to consumption in 2021 and 2020. In recent posts, I have noted the increase in HH deposits (“COVID-19 and the flow of financial funds in the UK”).
HH money monthly flows and 2019 average monthy flow (Source: BoE; CMMP)
HHs increased their deposits by £100bn in the first three quarters of 2020 and by a further £53bn in the 4Q20 alone. The OBR expects the level of “additional deposits” to reach £180bn by the middle of 2021. In the unlikely scenario that all these additional deposits were spent over the next four quarter, the OBR estimates that it would add c6% to consumption in 2021 and 2020.
Not so fast…
Such a positive scenario is unlikely for three key reasons. First, HHs typically save most unanticipated sources of wealth rather than spend them. Traditional consumption theory suggests that rather than spending all of an unanticipated increment to their wealth immediately, HHs are instead more likely to save most of it to allow for higher consumption in the future. An autumn 2020 BoE survey supports this theory. Only 10% of HHs planned to spend the additional savings built up during the pandemic. In contrast, around 66% planned to retain them in their bank account. (Note, that the first of the CMM three key charts for 2021 measures monthly HH deposit flows in relation to past trends).
NMG survey responses on what HHs plan to do with additional savings built up during the pandemic (Source: BoE; OBR; CMMP)
Second, the rise in savings is skewed towards high-income HHs. Another recent BoE survey notes that 42% of high-income HH were saving more and 16% saving less, compared to 23% of low-income HHs saving more and 24% saving less. This matters because high-income HHs typically have lower marginal propensities to consumer than low-income HHs. Empirical evidence suggests that annual spending typically rises by between 5-10% of unanticipated, incremental increases in wealth.
HH net savings (%GDP) 2007-2017 (Source: ONS; CMMP)
Third, history suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock. In the aftermath of the GFC, for example, the net savings of the HH sector peaked at 6.1% GDP in 2Q10. It took 26 quarters before net savings fell below 2% GDP (4Q16).
How COVID-19 altered the OBR’s forecasts for HH net savings (Source: OBR; CMMP)
The COVID-19 pandemic was a greater financial, economic (and mental) shock than the GFC. In response, the HH sector’s net savings increased from 0.4% at the end of 2019 to 7.0% in 3Q20. OBR forecasts indicate that net savings increased to 8.7% at year-end and are expected to peak at 10.4% GDP in 1Q21 (4.3ppt higher than post-GFC). Their forecasts also assume a rapid re-adjustment by HHs as vaccination levels rise and the economy re-opens with HH net savings falling below 2% by 3Q22 (ie, in six quarters) and remaining below 0.5% out to 1Q26. In my view, risks to these assumptions lie to the downside ie, HH net savings will remain higher than forecast here as HHs maintain larger precautionary savings.
But, what if size does matter…
The scale of accumulated HH savings provides support, however, for a more rapid re-adjustment than after the GFC and suggest that the UK has a higher level of gearing to a recovery than the euro area (EA).
The central OBR forecasts is “consistent with HHs on average spending 5% of the extra deposits accumulated during the pandemic each year, but somewhat front loaded into 2H21 and 1H22.” In other words, the OBR forecasts suggest that c.25% of the total stock of £180bn built up during the pandemic will have been used for consumption by 1Q26. This seems a reasonable assumption, in my view.
UK and EA HH monthly deposit flows expressed as a multiple of 2019 average monthly flows (Source: BoE; ECB; CMMP)
Note also that the “messages from the money sector” indicate that the scale of additional deposit flows in the UK, in relation to past trends, is higher in the UK than in the EA. In December 2020, for example, the monthly flow of HH money (£20bn) was 4.5x the average monthly flow recorded in 2019. In the EA, the respective multiple was 1.8x.
Potential beneficiaries?
If correct, the rebound in HH consumption is potentially good news for suppliers of consumer durables. So-called “social consumption” will naturally benefit too, but there is only so much lost time that can be made up (you can only eat so many meals in one day!). It is reasonable to assume, therefore, that a large proportion of additional expenditure is directed towards durable goods whose consumption is more likely to have been delayed during lockdown (eg, car sales).
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The key message
The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow of funds between the different sectors of the economy.
The UK government issued £227bn gilts in the first three quarters of 2020 to finance the support given to HHs and NFCs (and increased it net liability position by £130bn).
The BoE purchased a similar quantity of gilts in the secondary market (via APF) and financed this through the issuance of reserves. These reserves form liquid assets for the rest of the financial sector, counterbalanced by additional deposits from HHs and NFCs. Note that the net asset/liability positions of the money sector (the BoE and FIs) remained broadly unchanged at this point.
HHs increased their deposits by £102bn and their net asset position increased by £111bn. This increase in HH savings was intermediated to the UK government via the money sector, meaning that UK HHs have been the most important source of additional lending during the pandemic.
In contrast, the net lending position of NFCs and the RoW remained broadly unchanged.
Understanding how these flows will be unwound in the post-COVID period is the key to determining the speed and duration of the recovery in the UK economy. My next post will examine the HH sector dynamics in more detail.
Recall that the financial sector balances approach reognises that any net borrowing by one sector must be accompanies by net lending from another sector(s). The table below illustrates this balance in practice during the COVID-19 pandemic.
£ bn
C Bk reserves
Curr. & dep’s
Gilts
Loans and debt
Other
Total
Gov
0
-13
-227
44
65
-130
BoE APF
-259
0
231
28
0
0
FIs ex-APF
259
-204
47
-47
-47
8
HHs
0
102
1
26
-18
111
NFCs
0
123
1
-79
-30
16
RoW
0
-9
-53
27
30
-5
Balance
0
0
0
0
0
0
Net borrowing by one sector must be accompanied by net lending from another sector(s) (Source: OBR; BoE; ONS; CMMP)
COVID-19 and the UK flow of funds
The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow or funds between the different sectors of the economy. The analysis compares the patterns of financial flows between the five key sectors in the economy – HHs, NFCs, FIs, government and the RoW – in the first three quarters of 2020 and the final three quarters of 2019.
Recall that the financial sector balances approach recognises that any net borrowing of one sector must be accompanied by net lending from another sector(s).
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
As highlighted in my previous post, the UK government has provided unprecedented support to HHs and NFCs during the COVID pandemic. According to the OBR, this was financed (in net terms) by issuance of £227bn in gilts in the first three quarters of 2020. This compares with £34bn issuance in the final three quarters of 2019. The net liabilities of the government increased by £130bn over the period.
A similar quantity of gilts (£231bn) was purchased on the secondary market by the BoE’s Asset Purchase Facilty (APF) as part of quantitative easing (QE). The BoE financed this purchase by issuing an equivalent amount of its own liabilities (reserves). As a result the Bank’s net asset/liability position was unchanged.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The reserves issued by the BoE constitute assets for the rest of the UK financial sector. The counterpart/balance to these reserves is mainly the additional deposits from HH and NFCs that arose from the government’s support measures. Note again, that the net lending position of the financial sector remained broadly unchanged at this point.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The rise in HH deposits has been a consistent message from the money sector in 2020. The OBR notes that HH deposits increased by £102bn in the first three quarters in 2020. These savings have been intermediated to the government via the financial sector and the BoE through the flows described above. The net assets of the HH sector increased by £111bn.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The NFC sector also increased its deposits by £123bn over the period, while increasing net loans and other liabilities by £109bn. In aggregate, the net lending of NFCs changed little as a result but this masks significant differences in the experience of firms in different sectors.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
Foreign investors have played a limited role in the financing the increase in UK government borrowing over the period. The net lending positions changed little over the first nine months of 2020.
Conclusion
The COVID-19 pandemic and the associate responses from the UK government led to significant changes in the flow of funds between the key economic agents. The composition of these flows changed for most sectors but the main changes in net assets and liabilities were recorded by the HH and government sectors.
UK HHs represent an important source of additional lending over this period, with the increase in their liquid savings being intermediated to the government via the money sector (financials and the BoE).
The OBR is forecasting a 4% increase in real GDP in 2021 from a fall of 9.9% in 2022, followed by growth of 7.3%, 1.7%, 1.6% and 1.7% in the next four years out to 2025 respectively. The pace and sustainability of these forecasts depend on how the financial flows described above are unwound. In the next post, I will examine the outlook for the HH and NFC sectors in more detail.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
…in forecasts that assume unsustainable end-games?
The key chart
Historic and forecast trends in financial sector balances for the UK private sector, government and the RoW expressed as % GDP (Source: OBR; CMMP)
The key message
Seen from the perspective of financial sector balances, the latest OBR forecasts for the UK economy and public finances tell us three things.
First, the UK government’s response to the COVID-19 pandemic was timely, necessary and appropriate.
Second, the financial relationship between UK households, corporates, government and the rest-of-the-world will remain broadly unchanged during 2021.
Third, (obvious and familiar) risks to the medium-term forecast remain to the downside and imply persistent and significant fiscal and current account deficits (little has changed since November 2020).
Somewhat surprisingly, given the significant event risk that the Covid-19 pandemic represents, the medium-term outcomes forecast in March 2020, November 2020 and March 2021 are broadly similar – a return to an economy characterised by large and persistent sector imbalances, with combined public and private sector deficits and an increasing reliance on the RoW as a net lender.
This scenario is as unsustainable post-COVID as it was pre-COVID, and leaves the reader wondering about the value of official forecasts in presenting an accurate outlook for the future financial interactions between the key UK economic agents.
Please note that the summary comments and chart above are extracts from more detailed analysis that is available seperately. Please also note that subsequent posts will dig out the “hidden value”!
