Author: cgmallin

“And now, the not-so-good-news”

Too early for UK inflation hawks to get excitied

The key chart

Trends in UK M4ex – is this a different form of monetary expansion? (Source: Bank of England, CMMP analysis)

“Money sitting idle in a savings account does not contribute to GDP”

Dirk H. Ehnts, Modern Monetary Theory and European Macroeconomics

The key message

UK money supply (M4ex) increased 13.9% YoY in November 2020. Does this mean that investors positioned for a pick-up in UK inflation should be getting excited?

No, not yet (if at all).

As mentioned in previous posts, the message from the money sector is very different now from previous periods of rising money supply. The key 2020-21 messages remain:

  • heightened household uncertainty
  • weak household consumption
  • subdued overall credit demand

None imply ST inflationary pressures.

Household uncertainty – the chart that matters

Monthly flows in UK households sterling money holdings in £bn (Source: Bank of England; CMMP analysis)

Household M4 accounts for 64% of total M4ex. In November 2020, UK households increased their sterling money holdings by £17.6bn, up from £9.4bn in October. This represents the second highest monthly flow after May 2020’s £25bn and was almost 4x the size of the average monthly flow in 2019. Uncertainty reigns in the UK household sector.

Weak household consumption – the chart that matters

Monthly flows in UK consumer credit in £bn – a negative figure indicates net repayments (Source: Bank of England; CMMP analysis)

Households also made net repayments in consumer credit for three consecutive months between September and November 2020 of £0.8bn, £0.7bn, and £1.5bn respectively. The -6.7% YoY decline in consumer credit in November was the weakest level since the series began in 1994.

Subdued credit demand – the charts that matter

YoY growth rates in the BoE’s headline money (M4) and credit (M4 Lending) series – out of synch! (Source: Bank of England; CMMP analysis)
YoY growth rate in lending minus YoY growth rate in money – abnormal money and credit cycles (Source: Bank of England; CMMP analysis)

Finally, the gap between growth in M4 (13.9%) and ML lending (4.5%) remains at a record high of 9.4ppt. In other words, this is not a normal cycle with synchronised money and credit trends (albeit with traditional leading and lagging relationships). Consequently, and with credit demand remaining subdued, investors should be wary of assuming normal relationships between money supply and inflation (to the extent that such relationships exist at all).

Conclusion

“Monetary policy effectiveness is based on certain stable relationships between monetary aggregates.”

Richard Koo, The Holy Grail of Macroeconomics

To repeat the penultimate lesson from the money sector in 2020 – periods of monetary expansion differ in terms of their drivers and implications. The message in the pre-GFC period was one of over-confidence and excess credit demand. In contrast, the current message is one of elevated uncertainty, weak consumer demand and subdued overall credit demand (with the added uncertainty regarding the extent to which rising savings are forced or precautionary).

It is too early for UK investors who are positioned for a pick-up in inflations to get excited.

[Note that this post was drafted before the announcement of further UK lockdown restrictions on 4 January 2020]

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

“First, some good news”

Positive trends for UK mortgage providers

The key chart

Trends in UK mortgages during 2020 -balances, monthly flow and YoY growth rates (Source: Bank of England, CMMP analysis))

The key message

The Bank of England’s latest “Money and Credit” release (4 January 2021) provides three positive data points for UK mortgage providers. First, households borrowed £5.7bn secured on their homes in November 2020, the highest level since March 2016. Second, mortgage approvals are at their highest level (105,000) since August 2017, suggesting positive future lending trends. Third, the effective rate on new mortgages increased a further 5bp in November to 1.83%, up from August’s low of 1.72%.

That said, mortgage demand remains very subdued in relation to historic trends and rates on new lending continue to act as a drag on revenues generated from outstanding mortgage balances.

As noted, back in October and December 2020, this is no time for mortgage providers to relax despite these positive developments. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.

Six charts that matter

Worth repeating the key chart again! (Source: Bank of England; CMMP analysis)

UK households borrowed £5.7bn secured on their homes in November 2020, the highest level of monthly borrowing since March 2016. November’s monthly flow compares with average monthly borrowings of £4bn in 2019 and £2.7bn in 1H2020. The YoY growth rate in mortgages rebounded slightly to 2.9%, above the recent lows of 2.7% YoY recorded in August and October 2020.

Looking forward – trends in approvals for house purchases since 2007 (Source: Bank of England; CMMP analysis)

Mortgage approvals in November – an indicator for future lending – hit the highest level since August 2007. Approvals for house purchases increased to 105,000 from 98,300 in October and the 2020 low of 9,349 in May. In its commentary, the Bank of England noted that, “recent strength in approvals has almost fully offset the significant weakness earlier in the year.”

Trends in the effective rate on new mortgages (Source: Bank of England; CMMP analysis)

The effective rate on new mortgages (the actual interest rate paid) increased a further 5bp in November to 1.83%, up from August’s low of 1.72%. This rate is, however, still down 4bp YoY and 5bp YTD. The rate on the outstanding stock of mortgages was slightly lower at 2.11% in November (a new low).

Monthly flows (£bn) in lending to UK individuals (Source: Bank of England, CMMP analysis)

Resilient mortgage demand is the one bright spot in an otherwise gloomy UK retail lending market. Total lending to individuals grew by only 1.6% YoY, despite the 2.9% growth in mortgage lending. The annual growth rate in consumer credit fell to -6.7% in November, another series low. Since the beginning of March, UK consumers have repaid over £17bn in consumer credit.

UK mortgage lending since 2000 (Source: Bank of England; CMMP analysis)

That said, current mortgage demand remains very subdued in relation to past cycles (see graph above). Real YoY growth rate in mortgage has averaged only 2.2% YoY during 2020. This compares with an average real growth rate in excess of 9% YoY between November 2000 and November 2008.

Effective interest rates on new mortgages and the outstanding stock (Source: Bank of England; CMMP analysis)

The 28bp gap between the effective rate on new mortgage lending (1.83%) and the effective rate on the outstanding stock of mortgages (2.11%) is relatively narrow in relation to recent trends but on-going pressure on NIMs and revenue growth remains a key challenge for the sector.

Conclusion

As noted, back in October and December 2020, however, this is no time for mortgage providers to relax despite the positive developments noted above. The winners in 2021 and beyond will be those providers who accelerate digitalisation across operations, sales and finance and risk to differentiate themselves and improve the experience for their members.

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

“Seven key lessons from the money sector in 2020”

Why bother with banking sector analysis?

The key lessons

Banks may deliver poor LT investment returns but their interaction with the wider economy provides important insights for corporate strategy, investment returns and asset allocation (#1).

Starting from a simple understanding of core banking services, we can build a quantifiable, objective and logical analytical framework linking all domestic sectors with each other and with the rest of the world (#2).

This framework allows us to challenge official UK forecasts that assume unprecedented behaviour and dynamism from UK households and corporates in support of unsustainable outcomes (#3).

It also allows us to debunk EA myths and identify the key factors that will determine the shape of any recovery in Europe and investment returns in 2021 (#4).

The messages from the UK and EA money sectors during the pandemic have been very similar, albeit with the UK demonstrating higher gearing to current dynamics, including any return to normality (#5).

They also contrast sharply with the messages associated with previous periods of monetary expansion (#6).

Finally, humility and a willingness to unlearn the so-called lessons of the past is important, especially in relation to banking and macroeconomics. The outlook for 2021 will depend, largely, on whether policy makers are willing to challenge orthodox fiscal thinking (#7).

Will 2020-21 be a watershed moment?

“Seven key lessons from the money sector in 2020 – #7”

Humility and the willingness to unlearn the lessons of the past

Lesson #7

The final lesson is the importance of humility and a willingness to unlearn the lessons of the past, especially in relation to banking and macroeconomics. It is, after all, only six years since the Bank of England debunked the widely taught and held view that banks act simply as intermediaries, lending out deposits that savers place with them.

In the current context of large-scale fiscal responses to the pandemic, its will be important to see how other (so-called) lessons from the past are treated e.g. governments should budget like households, governments spend taxpayers money, deficits are evidence of over-spending/crowding out of the private sector, Chancellors have moral duties to balance the books etc.  

The shape and duration of any recovery and investment returns in 2021 will depend, for example, on whether the notion that fiscal expansion is indispensable to sustain demand is fully understood or not (#4). Will 2020-21 be a watershed moment in macro understanding/policy?

In this context, I am ending this series of summary posts with a link to a recent article published by David Andolfatto of the Federal Reserve Bank of St Louis on 4 December 2020. This important article may foreshadow a shift in macro policy understanding. In line with my preferred financial sector balances approach (#2), Andolfatto questions the “government as a household” analogy and also 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

Wherein indeed? Delicious food-for-thought for the Festive Season and for 2021…

“Seven key lessons from the money sector in 2020 – #6”

Different drivers, different implications

The key chart

2020 is not a re-run of 2008 – periods of monetary expansion can and do have different drivers and implications (Source: ECB; CMMP analysis)

Lesson # 6

The penultimate lesson(s) from the money sector is that periods of monetary expansion differ in terms of their drivers and implications and that there is no stable relationship between reserves, broad monetary conditions and inflation.

Broad money in the euro area (and the UK) may be growing at the same rates as 1Q2008 but current trends are not a repeat of 2008 dynamics.

Previous CMMP analysis compared the components and counterparts of both phases. The message in the pre-GFC period was one of (over-) confidence and excess credit demand. In contrast, the current message is one elevated uncertainty and subdued credit demand.

Today’s monetary expansion reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary). The message from the money sector supports rather than contradicts the ECB’s modest inflation expectations out to 2023.

“Seven key lessons from the money sector in 2020 – #5”

Similar messages, but is the UK more geared to recovery?

The key chart

What is the expansion in broad money in the UK and EA telling us? (Source: ECB; Bank of England; CMMP analysis)

Lesson #5

The UK and EA money sectors have been sending very similar messages during the pandemic, albeit it with more volatile YoY trends in the UK. Broad money is growing at the fastest rate since April 2008 in both regions with narrow money’s contribution to total money also reaching historic highs.

The overriding message here is that uncertainty reigns with HHs and NFCs maintaining a preference for holding highly, liquid assets despite earning negative/very low real returns. From a counterparts perspective, above trend NFC credit and resilient mortgage demand have been offsetting weak consumer credit. But again, the dominate message is one of subdued credit demand – the gap between money supply and private sector credit demand continues to hit new highs.

“Uncertainty” and “subdued credit demand” are four key words missing from the inflation hawks’ current narrative!

Looking forward, the key unknown is the extent to which increased savings are forced or precautionary. The OBR may be too optimistic in the assumed extent of recovery in HH consumption, but there is evidence here to suggest that the UK is likely to demonstrate a higher ST gearing to a return to normality than the EA.

“Seven key lessons from the money sector in 2020 – #4”

Debunking myths and identifying key drivers of future returns

The key chart

So far, so good – but is the wider notion that fiscal expansion is indispensable fully understood? (Source: Eurostat, CMMP analysis)

Lesson #4

In addition to helping challenge UK official forecasts (lesson #3), financial sector balances (lesson #2) have also allowed us to debunk three myths from the euro area and identify the key factors that will determine the shape and duration of any recovery and investment returns in 2021.

Back in April 2020, I challenged the arguments that: (1) painful structural reforms post-2000 were the main driver of Germany’s recovery and resurgent competitiveness; (2) existing fiscal frameworks (including the Stability and Growth Pact) were still relevant; and (3) “this crisis [was] primarily the hour of national economic policy.”

Focusing here on (2), in response to COVID-19, EA households increased their savings sharply and corporates stopped investing. The ECB called correctly for fiscal responses, “first and foremost” and the EU and European governments responded appropriately with a shift to more proactive and common fiscal policies.

Policy makers have acknowledged that private sector investment is unlikely to fill the gap left by COVID-19.

So far, so good. The wider question (see also lesson #7) is whether the notion that fiscal expansion is indispensable to sustain demand is fully understood.

“Seven key lessons from the money sector in 2020 – #3”

Official forecasts can fail common sense tests

The key chart

Historic and forecast trends in financial sector balances for the UK private sector, UK government and RoW expresses as a % GDP (Source: OBR; CMMP analysis)

Lesson #3

Given the importance of financial sector balances (lesson #2), it is a surprise that they only occupied two paragraphs and one chart in the OBR’s 217-page, “Economic and fiscal outlook” for the UK (November 2020). A cynic might wonder if this was because the one chart (reproduced above) countered much of the content of the other 216 pages. A more reasoned response might be that the power and application of financial sector balances remains under-appreciated even at these levels, which makes the framework more powerful for those who understand its implications.

In the case of the UK, for example, this approach highlights that official forecasts ask us to believe that UK households, corporates and overseas investors will behave highly unusually and with unprecedented degrees of dynamism in the post-pandemic period. Even then, the assumed result is simply a return to the unsustainable position pre-COVID where combined private and public sector deficits are offset by increasing RoW surpluses.

If we assume that November’s OBR forecasts are now a base case priced into UK assets, then lesson #3 points to downside risks to UK growth, upside risks to the level of borrowing, inflation staying below target and rates remaining lower for longer. More simply, lesson #3 also suggests that official forecasts can/often do fail common sense tests (see also lesson #4).

“Seven key lessons from the money sector in 2020 – #2”

Balance sheets are at the heart of every economy

The key chart

Trends in EA financial sector balances since 2008 (Source: Eurostat; CMPP analysis)

Lesson #2

CMMP analysis focuses on the relationship between the financial sector and the wider economy i.e., households (HHs), corporates (NFCs), government and the rest of the world (RoW). The second lesson is that the core services provided by banks – payments, credit and savings – produce a stock of contracts that can be represented by financial balance sheets. These balance sheets link each of these economic agents over time and form a quantitative, objective and logical analytical framework.

A fundamental principle of accounting is that for every financial assets (FA) there is an equal and offsetting financial liability (FL). By definition, net financial wealth (NFW) is therefore equal to the sum of FAs less the sum of FLs. If we take all private sector FAs and FLs, it is also a matter of logic that the sum of all the assets must equal the sum of all the liabilities.

The key implication here is that for the private sector to accumulate NFW it must be in the form of claims against another sector i.e., governments, the RoW, or a combination of the two.

In the current climate of rising government deficits, this insight is crucial to debates over whether deficits: (1) are evidence of overspending; (2) a burden on future generations; and/or (3) crowd out private investment. The fact that the answers given to these questions are generally incorrect only goes to show how poorly the relationship between the financial sector and the wider economy is understood. It also explains why official economic forecasts can/often do fail common sense tests (lesson #3).

“Seven key lessons from the money sector in 2020 – #1”

Lousy LT investments, but…

The key chart

Relative performance of leading European banks (SX7E) versus the wider SXXE European index (Source: CMMP analysis)

Lesson #1

I started 2020 by arguing that the true value in analysing developments in the financial sector lies less in considering investments in developed market banks and more in understanding the wider implications of the relationship between the banking sector and the wider economy for corporate strategy, investment decisions and asset allocation. Banks have underperformed again (c20% YTD in Europe) but the messages from the money sector have been as important as ever.

First, a quantitative, objective and logical analytical framework developed from an understanding of basic banking services (payments, credit and savings) has demystified confused economic/political debate (MMT?), explained the need for major policy reboots and highlighted the flawed assumptions in recent official forecasts.

Second, monetary developments have continued to provide reliable leading indicators of economic activity (that link directly into asset allocation models), key insights into the behaviour of households and corporates over time and between regions, and warnings of hidden risks in emerging economies. Third, the mechanical link between money supply and inflation has been challenged and replaced by an explanation of what will be required for LT secular trends (eg, growth vs value) to be reversed in a sustainable fashion.

And all from the simple observation that, “everyone has a balance sheet” (see Lesson #2).