Europe – Page 9 – Chris Mallin Macro Perspectives

“More consistent than Rafa!”

Spanish MFIs’ record of negative contribution to EA mortgages

The key chart

**EA mortgage growth (% YoY) and contribution from Spanish MFIs (ppt)** (Source: ECB; CMMP)

The key message

Spanish MFIs have a more consistent record than Rafael Nada at Roland-Garros.

While Rafa has won eight of the last ten French Open men’s singles championships (2011-2020) and a record 13 titles in total, Spanish MFIs have delivered an unbroken decade of negative contributions to euro area mortgage growth.

120 consecutive months of negative contribution since April 2011.

While the YoY growth rate and contribution were both marginally negative in April 2021, the last three months have seen positive monthly flows. Are Spanish MFIs about to rejoin the EA mortgage party in 2021?

The latest bank lending survey suggests a neutral/slightly negative supply-side outlook but, in combination, four factors suggest a more positive demand-side outlook:

The HH debt ratio has fallen back in line with the EA average (63% GDP) following a decade of deleveraging
The cost of borrowing is at a record low (1.49% in April 2021)
From (1) and (2), the HH debt service ratio has fallen to 6.5%, below its LT average of 7.9% and close to a 20 year low
House prices remain 28% below their peak in real terms and estimated valuations are less extreme than elsewhere in the EA

None of these four factors are new in themselves and future developments remain “highly dependent on the recovery path and the ability of Spanish and EA policymakers to prevent cliff edges by not abruptly ending support measures” (ECB, 2021). Nonetheless, Spain remains the EA’s third largest mortgage market and mortgage debt represents c80% of total HH debt. A continued rebound in monthly mortgage flows and sustained positive contributions to EA mortgage growth would represent an important signal for investors positioned for a recovery in Europe.

More consistent than Rafa!

Spanish MFIs have a more consistent record than Rafael Nada at Roland-Garros. While Rafa has won eight of the last ten French Open men’s singles championships (2011-2020) and a record 13 titles in total, Spanish MFIs have delivered an unbroken decade of negative contributions to euro area mortgage growth – 120 consecutive months of negative contribution since April 2011 (see key chart above).

**Outstanding stock of mortgages provided by Spanish MFIs and market share of EA** (Source: ECB; CMMP)

The outstanding stock of mortgages has fallen 23% from €663bn in April 2011 to €508bn in April 2018 (slightly above January 2021’s recent low of €506bn). Over the same period, the outstanding stock of EA mortgages has risen 27% from €3,767bn to €4,798bn. The market share of Spanish MFIs has fallen from 18% to 11% due to these divergent growth trends (see chart above).

**Stable “collective” market shares masks significant differences between the big 4** (Source: ECB; CMMP)

As an aside, the market share of German, French, Spanish and Dutch MFIs has remained remarkably stable over this period at 75%. This aggregate share trends masks very different trends at the country level, however. The market shares of German and French MFIs have risen from 26% to 30% and from 21% to 25% respectively, while the market share of Dutch MFIs has remained constant at 11%.

**YoY growth in Spanish MFI mortgages** (Source: ECB; CMMP)

**Monthly mortgage flows – three consecutive positive months** (Source: ECB; CMMP)

While the YoY growth rate and contribution were both marginally negative in April 2021, the last three months have seen positive monthly flows (see charts above). Does this meant that Spanish MFIs are about to rejoin the EA mortgage party? The latest bank lending survey suggests a neutral supply-side outlook, but four factors suggest a more positive demand-side outlook: HH debt ratios; the cost of borrowing; HH debt service ratios; and house prices and valuation.

HH debt ratios

The HH debt ratio has fallen from 86% GDP (2Q10) to 63% GDP, in line with the EA average. To mix sporting metaphors horribly, the past two decades has been a “game of two halves”.

Twenty years ago, the HH debt ratios for the EA and Spain were similar at 49% GDP and 46% GDP respectively. At their respective peaks in 2Q10, these ratios had risen to 64% GDP and 86% GDP. (Note that the BIS considers 85% GDP to be the threshold level above which HH debt becomes a constraint on future growth.). By 4Q19, the EA and Spanish debt ratios had fallen back to 58% GDP and 57% GDP respectively and ended 2020 at the same level of 63% GDP. (Note also that the increase in the debt ratio in 2020 was driven by GDP falling more than the fall in debt levels.)

Sustained HH deleveraging was a key explanatory factor behind negative growth and contributions from Spanish MFIs in the past.

Cost of borrowing

The cost of borrowing has fallen to a new low of 1.49% (April 2021). The cost of borrowing has fallen 23bp YoY and recent press articles suggest increased price competition in May and June particularly from those MFIs that lost market share during the lockdown.

**Fixed versus floating** (Source: ECB; CMMP)

Price competition is particularly strong in the fixed mortgage market. Spain has historically had a bias towards more floating rate lending than other EA economies (see chart above). However, in April 2021, the share of mortgages with a floating rate or an initial fixation of up to one year fell to 28%, slightly above the record low of 27% in March. For reference, the share of floating rate mortgage loans in the EA also hit a new low in April at 15% to total mortgage loans.

HH debt service ratios (affordability)

**Affordability risk close to twenty year low** (Source: BIS; CMMP)

The HH debt service ratio (DSR) in Spain is currently 6.5% (as at end 4Q20). This compares with a peak level of 11.7% in 3Q08 and a LT average of 7.9%. With lower debt ratios and record low costs of borrowing, it is unsurprising that affordability is not a significant demand constraint for Spanish HHs, currently.

House prices and (over)valuation

**Real YoY growth in house prices over past 20 years** (Source: BIS; CMMP)

**Real house price index trends 2010 = 100** (Source: BIS; CMMP)

House prices are 28% below their peak in real terms and valuations less extreme than elsewhere in the EA.

Spanish house prices peaked in 3Q07. They did not recover in real terms until 2Q14, almost seven years later. Despite the recovery since then, prices remain 28% below their peak level in real terms.

**Overvaluation estimates as at end 2020** (Source: ECB; CMMP)

In “Herd immunity”, I noted the resilience and risks in global housing since the COVID-19 pandemic hit, especially in advanced economies, and the fact that some of the largest increases in EA house prices during 2020 had occurred in economies where house prices were also among the most overvalued (Luxembourg, Denmark, Austria). According to ECB estimates, house prices in Spain are overvalued by around 5%, a more modest level than elsewhere in the region.

Conclusion

None of the four factors highlighted above are new in themselves and future developments remain “highly dependent on the recovery path and the ability of Spanish and EA policymakers to prevent cliff edges by not abruptly ending support measures” (ECB, 2021). Nonetheless, Spain remains the EA’s third largest mortgage market and mortgage debt represents c80% of total HH debt. A recovery in mortgage demand and sustained positive contributions to EA mortgage growth would represent an important signal of a recovery in the EA.

“Vamos, Rafa” – good luck in Friday’s semi-final against Novak!

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

“Consistent messages through atypical cycles”

Synchronised messages from the UK and EA money sectors

The key chart

**Don’t misread the messages from macro variables – this is an atypical cycle** (Source: BoE; ECB; CMMP)

The key message

It is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

Headline growth figures in key macro variables, including monetary aggregates, have been open to misinterpretation, leading to many false narratives regarding their implications for investment decisions and asset allocation. In this context, CMMP analysis has gone beyond the headlines to identify three key signals that help to interpret current trends in the UK and EA effectively. These signals focus on HH behaviour, the consumption/growth outlook and the policy context.

The messages from the UK and EA money sectors are remarkably consistent in direction if not in magnitude.

Monthly HH deposit flows are moderating in both regions (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (n.b. the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however (key signal #3). The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

Sustained recoveries require further moderations in HH deposit flows, a recovery in consumer credit, and a resynchronisation in money and credit cycles. The UK displays higher gearing than the EA to each of these key drivers but is lagging the EA in terms of positive signals so far…

Consistent messaging through atypical cycles

The UK and euro area (EA) money sectors have provided consistent messages regarding household (HH) behaviour, the consumption/growth outlook and the policy context in their respective regions throughout the COVID-19 pandemic.

**HH monthly money flows as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

Monthly HH deposit flows provide important insights into HH behaviour. During the pandemic, HHs in both regions increased their money holdings at elevated rates, despite earning negative returns. This behaviour contributed to neither growth nor inflation.

Deposit flows declined in both regions at the start of 2Q21 (see chart above). In the EA, monthly flows fell to €19bn in April 2021 from €62bn in March 2021. This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019. In the UK, monthly flows fell to £11bn in April 2021 from £16bn in March 2021, the smallest net flow since September 2020. While the direction of travel is the same in both regions, monthly money flows in the UK remain 2.3x above their 2019 average of £5bn.

**YoY growth rates in consumer credit** (Source: BoE; ECB; CMMP)

While uncertainty is falling in both regions, consumption remains subdued. On a positive note, the YoY growth rate in consumer credit in the EA turned positive (0.3%) for the first time since August 2020 (see chart above). In contrast, growth remained negative in the UK (-5.7%) albeit less negative than the historic low of -10% recorded in February 2021.

That said HHs in both regions repaid consumer credit during April 2021 (see chart below). While this is not a positive signal for growth, the scale of repayments is slowing at least. In the UK, for example, net repayments of £0.4bn was less than seen on average each month over the previous year (£1.7bn).

**Monthly flows in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

The policy context remains challenging, however, especially for central bankers. The effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates. The desynchronization of money and credit cycles during the pandemic was unprecedented in both the UK and the EA.

**Trends in the gap between growth in lending and growth in money supply** (Source: BoE; ECB; CMMP)

The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11ppt in the UK in February 2021 and 8ppt in the EA in January 2021. These gaps narrowed to 9ppt and 6ppt respectively in April. Nevertheless, they remain very wide in a historic context (see chart above).

Conclusion

To repeat, it is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.

The messages from the UK and EA money sectors are remarkable consistent in direction if not in magnitude. Monthly HH deposit flows are moderating (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (and the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however. The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.

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

“Herd immunity?”

Resilience and risks in global housing

The key chart

**Trends in global house prices since the GFC** (Source: BIS; CMMP)

The key message

Anyone looking for evidence of COVID-19 “herd immunity” need look no further than global housing markets!

House prices rose 4% globally in 2020 in real terms, the fastest rate of growth since the GFC. Prices rose 7% in advanced economies, compared with a more modest 2% in emerging economies. House price resilience during the pandemic reflects many factors: a recovery in HH incomes thanks to continued policy support; lower borrowing costs; reduced supply as construction activity slowed; temporary tax breaks; and perceptions that housing was/is a relatively safe investment.

The combination of rising prices and an uncertain macro backdrop has kept measures of overvaluation elevated. In the euro area, for example, above average increases in house prices occurred in Luxembourg, Slovakia, Estonia, Portugal, Denmark, Austria, the Netherlands and France. With the exception of Estonia, estimates suggested overvaluation in each of these countries before the start of 2020, notably in Luxembourg, Denmark and Austria. Similarly, the Bank of England indicated unease about the UK housing market recently (1 June 2021) after the Nationwide Building Society said that prices were growing at their fastest pace since 2014.

Current EA housing and lending dynamics reflect Minsky’s hypothesis that, over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors. The flow of funds towards property and financial asset markets (FIRE-based lending) is increasing at the expense of more productive flows to the real economy (COCO-based lending). FIRE-based lending in the EA hit a new high of €5,905bn in April 2021 and accounts for 52% of total lending with negative implications for leverage, growth, stability and income inequality.

Resilience and risks in global housing

Anyone looking for evidence of COVID-19 “herd immunity” need look no further than global housing markets! House prices rose 4% globally in 2020 (in real terms) according to latest BIS data release, the fastest rate of growth since the GFC. Prices are now 21% higher than their average after the GFC (see chart below).

**Real price change in 2020 plotted against real price change since the GFC** (Source: BIS; CMMP)

Prices rose 7% in “advanced economies” (especially New Zealand, Canada, Denmark, Portugal, Austria, Germany, US) compared with a more modest 2% in “emerging economies.” The resilience of housing markets reflects many factors: a recovery in HH incomes thanks to continued policy support; lower borrowing costs; reduce supply as construction activity slowed; temporary tax breaks; and the perceptions that housing was/is a relatively safe investment.

**EA trends – 2020 price change ploted against valuation at end-2019** (Source: ECB; CMMP)

The key risk here is that the combination of rising prices and an uncertain macro backdrop have kept measures of overvaluation elevated.

In their latest Financial Stability Review, for example, the ECB notes that “house price growth during the pandemic has generally been higher for those countries that were already experiencing pronounced overvaluation prior to the pandemic (see chart above).”

The largest/above average increases in house prices during 2020 in the EA occurred in Luxembourg (17%), Slovakia (16%), Estonia (9%), Portugal (9%), Denmark (9%), Austria (7%), the Netherlands (7%) and France (6%). With the exception of Estonia, ECB estimates suggest that house prices were overvalued in each of these countries before the start of 2020, notably in Luxembourg (39% overvalued, not shown in graph above), Denmark (16% overvalued) and Austria (15% overvalued).

On the 7 June 2021, the BIS will release 4Q20 credit and affordability data which will provide further insights into the risks associated with housing trends in the EA and the rest-of-the-world.

**The rise in FIRE-based lending in the euro area** (Source: ECB; CMMP)

In recent posts, I have noted an adaptation of Hyman Minsky’s hypothesis that states that over the course of a long financial cycle, there will be a shift towards riskier and more speculative sectors.

Minsky’s theory can be applied to the house price trends described above and to HH lending trends described in previous posts. Minsky’s “shift” is reflected in the decline in bank credit to the real sector (COCO-based credit) and an increase in funds flowing towards property and financial asset markets (FIRE-based credit).

FIRE-based lending in the EA hit a new high of €5,905bn in April 2021 and accounts for 52% of total lending with negative implications for leverage, growth, stability and income inequality.

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

“Has HH uncertainty peaked?”

An important first step in the road to euro area recovery

The key chart

**HH monthly money flows as a multiple of 2019 average monthly flows** (Source: ECB; CMMP)

The key message

The key message from the money sector at the start of 2Q21 is that the euro area (EA) has taken an important first step in the road to a sustained recovery.

**Trends in M3 growth (% YoY) and contributions (ppt) from M1 and private sector credit over the past twenty years** (Source: ECB; CMMP)

Recall that the rapid expansion in monetary aggregates during the COVID-19 pandemic was a reflection of DEFLATIONARY forces not inflationary ones, as some argue. Households (HHs) increased their money holdings (boosting M1 and M3) while simultaneously slowing consumption and repaying consumer credit. The key point here was that money sitting idly in overnight deposits contributed to neither growth nor inflation. This time, it really was different (see chart above)!

**Trends in monthly HH deposit flows since January 2021** (Source: ECB; CMMP)

At the start of 2Q21, monthly HH deposits flows fell to €19bn in April 2021 from €62bn in March 2021 (key signal #1).

This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019.

A sustained reduction in monthly deposit flows would indicate reduced uncertainty/improved confidence with positive implications for future consumption and economic growth.

**Trends in HH consumer credit since January 202**0 (Source: ECB; CMMP)

On a more cautious note, HHs repaid another €1bn of consumer credit (key signal #2) in April 2021, suggesting that the path to recover is still at a very early stage. The YoY growth rate in consumer credit turned positive (0.3%) for the first time since August 2020, but this was due to base effects and was despite the negative monthly flow (see chart above). HHs have repaid consmer credit in six of the past nine months.

**The widening gap between growth in lending and growth in money supply** (Source: ECB; CMMP)

Similarly, while the gap between money growth and credit growth (key signal #3) has narrowed from its recent historic high of 8ppt in January 2021 to 6ppt in April, it remains very high in a historic context (see chart above). Note that the YoY growth rate in adjusted loans to the private sector decreased to 3.2% in April 2021 from 3.6% in March 2021. Loans to NFCs fell from 5.3% to 3.2% while loans to HHs increased from 3.3% to 3.8% over the month (see chart below).

**Trends in mortgage, consumer credit and NFC lending since January 2019** (Source: ECB; CMMP)

In short, one of the three key signals for 2021 has turned positive, while the other two are “less negative.” Not time for Meatloaf to re-release an old hit yet, but welcome signs nonetheless since investment narratives require consistent refuelling.

In my next post, I will explore how and where investment risks may have shifted in the meantime.

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

“Making sense…”

Interpreting 1Q21 monetary trends in the UK and EA

The key chart

**Trends in YoY growth rates for UK and EA broad money** (Souce: BoE; ECB; CMMP)

The key message

Trends in monetary aggregates provide important insights into the interaction between the money sector and the wider economy. Headline growth figures can easily be misinterpreted, however, leading to false narratives regarding their implications for investment decisions and asset allocation.

To avoid this, CMPP analysis has identified three key signals that help to interpret current trends in the UK and euro area (EA) effectively: monthly household (HH) deposit flows (behaviour); the synchronisation of money and credit cycles (policy context); and consumer credit (growth outlook).

The UK and EA money sectors have provided consistent, if subdued, messages regarding HH behaviour, the policy context and the consumption/growth outlook during 1Q21:

HHs in the UK and EA continue to increase their money holdings at very elevated rates, despite earning negative returns. Such behaviour contributes to neither growth nor inflation – a challenge for inflation hawks
The unprecedented desynchronization of money and credit cycles continues to limit monetary policy effectiveness
HHs are still repaying consumer credit and YoY growth rates hit historic lows during 1Q21

The key messages from the money sectors (summarised above) have provided only limited nourishment for those positioned for sustained inflation and/or cyclical recovery in the UK and EA to date.

March data provided tentative encouragement in terms of the direction of travel but more substantive support may be required in 2Q21 to sustain recent performance.

Rather than focusing on headline growth numbers in broad money, investors should look instead for a more noticeable moderation in HH deposit flows, a resynchronisation in money and credit cycles and a recovery in consumer credit over the coming months.

Making sense of monetary aggregates

The CMMP approach

Trends in monetary aggregates provide important insights into the interaction between the money sector (central banks, FIs and NBFIs) and the wider economy. Headline YoY growth figures can easily be misinterpreted, however, leading to false narratives regarding their implications for investment decisions and asset allocation.

To avoid this, CMPP analysis has identified three key signals that help to interpret current trends in the UK and EA effectively: monthly HH deposit flows (behaviour); the synchronisation of money and credit cycles (policy context); and consumer credit (growth outlook).

A review of 1Q21

The UK and EA money sectors have provided consistent, if subdued, messages regarding household (HH) behaviour, policy effectiveness and the consumption/growth outlook during 1Q21.

**Monthly HH deposit flows as a multiple of 2019 average monthly flows** (Source: BoE; ECB; CMMP)

HHs in the UK and EA continue to increase their money holdings at elevated rates, despite earning negative returns. UK and EA monthly flows of HH deposits are still 3.5x and 1.9x the levels seen in the pre-COVID periods. These latest data points for March 2021 are below the respective peaks of 5.8x (May 2020) and 2.4x (March 2020) for the UK and EA respectively. Nonetheless, they show that HHs are still preferring to hold highly liquid assets (overnight deposits), despite earning negative real returns.

High levels of precautionary and forced savings indicate that HH uncertainty remains elevated and consumption delayed (see below). The challenge here for inflation hawks is that money sitting idly in overnight deposits contributes to neither GDP growth nor inflation.

**Gap between lending growth and money growth in the UK and EA** (Source: BoE; ECB; CMMP)

The unprecedented desynchronization of money and credit cycles continues to limit monetary policy effectiveness. The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11.4ppt in the UK in February and 8.0ppt in the EA in January. This matters because the effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates.

The latest data for March 2021, indicates that the gaps have narrowed slightly to 10.8ppt in the UK and 6.5ppt in the EA. Again, inflation hawks will be disappointed, however, by the slowdown in the growth rates in private sector credit. In the UK, this fell from 3.9% YoY in February to only 1.5% YoY in March and in the EA, from 4.5% YoY in February to 3.6% in March.

HHs are still repaying consumer credit and YoY growth rates hit historic lows during 1Q21. In the UK, HHs have repaid consumer credit for seven consecutive months. In the EA, they have repaid consumer credit in five of the past seven months.

**YoY growth rates in UK and EA consumer credit** (Source: BoE; ECB; CMMP)

In both regions, the YoY growth rate hit a historic low in February of -10.0% in the UK and -2.8% in the EA before. In March the rate of decline slowed to -8.6% and -1.7% in the UK and EA respectively.

Investment implications

Investment narratives, like endurance athletes, require consistent refuelling to maintain performance. The best returns from equities are typically when economies are still weak but the rate of growth is either inflecting upwards or looking less weak. If such trends are accompanied by rising bond yields then cyclical sectors/stocks will typically outperform defensive sector/stocks (Oppenheimer, 2020). The key messages from the money sectors (summarised above) have provided only limited nourishment for those positioned for sustained inflation and/or cyclical recovery in the UK and EA in 2021 to date.

What to watch for in 2Q21

March data provided tentative encouragement in terms of the direction of travel but more substantive support may be required in 2Q21 to sustain recent performance. Rather than focusing on headline growth numbers in broad money, investors should look instead for a more noticeable moderation in HH deposit flows, a resynchronisation in money and credit cycles and a recovery in consumer credit over the coming months.

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

“1Q21 update from the EA money sector”

Money growth peaked, but the message remains unchanged

The key chart

**What are the messages from the money sector as money growth peaks?** (Source: ECB; CMMP)

The key message

At the end of 1Q21, the cyclical and structural messages from the EA money sector remain unchanged. In terms of ST tactical trends and the outlook for 2021, we are looking for evidence of: (1) a moderation in HH deposit flows; (2) a resynchronisation of money and credit cycles; and (3) recovery in consumer credit. In terms of LT secular trends, we focus on the split between more productive COCO-based and less productive FIRE-based lending and the hidden risks of QE.

HH deposit flows remain almost double the levels seen pre-COVID and the enduring preference for holding highly liquid assets (despite their negative real returns) indicates persistently high levels of HH uncertainty. The gap between the money and credit cycles (evidenced in banks’ 1Q21 earnings) has stopped widening but remains very significant. Finally, consumer credit is still falling (and HHs repaid credit again in March) but at a slower rate than earlier in the quarter. In short, investors positioned for a sustained upturn in EA inflation will need to be patient still.

Resilient mortgage demand has been a key feature in an otherwise lacklustre retail banking sector (as in the UK). The 5.0% YoY increase in EA mortgages in March was the fastest rate of growth since May 2008. Mortgages are the largest segment of FIRE-based lending, which reached a new high of €5,891bn at the end of March, up 28% from its January 2009 level, and represented almost 52% of total lending. More productive COCO-based lending totalled €5,478bn, lower than its January 2009 peak of €5,517bn. COCO-based lending’s share of total lending has fallen from 55% to 48% of total lending over this period. The ECB is correct to highlight the positive impact of unorthodox monetary policy in terms of keeping borrowing affordable and supporting access to credit for NFCs and HHs. That said, the hidden risks of QE in “fuelling the fire” and their negative implications for leverage, growth, financial stability and income inequality in the EA should not be overlooked.

Money growth may have peaked, but the core messages from the money sector remain unchanged.

The core messages in six key charts

Key signals for 2021

**Persistent HH uncertainty reflected in monthy deposit flows** (Source: ECB; CMMP)

**The gap between the money and credit cycles has narrowed slightly, but remains significant** (Source: ECB; CMMP)

**HHs are repaying consumer credit but YoY declines are slowing** (Source: ECB; CMMP)

FIRE-based lending and the hidden risks of QE

**FIRE-based lending hits a new high at the end of 1Q21** (Source: ECB; CMMP)

**COCO-based lending is still lower than its 2009 peak** (Source: ECB; CMMP)

**By fuelling the fire, QE brings hidden risks that investors should not forget** (Source: ECB; CMMP)

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

“Time to refuel”

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…

“Little cheer yet II – the UK”

UK – EA in harmony…

Another short key message

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.

What would Vladimir and Estragon have to say?

“Little cheer yet…”

Key signals revisited in February

A short key message

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.

“Beyond the headlines”

Growth, affordability (and structure) matter too

The key chart

**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.

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.

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.