The recovery in NFC credit demand is a positive sign but masks the widening volume gap between large corporate and SME funding (% YoY, £25m annual turnover threshold) Source: Bank of England; CMMP analysis
Summary
UK corporate lending grew 11% in April 2020; the fastest rate of growth since July 2008 and in direct contrast to slowing trends in the household sector. April’s monthly change was lower than March’s “dash for cash” but was still double the monthly amounts borrowed over the previous six months. The cost of borrowing also fell to the lowest level since December 2010. NFCs are also increasing financing from bonds, commercial paper and, to a lesser extent, equities.
Behind these positive trends, the gap between large NFCs and SMEs is widening in volume terms. SMEs are benefitting from lower borrowing costs but volumes remain low and growth subdued. Furthermore, only 24p in every £ lent in the UK is directed to the NFC sector. More concerning, 77p in every pound is directed at less-productive FIRE-based lending (FIs and real estate).
The fact that NFCs are accessing finance in larger volumes and at lower costs is welcome, but the widening gap between large NFCs and SMEs and the on-going concentration of lending in less-productive sectors means that headline numbers are not as positive as they appear at first.
Mind the financing gap
In April, NFC lending grew at the fastest rate (11% YoY) since July 2008, in contrast to slowing growth (3% YoY) in the HH sector Source: Bank of England; Haver; CMMP analysis
UK corporate (NFC) lending grew 10.7% YoY in April 2020, the fastest rate of growth since July 2008. This was in contrast to trends in the household (HH) sector, where credit growth slowed to only 2.5%, the slowest rate of growth since June 2015.
M4L in the NFC sector rose £8.4bn in April versus £4.3bn average over the previous six months Source: Bank of England; CMMP analysis
Outstanding NFC loans grew by £8.4bn in April. This was lower than the £30.2bn raised in March but was still approximately double the average amounts borrowed over the previous six months (£4.3bn). The cost of (new) borrowing for NFCs fell to 2.26%, the lowest rate since December 2010 and 30bp lower than in February.
NFCs raised £32bn and £16bn from banks and financial markets in March and April 2020 respectively, versus an average of £3bn over the past three years Source: Bank of England; CMMP analysis
Looking at wider financing trends, NFCs raised a total of £16.3bn from financial markets in April, down from the £31.6bn raised in March but still above the average monthly financing of £3.2bn seen over the past three years. After March’s “dash for cash” from banks, NFC repaid £1.0bn of bank loans in April but raised £7.7bn in bonds and £7.0bn in commercial paper (including finance raised through the Covid Corporate Financing Facility) and £1.4bn in equity.
After March’s “dash for cash” from banks, NFCs turned to the bond and commercial paper markets in April (£bn) Source: Bank of England; CMMP analysis
These positive trends mask that (1) the gap between large corporates and SMEs is widening sharply in volume terms and, that (2) NFC lending remains a relatively small part of UK bank lending. SMEs are benefitting from lower borrowing costs: the effective rate on new loans to SMEs fell by 52bp to 2.49% in April the lowest level since 2016 (when the BoE series began) and almost 100bp below the 3.44% cost of borrowing in February. SMEs borrowed £0.3bn in April and March but this is only 1.2% higher than a year earlier.
SME credit growth is above recent average but remains subdued in absolute terms (% YoY) Source: Bank of England, CMMP analysis
Despite the rise in NFC lending described above, only 24p in every £ of UK lending is lent to the NFC sector. Alternatively, using my preferred distinction between more productive “COCO-based” and less-productive “FIRE-based” lending, 77p in every pound lent in the UK is directed at financial institutions and real estate with obvious negative implications for leverage, growth, stability and income inequality.
Conclusion
The fact that UK corporates are accessing finance in larger volumes and at lower costs is welcome. Nonetheless, the widening gap between large corporate and SME financing is of concern as is the fact that UK lending remains concentrated in less-productive FIRE-based lending. This week’s Bank of England data contained good news for sure, but not to the extent that headline numbers might suggest.
Please note that summary comments above are extracts from more detailed analysis that is available separately.
Messages from the money sector III – UK Households
The key chart
Risks to UK growth and bank lending from the HH sector rose sharply at the start of 2Q20 (% YoY) Source: Bank of England; CMMP analysis
Summary
Risks to the UK growth outlook and bank lending from weakness in the household (HH) sector were evident before the Covid-19 pandemic hit. The “message from the money sector” (and from this week’s Bank of England monetary data) is that these risks rose at unprecedented rates at the start of 2Q20.
HHs increased deposit holdings in April 2020 by four-times the average monthly amount seen over the past two decades, despite negative real deposit rates. At the same time, they repaid debt in record amounts, notably consumer debt. Mortgage approvals also collapsed and mortgage lending grew at the lowest monthly rate since December 2011.
While it is dangerous to over-interpret one month’s data, the early message is clear: with UK HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.
Caution not consumption
In “Poised to disappoint”, I highlighted the dominant role that HHs play in UK economic activity (FCE/GDP) and bank lending (the desire to buy properties). The HH sector had been funding recent consumption by dramatically reducing its savings rate and accumulation of net financial assets. With real growth in disposable income slowing and the savings rate close to historic lows, I concluded that the risks to UK growth lay to the downside even before Covid-19 hit.
Extreme caution – HH deposits rise at 4x the average monthly rate seen over the past twenty years (£mn) Source: Bank of England; Haver; CMMP analysis
The current “message from the money sector” is that these risks have risen sharply and at an unprecedented rate. April’s monetary aggregates (released on 2 June 2020) showed that HHs increased their holdings of deposits by £16bn in April 2020, a rate that is 4x the size of the average monthly increase of the past twenty years and despite negative real rates of return.
Trends in UK HH deposit rates in nominal and real terms – rates remain negative in real terms but less so than in the recent past Source: Bank of England; Haver; CMMP analysis
Interest rates on new time deposits fell 15bp to 0.98% while rates on sight deposits fell slightly to 0.41%. Deposit rates remain negative in real terms but less so than in the recent past due to the decline in inflation below 1.0%. The key message here is the HH sector’s rising preference for liquidity indicates very high levels of caution and a low appetite for risk.
HHs repaid twice as much consumer credit in April than in March (£bn LHS, % growth YoY RHS) Source: Bank of England; CMMP analysis
At the same time, HHs are repaying debt in record amounts most notably consumer debt. They repaid £7.4bn of consumer debt in April 2020, twice the amount repaid in March. These repayments were the largest net repayments since the series began and unprecedented in scale (see graph below).
Current repayment levels are the largest since the series began and unprecendented in scale (£bn) Source: Bank of England; Haver; CMMP analysisConsumer credit now growing at the slowest rate since August 2012 (% YoY) Source: Bank of England; Haver; CMMP analysis
The largest repayments (£5.0bn) were on credit cards, but HH also repaid £2.4bn of “other loans” (eg, car finance). In March and April, credit cards fell -0.3% and -7.8% YoY compared with 3.5% growth in February. Growth in other loans fell from 6.8% in February to 5.6% in March and 3.1% in April. While the slowdown in consumption is not surprising, its scale and pace send important signals regarding the hit to future consumption.
Within consumer credit, credit cards were hit hardest (% YoY) Source: Bank of England; CMMP analysis
The money sector is also sending important messages about weakness in the housing market. Approvals for house purchase and remortgage have fallen 78% and 34% since February. Lending has also fallen rapidly. New mortgage borrowing fell 38% from £23.1bn in February to £14.1bn in April. At the same time, repayments also fell 26% from £18.8bn to £13.bn, reflecting (in part) the effect of payment holidays.
Trends in approvals (January – April 2020) show volumes collapsing in two months Source: Bank of England; CMMP analysis
With gross lending falling faster than repayments, net mortgage borrowing rose by only £0.3bn in April compared with an average rise of £4.5bn over the previous six months. This net increase was the lowest since December 2011.
April’s net increase in mortgages (£0.3bn) was the slowest since December 2011 Source: Bank of England; CMMP analysis
Conclusion
It is dangerous to over-interpret one month’s data. Nevertheless, the early 2Q20 message from the money sector is clear: with HHs displaying “extreme caution not consumption” and repaying debts despite low costs of borrowing, the on-going risks to a v-shaped recovery and to the UK banking sector profitability have risen sharply.
Please note that the summary comments above are extracts from more detailed analysis that is available separately.
Appropriate and necessary responses cannot hide on-going vulnerabilities
The key chart
Government debt ratios are expected to increase to new highs and by more than in response to the GFC- breakdown by region in percentage points for 2020 Source: IMF; CMMP analysis
Policy makers have introduced extraordinary fiscal and monetary policy measure in response to the crisis that have, in many cases, exceeded the measures introduced in the aftermatch of the GFC. These measures have been appropriate and necessary but cannot hide on-going regional and country vulnerabilities. Despite relatively high debt levels, advanced economies are positioned better than emerging and LIDC economies thanks to their ability to borrow at historically low rates that are likely to remain even after Covid-shutdowns end.
The EA policy response has been impressive in scale but assymetric in delivery and risk. Government debt levels across the EA are forecast to increase by between 4ppt and 24ppt taking the aggregate government debt ratio above 100% GDP. A major complicating factor here, is that the countries with the weakest economies, which includes those that have been hit hardest by the virus, have limited fiscal headroom to do “whatever it takes” to stimulate their economies. The sustainability of government debt levels in these economies is at risk of a more severe and prolonged downturn. The enduring myth that this is “the hour of national economic policy” means that this risk cannot be fully discounted. While the balance of power is shifting towards a common-European solution, execution risks remain.
Investment returns, including the impact of country and sector effects, will be driven by how this debate concludes as will the future of the entire European project.
Responses and vulnerabilities
The level, growth, affordability and structure of debt are key drivers of LT global investment cycles with direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options; investment risks and asset allocation.
Global debt levels and debt ratios were already at, or close to, all-time highs when Covid-19 hit Source: BIS; Haver; CMMP analysis
Global debt levels and debt ratios were at all time highs (levels), or very close to them (ratios), when the Covid-19 pandemic hit global economies. At the end of 2019, global debt totalled $191trillion of which $122trillion (64%) was private sector debt and $69trillion (36%) was public sector debt. Private sector debt included $57trillion (46%) of debt from advanced economies excluding the euro area (EA), $23trillion (18%) of EA debt, $15trillion (12%) of debt from emerging economies excluding China and $29trillion (24%) of Chinese debt.
“Global debt is shifting east” – trends and breakdown of private sector debt 1999-2019 ($billions) Source: BIS; Haver; CMMP analysis
The breakdown of global debt is largely unchanged since previous analysis. The total debt ratio (debt as a % of GDP) was 243% at the end of 2019, very close to its 3Q16 high of 245% GDP. Similarly, the global PSC debt ratio of 156% was also very close to its 3Q18 high of 159% of GDP. Total EM and Chinese debt ratios both hit new highs of 194% GDP and 259% of GDP respectively.
Trends in global and EA total debt and PSC debt ratios since 2004 – develeraging in the EA began later and has been more gradual than in other advanced economies Sourrce: BIS; Haver; CMMP analysis
The exception here was the euro area (EA) which remained, “trapped by its debt overhang and out-dated policy rules.” EA total debt and private sector debt ratios both peaked in 3Q15 at 281% and 172% respectively. At the end of 2019 these ratios had fallen to 262% and 165% respectively but remained above the respective global averages of 245% and 156%. As detailed in “Are we there yet?”, high debt levels help to explain why money, credit and business cycles in the EA are significantly weaker than in past cycles, why inflation remains well below target, and why rates have stayed lower for longer than many expected. In spite of this, the collective pre-crisis fiscal policy of the EA nations was (1) about as tight as any period in the past twenty years and (2) was so at a time when the private sector was running persistent net financial surpluses (largely above 3% GDP) since the GFC. A policy reboot in the EA was overdue even before the pandemic hit.
Covid-19 elevated the need for fiscal policy action to unprecedented levels (global budget deficit as a percentage of GDP, broken down by region) Source: IMF; CMMP analysis
Policy makers have introduced extraordinary fiscal and monetary policy measures in response to the crisis that have, in many cases, exceeded the measures introduced in the aftermath of the GFC. IMF forecasts suggest that the aggregate, global fiscal deficit will total -6.5% of GDP in 2020e versus -4.9% in 2009. The US will be the main driver (-2.37% GDP 2020e versus -1.63% 2009), followed by the EA (-1.01% GDP versus -0.85% GDP), China (-1.0% GDP versus –0.15%), emerging economies (-0.65% GDP versus -1.09% GDP) and the RoW (-1.17% GDP versus -1.20% GDP).
Global debt ratios expected to hit new highs (% GDP) in 2020e Source: IMF; CMMP analysis
As a result, government debt ratios are expected to reach new highs in 2020e of 96% of GDP a rise of 13ppt over 2019. Advanced economies’ government debt is expected to reach 122% GDP versus 105% in 2019 and 92% in 2009. Emerging markets’ government debt is expected to reach 62% GDP versus 53% in 2019 and 39% in 2009. LIDC government debt is expected to reach 47% GDP versus 43% in 2019 and 27% in 2009.
EM and LIDC debt levels remain relatively low in comparison with advanced economies, but are growing rapidly in contrast to more stable trends in advanced economies Source: IMF; CMMP analysis
While these responses have been necessary and appropriate, they have also exposed underlying vulnerabilities relating to the starting position of individual regions and countries with the advanced world being having greater reslience than emerging and LIDC economies (IMF classifications). The effectiveness of fiscal responses is a function of the level of debt, the cost of servicing that debt, economic growth and inflation. While debt levels in emerging and LIDC ecomomies remain relatively low in comparision with advanced economies they have continued to grow rapidly in contrast to the more stable trends in advanced economies (at least up until 2020).
LIDC borrowing costs have risen sharply and have become more volatile (interest expense to tax revenue) Source: IMF; CMMP analysis
Governments in advanced economies are able to borrow at historically low rates and these rates are forecast to remain low for a long period even after the Covid-induced shutdowns end (IMF, Global Financial Stability Review, April 2020). In contrast, for many frontier and emerging markets (and, at times, some advanced economies), borrowing costs have risen sharply and have become more volatile since the coronavirus began spreading globally (IMF, Fiscal Monitor, April 2020). These contrasting trends are illustrated in the graph above which shows IMF forecasts of LIDC interest to tax revenue ratios increasing from 20% in 2019 to 33% in 2020e. This compares with a ratio of 12% in 2009 and the current ratio of 10% for advanced economies (which is largely unchanged since 2009 despite the increase in government debt levels).
Trends in EA budget deficits (% GDP) – the EA policy response has been impressive in scale Source: European Commission; Haver; CMMP analysis
The EA policy response has been impressive in scale but assymetric in delivery and risk. All member states have introduced fiscal measures aimed at supporting health services, replacing lost incomes and protecting corporate sectors. Measures have included tax breaks, public investments and fiscal backstops including public guarantees or credit lines. According to European Commission forecast, the 2020e budget deficit for the EA will total -8.5% of GDP but will vary widely from between -4.8% in Luxembourg to -11.1% in Italy. The ECB notes that, while this projected headline is signficantly larger than during the GFC, it is comparable to the relative decline in GDP growth.
Debt levels across the EA are forecast to increase by between 4ppt (Luxembourg) and 24ppt (Italy), taking the aggregate EA government debt ratio to 103% GDP in 2020e. In its May 2020 Financial Stability Review, the ECB also notes that a number of countries, including Italy, Spain, France, Belgium and Portugal, “face substantial debt repayments needs over the next two years”. The key point here is that while current fiscal measures are important in terms of mitigating against the cost of the downturn and hence providing some defence against debt sustainability concerns, a worse-than-expected recession would give rise to debt sustainability risks in the medium term.
“Limited headroom” – forecast changes in government debt to GDP ratios plotted against 2019 actual debt to GDP ratios Source: European Commission; Haver; CMMP analysis
A major complicating factor here is that the countries with the weakest economies, which includes those that have been hit hardest by Covid-19, have limited fiscal headroom to do whatever it takes to stimulate their economies. The largest percentage point increased in government debt ratios are forecast to occur in Italy (24ppt), Greece (20ppt), Spain (20ppt) and France (18ppt) – compared with an increase of 17ppt for the EA as a whole – economies that ended 2019 with above average government debt to GDP ratios (135%, 177%, 95% and 98% GDP respectively).
Differences in funding costs for different EA economies versus Germany (spread in respective 10Y bond yields in ppt, 26 May 2020) Source: Haver; CMMP analysis
The sustainability of government debt levels in already highly indebted EA countries would be put at risk by a more severe and prolonged economic downturn. Funding costs are already higher in Greece (2.1ppt), Italy (2.0ppt), Spain (1.2ppt) and Portugal (1.1ppt) than in Germany based on current 10Y bond yields and more volatile – see graph of the spread between Italian and German 10Y bond yields below.
The spread between Italian and German 10Y bond yields continues to be volatile, highlighting the on-going debt sustainability risks (spread in ppt) Source: Haver; CMMP analysis
The enduring myth that this is “the hour of national economic policy” means that these risks cannot be discounted. The May 2020 Bundesbank Monthly Report states, for example, that, “fiscal policy is in a position to make an essential contribution to resolving the COVID19 crisis. [But] This is primarily a national task.” This view is also supported by the so-called “frugal four” ie, the Netherlands, Austria, Denmark and Sweden who have been opposed to various “common solutions”, most recently the EC proposal to issue joint debt to fund grants to those countries hit hardest by the crisis.
The EC is supported, however, by the ECB. In a recent interview, Christine Lagarde, the President of the ECB, argues that, “The solution, therefore, is a European programme of rapid and robust fiscal stimulus to restore symmetry between the countries when they exit from the crisis. In other words, more help must be given to those countries that need it most. It is in the interests of all countries to provide such collective support.”
The balance of power is shifting towards a common-European solution recently but execution risks remain. As I write this post (27 May 2020), Ursual von der Leyen, the EC President, has announced plans to borrow €750bn to be distributed partly as grants (€500bn) to hard-pressed member states – the “Next Generation EU” fund. Added to her other plans, this would bring the total EA recovery effort to €1.85trilion.
The scale of this intervention/borrowing is unprecedented and includes plans to establish a yield curve of debt issuance with maturities out to 30 years. Repayments would not start until 2028 and would be completed by 2058. France’s President Macron was among EA leaders who quickly welcomed this proposal and pressure is mounting on the so-called “frugal four” countries – Austria, Denmark, the Netherlands and Sweden – to soften their opposiion to the use of borrowed money for grants.
Investment returns, including the impact of country and sector effects, will be driven to a large extent by how this debate concludes, as will the future of the entire European project.
Please note that the summary comments above are extracts from more detailed analysis that is available separately
Time for a policy reboot – does it make sense to run tight fiscal policy (1) at this point in the cycle, and (2) when the private sector is running persistent financial surpluses? (4Q sums, % GDP) Source: ECB; Haver; CMMP analysis
Introduction
In my previous post, “Policy reboot 2020?” I suggested that, “progress towards dealing with the debt overhang in Europe remains gradual and incomplete”. This prompted two follow-up questions:
How do I monitor this progress within the Macro Perspectives framework?
Why does it matter?
In this post, I present eight graphs that are key to monitoring this progress:
Private sector debt ratios (PSDRs)
Costs of borrowing
Lending spreads versus policy rates
Growth in broad money (M3)
Growth in private sector credit
Money supply vs demand for credit dynamic
Inflation
Private sector net financial balances
Summary and implications
The eight graphs confirm that the EA is still dealing with the legacy of a debt overhang. Private sector debt levels are still too high, money, credit and business cycles are significantly weaker than in past cycles and inflation remains well below target.
In spite of this, the collective fiscal policy of EA nations is (1) about as tight as any period in the past twenty years and (2) is so at a time when the private sector is running persistent net financial surpluses (largely above 3% GDP since the GFC).
An important lesson from Japan’s experience of a balance sheet recession is that the deflationary gap in economies facing debt overhangs is equal to the amount of private unborrowed savings. These savings (at a time of zero rates) are responsible for weakness in the economy, and it is because the economy is so weak that fiscal stimulus is necessary (Koo, R. 2019).
Ironically, the EA is positioned better to ease fiscal policy than the UK (where both the private and public sector are running simultaneous financial deficits) but we are more likely to see fiscal stimulus in the latter (March 2020) than in the former.
It’s time for a policy reboot in the EA for 2020 and beyond.
Eight key charts
Key chart 1: Private sector debt ratios
Too little, too late? Private sector deleveraging in the EA began later and has been more gradual than in the UK and the US (private sector debt as % GDP) Source: BIS; Haver; CMMP analysis
The first chart illustrates twenty-year trends in private sector debt ratios (PSDR) – private sector debt as a percentage of GDP – for the UK, EA and US. The three vertical, dotted lines mark the point of peak PSDR for each economy. This is the standard starting point for analysing debt overhangs.
Private sector deleveraging began much later and has been more gradual in the EA than in both the US and the UK. The PSDR in the EA is now the highest among these three economies.
The US PSDR peaked first at 170% GDP in 3Q08, fell to a post-GFC low of 147% GDP in 3Q15 (co-incidentally the point when the EA PSDR peaked) and is currently 150% GDP
The UK PSDR peaked one quarter later (4Q08) at 194% GDP, fell to 160% GDP in 2Q15 and is currently 163%
The EA PSDR continued to rise after the GFC before peaking at 172% in 2Q15 and declining slightly to 166% currently
For reference, but not shown here, household (HH) and corporate (NFC) debt ratios (the two sub-sets behind these totals) differ across the three economies. In the EA, the NFC PSDR is 108% (above the BIS’ maximum threshold of 90%) but the HH PSDR is only 58%. In the UK and US these splits are 79%:84% (see “Poised to disappoint”) and 75%:75% respectively. In other words, the risks lie in different places in each economy.
Key chart 2: Cost of borrowing
The cost of borrowing for HH and NFCs has fallen sharply, reflecting relatively weak credit demand (composite costs %, nominal terms) Source: ECB; Haver; CMMP analysis
The second chart illustrates the ECB’s composite measures for HH and NFC cost of borrowing (in nominal terms). The cost of borrowing typically falls in periods of debt overhang, reflecting weak demand for credit.
Weak credit demand is reflected in the cost of borrowing for EA HHs and
NFCs falling sharply.
HH and NFC costs of borrowing both peaked in
3Q08 at 5.6% and 6.0% respectively
The HH cost of borrowing hit a new low in
December 2019 of 1.41%
The NFC cost of borrowing hit a low of 1.52% in
August 2019 and is currently 1.55%
For reference, costs of borrowing in real terms (shown here) remain low at 0.11% for HH and 0.25% for NFCs but above their October 2018 lows of -0.49% and -0.65% respectively.
Key chart 3: Spreads vs policy rates
Lending spreads at, or close to, post-GFC lows (composite cost minus MRR, ppt) Source: ECB, Haver, CMMP analysis
The third chart illustrates the spread between composite borrowing
rates and the ECB’s main refinancing rate (MRR). These spreads typically narrow
during periods of debt overhang.
Spreads between borrowing costs and the ECB’s main policy rate are at,
or slightly above, post-GFC lows.
HH spreads have declined from 2.97% in May 2009 to a new post-GFC low of 1.41%
NFC spreads have declined from 2.76% in May 2014 to 1.55% currently, slightly above their post-GFC low of 1.55%
Key chart 4: Growth in broad money (M3)
Growth in M3 has been steady since 2014 easing, but subdued in relation to past trends (% YoY) Source: ECB; Haver; CMMP analysis
The fourth chart illustrates the twenty-year trend in the growth of
broad money (M3). Broad money reflects the interaction between the banking
sector and the money-holding/real sector.
Growth rates in broad money have been stable since ECB easing in 2014
but subdued in comparison with previous cycles.
In December 2019, M3 grew by 5.0% YoY
Narrow money (M1) contributed growth of 5.3% which was offset by negative growth in short term marketable securities
For reference, the share of M1 within M3 has risen from 42% in December 2008 to a new high of 68%, despite the fact that HH overnight deposit rates are -1.25% in real terms.
Key chart 5: Private sector loan growth
Private sector credit growing at the fastest rate in the current cycle, but growth is subdued in relation to past cycles (% YoY) Source: ECB; Haver; CMMP analysis
The fifth chart illustrates YoY growth in private sector credit, the main counterpart to M3.
Private sector credit is growing at the fastest rate in the current
cycle but also remains subdued in relation to past cycles and highly
concentrated geographically (Germany and France).
Private sector credit grew 3.7% YoY in December
2019 (3m MVA) above the average growth rate of 3.5%
Germany and France together contributed 2.8% of
the 3.7% growth in HH credit and 2.6% of the 3.2% growth in NFC credit in 2019
Key chart 6: Money supply vs credit demand
The gap between the supply of money and the demand for credit has started to widen again, indicating an on-going deficiency in credit demand Source: ECB; Haver; CMMP analysis
The sixth chart – one of my favourite charts – illustrates the gap between the supply of money (M3) and the demand for credit by the private sector. In typical cycles, monetary aggregates and their counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing.
The gap between the growth in the supply of money and the demand for
credit indicates on-going deficiency in credit demand in the EA.
Since 4Q11, broad money and private sector credit trends have diverged with gaps peaking in 3Q12 and 1Q15
The gap narrowed up to September 2018 but has widened out again recently
Key chart 7: Inflation
Inflation persistently below the ECB 2% target during 2019 (% YoY) Source: ECB; Haver; CMMP analysis
The seventh chart ilustrates the twenty-year trend in inflation (HICP) plotted against the ECB’s current inflation target. Again, inflation rates tend to much lower in periods of debt overhang.
Inflation remained below the ECB’s target throughout 2019 and finished
the year at 1.3%
Inflation ended 2019 at 1.3%, below the ECB’s target of 2%
Key chart 8: Private sector financial balance
The private sector is running a net financial surplus in spite of negative/low rates (4Q sums, % GDP) Source: ECB; Haver; CMMP analysis
The eighth, and final chart, illustrates trends in the private sector’s net financial surplus. In this analysis, 4Q sums are compared with GDP.
Finally, the private sector (in aggregate) is running a financial surplus in spite of negative/very low policy rates – a very strong indication that the economy is still suffering from a debt overhang
In aggregate, the EA private sector is running a
net financial surplus equivalent to 3.1% of GDP (3Q19) at a time when deposit
rates are negative (average -0.9% during 3Q19)
Why does this matter?
…Fiscal rules should be designed to favor counter-cyclical fiscal policies. Nevertheless, despite various amendments to strengthen the counter-cyclical features of the [EA] rules, the outcomes have been mainly pro-cyclical.
IMF, Fiscal rules in the euro area and lessons from other monetary unions, 2019
The EA is still dealing with the legacy of a debt overhang. Private sector debt levels are still too high, money, credit and business cycles are significantly weaker than in past cycles and inflation remains well below target.
Does this make sense #1? Collective fiscal policy is about as tight as at any point in past twenty years (Government net financial deficit, 4Q sum, % GDP) Source: ECB; Haver; CMMP analysis
In spite of all of this, the nations of the EA are collectively running a fiscal policy that is about as tight as at any period in the past twenty years. They are also doing this at a time when the private sector is running persistent net financial surpluses. Clearly, these developments fail a basic “common sense test”.
Does this make sense #2. The key chart again – what is the logic of running a tight policy when the private sector is running persistent surpluses (largely above 3% GDP) Source: ECB; Haver; CMMP analysis
Its worth noting that fiscal policy rules in the EA, including the Stability and Growth Pact, were created without reference to the private saving and for an economic environment that no longer exists (eg, positive rates, high inflation, government mismanagement etc.).
Are current rules still fit for purpose – government deficit/surplus as % GDP (y axis) plotted against government debt as % GDP (x axis)? Red lines indicate current SGP rules, green line indicates a balanced budget. These rules were designed for a different type of recession and constrain appropriate policy responses today Source: ECB; Haver; CMMP analysis
Leaving aside, the weak track record of adherence to these rules by member states, the obvious question is whether these rules remain relevant and whether the current policy mix is appropriate?
An important lesson from the experience of Japan’s balance sheet recession is that the deflationary gap in economies facing debt overhangs is equal to the amount of private unborrowed savings. Balance sheet recession theorists, such as Richard Koo, argue that these, “unborrowed savings (at a time of zero interest rates) are responsible for the weakness in the economy, and it is because the economy is so weak that fiscal stimulus is necessary”.
Relating the same argument to inflation targets, when inflation and inflation expectations are below target and rates are zero or negative, fiscal policy should lead with an expansionary stance and monetary policy should cooperate by focusing on guaranteeing low interest rates for as long as needed.
The UK is not as well positioned as the EA to relax fiscal policy – the UK private and public sectors are running simultanous deficits – but we are more likely to see UK fiscal easing first, in the March 2020 budget (4Q sums, % GDP) Source: ONS; Haver; CMMP analysis
Ironically, the EU is positioned better to relax fiscal policy than the UK (where both the private and public sector are running simultaneous deficits) but we are more likely to see fiscal easing in the latter (March 20202 budget) before the former.
In short, it is time for a policy reboot in the EA for 2020 and beyond.
Please note that the summary comments above are extracts from more detailed analysis that is available separately.
The developed world continues to deleverage but risks remain
The key chart
Only Italy, Austria, Greece, Germany and the US have NFC and HH debt ratios (% GDP, 1Q19) below BIS “maximum threshold” levels (dotted red lines) Source: BIS; Haver; CMMP analysis
Summary
The developed world continues to deleverage. This process has already led to dramatic shift in the structure of global private sector debt (see “The Changing Face of Global Debt”). With private sector debt levels still “too high” in the developed world, this trend is set to continue.
Risks associated with excess credit growth in the developed world are lower than in past cycles and remain concentrated by economy (Sweden, Switzerland, Canada and France) and by sector (NFC credit more than HH credit). Despite lower borrowing costs, affordability risks are still evident is both the NFC (Canada, France) and HH sectors (Norway, Canada, and Sweden).
Progress in dealing with the debt overhang in the Euro Area remains slow and incomplete. Long term secular challenges of subdued GDP, money supply and credit growth persist while unorthodox monetary policy measures risk fuelling further demand for less-productive “FIRE-based” lending with negative implications or leverage, growth, stability and income inequality (see “ Fuelling the FIRE” – the hidden risk in QE).
Trends in DM debt ratios
Aggregate private sector debt ratios for the Euro Area, and the BIS sample of advanced and emerging economies (% GDP) – the developed world continues to deleverage while the emerging world plays “catch-up” Source: BIS; Haver, CMMP analysis
The developed world continues to deleverage. Private sector credit as a percentage of GDP has fallen from a peak of 181% in 3Q09 to 162% at the end of the 1Q19. This has involved a (relatively gradual) process of “passive deleveraging” where the stock of outstanding debt rises but at a slower rate than nominal GDP.
The process of deleveraging in the Euro Area started later. Private sector credit as a percentage of GDP peaked at 172% in 1Q15 and has fallen to 162% at the end of 1Q19, in-line with the average for the BIS’ sample of advanced economies.
The outstanding stock of debt continues to rise ($ billion) but at a slower rate than nominal GDP Source: BIS; Haver; CMMP analysis
This process has led to a dramatic shift in the structure of global debt. In 1Q00, the advanced world accounted for 90% of global private sector credit, with advanced economies excluding the Euro Area accounting for 70% and the Euro Area 20%. Emerging markets accounted for only 10% of global private sector credit with 7% from emerging markets excluding China and 3% from China.
The changing face of global debt (% GDP) – shifting East and towards emerging markets Source: BIS; Haver; CMMP analysis
At the end of 1Q19, the advanced world’s share of global debt had fallen to 64% (advanced economies ex Euro Area 47%, Euro Area 18%) while the emerging markets share has increased to 36% (EM ex China 12%, China 24%).
Where are we now?
The key chart repeated. The Netherlands, Sweden, Norway, Canada, Switzerland and Denmark have NFC and HH debt ratios (% GDP, 1Q19) above BIS threshold levels (dotted red lines) Source: BIS; Haver; CMMP analysis
With debt levels remaining “too high” in the advanced world this trend is likely to continue. The BIS considers corporate (NFC) and household (HH) debt ratios of 90% and 85% respectively to be maximum thresholds above which debt becomes a constraint on future growth.
In our sample of advanced economies, only Greece, Germany, Italy, Austria and the US have debt ratios below these thresholds in both sectors. In contrast both NFC and HH debt levels are above the BIS thresholds in the Netherlands, Sweden, Norway, Switzerland, Denmark and Canada. NFC debt ratios remain above the threshold in Ireland, Belgium, France, Portugal and Spain and while the UK has “excess” HH debt. In short, progress towards dealing with high levels of private sector debt remains incomplete.
Associated risks
Private sector growth risks
The highest rates of “excess credit growth” (3-year RGF 1Q19) have occurred in economies where PSC debt levels are already high: Switzerland, Sweden, Canada, France Source: BIS; Haver; CMMP analysis
Risks associated with “excess credit growth” in developed markets are lower than in past cycles. I introduced my Relative Growth Factor analysis in “Sustainable debt dynamics – Asia private sector credit”. In short, this simple framework compares the relative growth in credit versus GDP (3 year CAGR) with the level of debt penetration in a given economy.
Among the high risk economies, Canada has seen the most obvious adjustment (trends in 3-year RGFs since March 2002) Source: BIS; Haver; CMMP analysis
In terms of total private sector debt, the highest “growth risks” can be seen in Sweden, Switzerland, Canada and France. Private sector credit in each of these economies has outstripped GDP growth on a CAGR basis over the past three years despite relatively high levels of private sector debt. Canada has made the most obvious adjustment among this sample of relatively high risk economies with the RGF falling from over 4% two years ago to 1.8% currently.
NFC sector growth risks
NFC sector growth risks are highest in Switzerland, Sweden, Canada and France (3-year CAGR) Source: BIS; Haver; CMMP analysis
In the NFC sector, the highest risks can be observed in
Switzerland, Sweden, Canada and France. RGFs for these for these economies were
3.9%, 3.0%, 2.7% and 1.8% respectively, despite NFC debt levels that are well
above the BIS threshold. As above, Canada’s rate of excess NFC credit growth is
slowing in contrast to trends in Switzerland and Sweden.
Contrasting trends between NFC sector risks in Canada versus Switzerland and Sweden Source: BIS; Haver; CMMP analysis
HH sector growth risks
HH sector growth risks are lower than NFC sector growth risks (3-year CAGR) Source: BIS; Haver; CMMP analysis
In the HH sector, RGF analysis suggest that the highest risks are in Norway, Switzerland, Canada, Norway (and the UK). RGFs in these economies were 1.3%, 1.1%, 0.7% and 0.4% respectively. In other words, excess HH credit growth risk is lower than in the NFC sector. Furthermore, the rates of excess HH credit growth in each of these economies is lower than in the recent past, especially in Norway and Canada.
Rapid adjustments in Norway and Canada among relatively high HH sector growth risk economies Source: BIS; Haver; CMMP analysis
Affordability risks
Despite lower borrowing costs, affordability risks remain. BIS debt service ratios (DSR) provide, “important information about the interactions between debt and the real economy, as they measure the amount of income used for interest payments and amortisations.” (BIS, 2017). The perspective provided by DSRs complements the analysis of debt ratios above but differs in the sense that they provide a “flow-to-flow” comparison ie, the debt service payments divided by the flow of income. In the accompanying charts, DSR ratios for private sector, corporate and household credit are plotted against the deviation from their respective long term averages.
Canada and France display the highest NFC affordability risk levels (1Q19 DSR versus LT average) Source: BIS; Haver; CMMP analysis
NFC affordability risks are highest in Canada and France. Debt service ratios (57% and 55% respectively) are not only high in absolute terms but they also illustrate the highest deviations from their respective long-term averages (47% and 49% respectively). In the HH sector, the highest affordability risks are seen in Norway, Canada and Sweden, although the level of risk is lower than in the NFC sector.
Norway, Canada and Sweden display the highest HH sector affordability risk (albeit lower than in the NFC sector) Source: BIS; Haver; CMMP analysis
Implications for the Euro Area
Progress in dealing with the debt overhang in the Euro Area remains slow and incomplete. Long term secular challenges of subdued GDP, money supply and credit growth persist. The European Commission recently revised its 2019 forecast down by -0.1ppt to 1.1% and its 2020 and 2012 forecasts down by -0.2ppt to 1.2% in both years, with these forecasts relying on “the strength of more domestically-oriented sectors.
Subdued Euro Area growth forecast to continue (% YoY) Source: European Commission; Haver; CMMP analysis
Growth in broad money (5.5%) and private sector credit (3.7%) in September remains positive in relation to recent trends but relative subdued in relation to past cycles. Furthermore, the renewed widening in the gap between the growth in the supply of money and the demand from credit (-1.8%) indicates that the Euro Area continues to face the challenge of deficiency in the demand for credit.
Gap between growth in supply of money and demand for credit illustrates the fundamental problem – a deficiency in credit demand across the Euro Area (% YoY, 3m MVA) Source: ECB; Haver; CMMP analysis
This has on-going implications for policy choices. Unorthodox monetary policy measures risk fuelling further demand for less-productive “FIRE-based” lending with negative implications or leverage, growth, stability and income inequality (see “ Fuelling the FIRE” – the hidden risk in QE).
“Fuelling the FIRE” – split in EA lending over the past twenty years between productive (COCO) and less productive (FIRE) based lending (% total lending) Source: ECB; Haver; CMMP analysis
Please note that the summary comments above are abstracts from more detailed analysis that is available separately.
Global finance continues to shift to the East and towards emerging markets making it unrecognisable from the industry that existed twenty years ago
The key chart
The changing face of global debt (% of total PSC) – shifting East and towards emerging markets Source: BIS; Haver; CMMP analysis
Summary
In this post, I summarise my analysis of the latest Bank of International Settlement (BIS) Quarterly Review with respect to level and trends in global debt and global debt ratios. The key points are:
The level of global debt hit a new high of $183 trillion in 1Q19
Global debt ratios – debt expressed as a percentage of GDP – have rebounded since 3Q18, but remain below peak 1Q18 levels.
Deleveraging continues, however, in all sectors across the Euro Area
Emerging markets remain the most dynamic segment of global finance, accounting for 36% of total private sector credit compared to only 10% two decades ago
China remains the main driver of this growth, accounting for 24% of global PSC, but the misallocation of credit towards SOEs continues
Global finance continues to shift East and towards emerging markets making it unrecognisable from the industry that existed twenty years
Further research analyses (1) whether current trends are sustainable and (2) the associated investment risks.
A new high for global debt levels
The level and breakdown of global debt between governments, corporates (NFC) and households (HH) Source: BIS; Haver; CMMP analysis
The level of global debt hit a new high of $183 trillion at the end of 1Q19. Corporate (NFC) credit is the largest sub-segment (39% of total) at $72 trillion. Government debt is the second largest sub-segment (35% of total) at $65 trillion, while household credit is the smallest sub-segment (25% of total) at $47 trillion.
Aggregating NFC and HH credit together, private sector credit totals $118 trillion or 65% of total global debt, down from 70% at the end of 2008. The shift in the balance of total debt from the private sector to government debt since the GFC reflects a shift from HH to government debt. In 2008, the split of total debt between HH, NFC and government debt was 31%, 39% and 30%. Today, the split it is 25%, 39%, 35% (1Q19).
The level and breakdown of global debt between the government and the private sector (PSC) Source: BIS; Haver; CMMP analysis
Leverage is also rising again…
Trends in total global debt and global debt ratios Source: BIS; Haver; CMMP analysis
Global debt ratios – debt expressed as a percentage of GDP – have risen for two consecutive quarters (an end to recent deleveraging trends) but remain below peak 1Q18 levels. The outstanding stock of global debt across all sectors fell between 1Q18 and 3Q18 before rebounding in 4Q18 and 1Q19. Debt ratios have rebounded but remain below peak levels.
Viewed over a twelve month period, we can observe different forms of deleveraging in action. In the HH and government sectors the absolute stock of debt has risen (to new highs) over the past twelve months but at a slower rate than the growth in nominal GDP. This represents a passive form of deleveraging as the debt ratio declines despite the stock rising in absolute terms. In contrast, the absolute level of NFC debt in 1Q19 ($72 trillion) is slightly below the level recorded in 1Q18 ($73 trillion). Hence the fall in the NFC debt ratio from 97% to 94% over the twelve months represents a mild form of active deleveraging.
Despite the recent rebound, the NFC sector has seen a mild form of active deleveraging over the past twelve months Source: BIS; Haver; CMMP analysis
Recent developments provide some support for the concept of debt thresholds ie, the level of debt above which debt becomes a drag on growth. The BIS estimate that this threshold in 90% for the NFC sector and 85% for the HH and government sectors. At the end of 1Q2019, NFC debt stood above this threshold at 94%, government debt was just below at 84%, while HH debt was well below at 60%. In short, the different form of deleveraging in the NFC sector described above reflects the fact that NFC debt ratios remain too high and above the BIS thresholds.
…except in the Euro Area
Private sector credit in the Euro Area is slightly lower now ($21 trillion) than in 3Q09 ($22 trillion) Source: BIS; Haver; CMMP analysis
However, gradual deleveraging continues in all sectors in the Euro Area. Interestingly, Euro Area deleveraging began first in the HH sector where debt ratios peaked at 64% in 4Q12. As elsewhere, this has been a passive form of deleveraging where the absolute stock of HH debt rises (to a new peak level in 1Q19) at a slower rate that the growth in nominal GDP. Total, PSC, NFC and government debt levels peaked later (1Q15) and have involved both passive and active forms of deleveraging. The stock of total debt reached new highs at the end of 1Q19 in total and in the PSC and HH sectors. In contrast, it is falling in the NFC and government sector where deleveraging is in its active form and where debt ratios of 105% and 98% remain above their respective BIS threshold levels.
On-going deleveraging in the Euro Area depresses global debt ratios – but progress is slow due to the type of deleveraging involved Source: BIS; Haver; CMMP analysis
Emerging market dynamism…
Trends in global debt with breakdown between advanced and emerging markets Source: BIS; Haver; CMMP analysis
Emerging markets remain the most dynamic segment of global finance, accounting for 36% of total private sector credit compared to only 10% two decades ago. Emerging market PSC totalled $42 trillion at the end of 1Q19 a rise of 225% over the past ten years or a CAGR of 12% per annum. Of this, NFC credit totalled $30 trillion (71% total PSC) and HH credit totalled $12 trillion (29% total PSC). NFC credit is typically larger than HH credit in emerging markets due to their relative stage in industry development. For reference the split between NFC and HH credit in advanced economies is currently 55% and 45% respectively.
Emerging market debt accounts for 36% of total PSC versus only 10% twenty years ago Source: BIS; Haver; CMMP analysis
Debt ratios are catching up with the developed world and in some cases now exceed the BIS threshold levels too. PSC, HH and NFC debt levels reached 142%, 42% and 101% of GDP at the end of 1Q19 versus respective ratios of 162%, 89% and 72% respectively for advanced economies. Note that emerging NFC debt ratios currently exceed the BIS threshold but this reflects (1) the impact of China, which is discussed below, and (2) the fact that the BIS choses to include Hong Kong (NFC debt 222% of GDP) and Singapore (NFC debt 117% of GDP) in its sample of emerging economies.
Playing “catch-up” – emerging market PS debt ratios (% GDP) are close to advanced economies’ levels Source: BIS; Haver; CMMP analysis
…driven by China
China remains the main driver of EM debt growth and now accounts for 24% of global private sector credit alone. PSC growth in China has grown 366% over the past ten years at a CAGR of 17% to reach $28 trillion at the end of 1Q19. Of this NFC credit was $21 trillion (74%) and HH credit was $7 trillion (26%), but it should be noted that China’s SOEs account for 68% of total NFC credit*.
Twenty years ago, China accounted from 3% of global debt and 31% of total EM debt. Today, these shares have risen to 24% and 67% respectively. China’s outstanding stock of debt exceeded the rest of EM in 3Q11.
China leaves the rest of EM behind after 3Q11 (PSC % GDP) Source: BIS; Haver; CMMP analysis
The NFC debt ratio peaked at 163% of GDP in 1Q17 and fell to 152% in 4Q18 as the growth in NFC debt lagged growth in GDP. However, in the 1Q19, this ratio rose back to 155% and remains well above the BIS threshold of 90%.
*The supply of credit to (the more profitable) private sector NFCs remains constrained and well below the BIS threshold, highlighting the on-going misallocation of credit in the Chinese economy. Further analysis of China’s debt dynamics follows in future posts.
China’s NFC debt ratio is rising again despite being well above the BIS threshold (90%) and levels seen in the RoW Source: BIS; Haver; CMMP analysis
Shifting East and towards EM
Growth in global debt increasing driven the China and EM ($ trillions) Source: BIS; Haver; CMMP analysis
Global finance continues to shift to the East and towards emerging markets making it unrecognisable from the industry that existed twenty years. In March 2000, global debt was structured split between advanced economies ex Euro Area (70%), the Euro Area (20%), emerging markets ex China (7%) and China (3%). Today, those splits are 47%, 18%, 12% and 24% respectively. The face of global debt is changing dramatically.
My next research analyses (1) whether current trends are sustainable and (2) the investment risks associated with these trends
The changing face of global debt (% PSC debt outstanding) Source: BIS; Haver; CMMP analysis
Please note that the summary comments above are abstracts from more detailed analysis that is available separately.
How I combine three different time perspectives into a consistent investment strategy
As an investor, I combine three different time perspectives into a single investment thesis or strategy
Long-term (LT) investment perspective
My LT investment perspective focuses on analysing key structural drivers that extend across multiple business cycles.
As a macro and monetary economist, I start by analysing the level, growth, affordability and structure of debt. In my experience, this is the most important feature of LT secular cycles with direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options; investment risks and asset allocation.
My LT investment perspective reflects my early career in Asia and my experience of Japan’s balance sheet recession.
Medium-term (MT) investment perspective
My MT investment perspective centres on: analysing money, credit and business cycles; the impact of bank behaviour on the wider economy; and the impact of macro and monetary dynamics on bank sector profitability.
Growth rates in narrow money (M1) and private sector credit demonstrate robust relationships with the business cycle through time. My interest is in how these relationships can assist investment timing and asset allocation.
My investment experience in Europe shapes my MT investment perspective, supported by detailed analysis provided by the European Central Bank (ECB).
Short-term (ST) investment perspective
Finally, my ST investment perspective focuses on trends in the key macro building blocks that affect industry value drivers, company earnings and profitability at different stages within specific cycles.
My ST investment perspective is influenced by my experience of running proprietary equity investments within a fixed-income environment at JP Morgan. This led me to reappraise the impact of different drivers of equity market returns.
One strategy
My investment outlook at any point in time reflects the dynamic between these three different time perspectives.
My conviction reflects the extent to which they are aligned.
