Faster indicators vs. key signals from the UK money sector
The key chart
Change (ppt) in credit and debt card spending versus February 2020 levels (Source: ONS; CMMP)
The key message
Investment narratives, like endurance athletes, require consistent refuelling to sustain their performance particularly as they transition between phases in market cycles. It may take some time before the three key signals for 2021 – a moderation in household savings, a recovery in consumer credit, and a re-synching of money and credit cycles – provide sustained nourishment. In the meantime, so-called “faster indicators” such as estimates for UK spending on credit and debit cards take on greater prominence.
These indicators show a steady increase in spending since the start of the year led by a recovery in spending at stores selling “work-related” and “delayable” goods and services. The latest data release from the ONS (27 May 2020) indicates a loss of momentum in this recovery, however, particularly in the case of delayable goods. With the exception of spending on “staples”, credit and debit card purchases have fallen back/remain below their pre-COVID levels.
The risk with volatile data series (such as faster indicators) is that short term “sugar rushes” are mistaken for more sustainable nourishment. The direction of travel is clearly positive but the recovery in UK consumption remains tentative still. As equity markets transition between their “hope” and “growth” phases, investors who have already paid for expected future growth in cash flows may well pause at this stage and wait for more concrete evidence of sustained growth…
Sugar rushes vs sustained nourishment
Recovery in spending YTD (ppt) versus February 2020 levels (Source: ONS; CMMP)
UK spending on debit and credit cards has increased steadily since the start of the year led by a recovery in “work-related” and “delayable” spending. In the week to 20 May 2021, the aggregate CHAPS-based indicator of credit and debit card purchases was at 96% of its pre-COVID, February 2020 average. This represents a 31ppt increase since early January 2021. The largest increases in spending over this period have been seen in “work-related” spending (eg, public transport, petrol) which has risen 45ppt and in “delayable” spending (eg, clothing, furnishings) which has risen 41ppt (see chart above).
Recent trends in aggregate and delyable spending showing impact of store reopening on 12 April (Source: ONS; CMMP)
The latest data release from the ONS (27 May 2021) indicates a loss of momentum in this recovery, however, particularly in the case of delayable goods. Aggregate spending peaked at 106% of February 2020 levels in the week to 5 May 2021 and has fallen back to 96% in the week to 20 May 2021. Spending on delayable goods rose sharply in April following the reopening of non-essential retail stores (12 April 2021). In the following week, spending was 22ppt above the February 2020 levels and remained above them until the week to 11 May 2021. Since then, it have fall back to 94% in the week to 20 May 2021.
Where are we now? Spending versus February 2020 levels (Source: ONS; CMMP)
With the exception of spending on “staples”, purchases have fallen back/remain below their pre-COVID levels. Other data sources (eg, Barclaycard payments data) indicate an immediate boost in spending in the hospitality sector following the relaxation of lockdown restrictions on 17 May 2021 but these trends are only partially captured here and social spending remained 16ppt below February 2020 levels in the week to 20 May 2021. Aggregate, delayable and work-related spending remain 4ppt, 6ppt and 1ppt below February 2020 levels respectively.
Conclusion
The risk with volatile data series (such as faster indicators) is that short term “sugar rushes” are mistaken for more sustainable trends. The direction of travel is clearly positive but the recovery in UK consumption remains tentative still. As equity markets transition between their “hope” and “growth” phases, investors who have already paid for expected future growth in cash flows may well pause at this stage and wait for more concrete evidence of sustained growth…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
UK consumers are spending on “delayable” goods again
The key chart
Credit and debit card payments versus pre-COVID levels by type of spending (Source: ONS; CMMP)
The key message
In my previous post, “More bullish on UK consumption”, I highlighted potentially good news for UK suppliers of consumer durables. The latest data on UK spending on credit and debit cards provides further support.
At the end of 1Q21, credit and debit card purchases of so-called “delayable” goods were still 31% below the average levels recorded in February 2020 (“pre-COVID”). These purchases recovered strongly in April, however, following the reopening of non-essential retail stores (12 April) and ended the month 6% above pre-COVID levels. Aggregate credit and debit purchases also recovered last month but remain marginally below pre-COVID levels due to the on-going weakness in “social” spending.
A recovery in consumer credit is one of three key signals to watch in the 2021 messages from the money sector. March 2021 data provided only tentative encouragement in terms of the direction of travel, but April’s trends in so-called “faster indicators” may be the start of more substantive support…
Bashing the plastic
In my previous post, “More bullish on UK consumption”, I highlighted potentially good news for UK suppliers of consumer durables. I quantified the level of excess money holdings that UK households have accumulated during the COVID-19 and the potential spending boost in 2H21 and 1H21. I argued that:
“it is reasonable to assume that a large proportion of this will be directed towards durable goods whose consumption was delayed during lockdown.”
The latest data on UK spending on credit and debit cards provides further support. The ONS provides this data based on daily Clearing House Automated Payment System (CHAPS) payments at around 100 major retail companies. Companies are allocated to one of four categories based on their primary business:
“Staples”: companies that sell essential goods such as food and utilities
“Work-related”: companies providing public transport or selling petrol
“Delayable”: companies selling goods whose purchased could be delayed such as clothing or furnishings
“Social”: spending on travel and eating out
Aggregate and delayable payments up to end-1Q21 (Source: ONS; CMMP)
At the end of 1Q21, credit and debit card purchases of so-called “delayable” goods were still 31% below the average levels recorded in February 2020 (“pre-COVID”). The chart above illustrates the backward looking, seven day rolling average of purchases. Lockdown restrictions had a clear, negative impact on delayable goods purchases in 2Q20 and 1Q21. Aggregate credit and debit card purchases were also 13% below pre-COVID levels at the end of 1Q21, supported only by spending on “staples”.
What a difference a month makes – payment trends during April 2021 (Source: ONS; CMMP)
These purchases recovered strongly in April, however, following the reopening of non-essential retail stores (12 April) and ended the month 6% above pre-COVID levels (see chart above). Aggregate credit and debit purchases also recovered last month but remain marginally below pre-COVID levels due to the on-going weakness in “social” spending (see chart below).
Too early yet for a strong recovery in social spending (Source: ONS; CMMP)
Conclusion
A recovery in consumer credit is one of three key signals to watch in the 2021 messages from the money sector. March 2021 data provided only tentative encouragement in terms of the direction of travel, but April’s trends in so-called “faster indicators” may be the start of more substantive support…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Estimated growth in excess UK money holdings in £mn (Source: CMMP)
The key message
UK households (HHs) were already “poised to disappoint” before COVID-19 hit as post-GFC consumption drivers proved unsustainable. During the pandemic, consumption fell much faster than incomes as savings increased markedly. HHs continued to accumulate money holdings at rates well in excess of the pre-COVID period in 1Q21 while YoY declines in consumer credit hit historic levels.
Monthly money flows followed the timing of lockdown restrictions and relaxations closely. This suggests a relatively large element of “forced” savings that could be released relatively quickly to support economic activity. That said, much of these accumulated savings have accrued to HHs that already have sizable savings, have higher incomes, and are older – such HHs typically spend less from any extra savings they accumulate.
Excess money holdings reached £139bn at the end of 1Q21 (CMMP estimates) and could total £164bn by the end of 1H21 (below the OBR’s forecast of £180bn). The latest Bank of England forecast suggests that 10% of these excess money holdings will be spent over the next three years, compared with 5% previously (and current OBR forecasts). This c£16bn spending boost is likely to be front loaded into 2H21 and 1H22.
It is reasonable to assume that a large proportion of this will be directed towards durable goods whose consumption was delayed during lockdown (eg, car sales). So-called “social consumption” will naturally benefit too, but there is only so much time that can be made up – you can only eat so many meals in one day!
Please note that the summary comments above and charts below are extracts from more detailed analysis that is available separately.
The key message in six charts
Post-GFC/Pre-Covid: HH consumption funded initially by slowing rate of savings
Trends in HH savings and savings ratio since 4Q07 (Source: ONS; CMMP)
During COVID: HH savings increased markedly
Impact of COVID pandemic on HH savings rate (Source: ONS; CMMP)
1Q21 – HHs accumulate money holdings at c.4x pre-COVID levels
Monthly flows of HH money holdings in £bn (Source: BoE; CMMP)
Challenges and opportunities for UK mortgage providers
The key chart
Trends in YoY growth rates in UK mortgages, consumer credit and corporate credit (Source: BoE; CMMP)
The key message
The relative stability in UK mortgage demand has been a consistent theme in the “message from the UK money sector” over the past five years. During the COVID-19 pandemic, this stability was the only bright spot in an otherwise gloomy UK retail finance market:
Monthly net borrowing hit £11.8b in March 2021, the strongest net borrowing since records began in 1993, driven by the expected ending of temporary stamp duty tax relief
Looking forward, approvals are below their November 2020 peak but remain relatively strong
Margin pressures are easing as the effective rate on new mortgages continues to rise, but remain a challenge for mortgage providers.
Against this cyclical backdrop, digital transformation remains the primary challenge and opportunity for the sector as providers seek to meet their customers’ needs more effectively while delivering operational efficiencies.
Experience across Europe shows how digitalisation can deliver tangible benefits including reduced costs, automated scoring/applications, enhanced market segmentation, and improved treasury and liquidity management.
Challenges and opportunities
The relative stability in UK mortgage demand has been a consistent theme in the “message from the UK money sector”. Over the past five years, the annual (nominal) growth in mortgages has averaged 3.3%. The lowest rate of growth (2.7%) was recorded in August 2020 and October 2020 and the maximum rate of growth (3.8%) in March 2021. The relative stability in mortgage demand contrasts sharply with the more volatile corporate (NFC) and consumer credit demand, especially during the COVID-19 pandemic (see key chart above).
Twenty-year trends in UK mortgage demand (Source: BoE; CMMP)
That said, current mortgage demand remains subdued in relation to historic trends. For reference, the average nominal and real rates of growth in the five years between March 2003 and March 2008 were 12.2% and 10.1% respectively, compared with 3.3% and 1.5% averages in the past five years (see chart above).
Monthly flows (£bn) in UK lending to individuals since January 2020 (Source: BoE; CMMP)
During the COVID-19 pandemic, this stability was the only bright spot in an otherwise gloomy UK retail finance market. The chart above illustrates monthly mortgage flows in blue, other consumer credit in maroon and credit cards in green. The weakest net borrowing occurred at the height of the pandemic in April 2020, but mortgage borrowing remained positive. In contrast, UK households have been repaying consumer credit in each of the past seven months.
The latest data for March 2021, for example, shows lending to individuals totalling £11.3bn. This includes £11.8bn mortgage borrowing and net repayments of both credit cards and other consumer credit of £-0.4bn and £-0.2bn respectively.
A new high in monthly net borrowing of £11.8bn (Source: BoE; CMMP)
Monthly net borrowing hit £11.8b in March 2021, the strongest net borrowing since records began in 1993. Net borrowing had averaged £6bn over the previous six months, with a gradually rising trend. The large jump in March reflects expectations that temporary stamp duty tax relief would be ended in March. This has now been extended to the end of June 2021. The previous peak in monthly net borrowing (£10.4bn) occurred in October 2006.
Trends in approvals for house purchase (Source: BoE; CMMP)
Approvals are below their November 2020 peak but remain relatively strong. The number of approvals for house purchases has fallen from 103,100 in November last year to 82,700 in March 2021. The latest approvals are 45% and 32% above the 56,945 and 62,663 approvals in March 2020 and March 2019 respectively.
Effective rates on new mortages and on the outstanding stock (Source: BoE; CMMP)
Margin pressures are easing as the effective rate on new mortgages continues to rise, but remain a challenge for mortgage providers. The effective rate of interest paid on the outstanding stock of mortgages has been stable during 1Q21 but at a new low of 2.08bp, down 4bp YTD. The effective rate on new mortgages has risen to 1.95% from the series low of 1.72% in August 2020. So while margin pressures remain, the spread between the effective rates has narrowed to 13bp.
What now for UK mortgage providers?
Against this cyclical backdrop, digital transformation remains the primary challenge for the sector as providers seek to meet their customers’ needs more effectively while delivering operational efficiencies.
Experience across Europe shows how digitilisation is already delivering tangible results across operations, sales and risk. Examples include: the automation of credit applications to deliver 70% FTE reductions; improved risk scoring for first time borrowers; micro-segmentation to support more targeted sales; and optimised treasury and liquidity management.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
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
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 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.
Monthly flows in UK and EA consumer credit (Source: BoE; ECB; CMMP)
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.
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…
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.
Are the risks associated with excess growth re-emerging? Excess credit growth versus penetration rates (Source: BIS; CMMP)
The key message
Risks associated with “excess credit growth”, which had been declining in the pre-Covid period, have re-emerged during the pandemic.
Some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed maximum threshold levels (Singapore, France, Hong Kong, South Korea, Japan, Canada).
Affordability risks are also increasing within and outside (Sweden, Switzerland, Norway) this sub-set despite the low interest rate environment.
Risks are more elevated in the corporate (NFC) sector than in the household (HH) sector but are not unique to either the developed market (DM) or emerging market (EM) worlds – one more reason to question the relevance of the current DM v EM distinction
Much of the debate relating to global debt focuses exclusively on the level of debt and, to a lesser extent, on the debt ratio (debt as a percentage of GDP). This analysis highlights how the addition of growth and affordability factors provides a more complete picture of the risks associated with current trends and their investment implications.
Introduction
As noted above, much of the recent debate about global debt has been restricted to its level in absolute terms or as a percentage of GDP. The addition of other factors – the rate of growth in debt, its affordability and, in the case of many EMs, its structure – provides a more complete picture, however.
In this post, I add condsideration of the rate of growth in global debt to my previous analysis in “D…E…B…T, Part II.” The approach is based on the simple relative growth factor (RGF) concept which I have used since the early 1990s as a first step in analysing the sustainability of debt dynamics. I also link both to the affordability of debt as measured by debt service ratios (DSRs).
In short, this approach compares the rate of “excess credit growth” with the level of debt penetration in a given economy. The three-year CAGR in debt is compared with the three-year CAGR in nominal GDP to derive a RGF. This is then compared with the level of debt expressed as a percentage of GDP (the debt ratio).
The concept is simple – one would expect relative high levels of excess credit growth in economies where the level of leverage is relatively low and vice versa. Conversely, red flags are raised when excess credit growth continues in economies that exhibit relatively high levels of leverage or when excess credit growth continues beyond previously observed levels.
The key trends
Rolling private sector RGF for all BIS reporting, developed and emerging economies (Source: BIS; CMMP)
In the pre-COVID period, the risks associated with excess credit growth had been declining in developed (DM) and emerging (EM) economies (see chart above illustrating rolling RGF trends). In response to the pandemic, however, credit demand has risen while nominal GDP has fallen sharply. As a result, the RGF (as at the end of 3Q20) for all economies, DM and EM have risen to 3%, 2% and 4% respectively. As can be seen, these levels are elevated but remain below those seen in previous cycles during the past 15 years.
Private sector credit snapshots
Excess PS credit growth versus PS debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of private sector RGF by country (Source: BIS; CMMP)
Importantly, out of the top-ten economies experiencing the highest rates of excess private sector credit, six have private sector debt ratios higher than the threshold levels above which debt is considered a constraint to future growth – Singapore, France, Hong Kong, South Korea, Japan and Canada. In the graph above, and in similar ones below, the orange bar indicates where debt ratios exceed the threshold level.
Excess PS credit growth versus PS debt ratios as at end 3Q20 in LATEMEA (Source: BIS; CMMP)
Argentina and Chile have the highest private sector RGFs among the sample of LATEMEA economies. The associated risks are higher in the case of Chile than in Argentina given the two economies debt ratios of 169% GDP and 24% GDP respectively. As highlighted below, the risks in Chile relate primarily to excess growth in the NFC sector.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are also relatively high in France, Hong Kong, South Korea, Japan and Canada despite the low interest rate environment. Outside this subset, affordability risks are relatively high in Sweden, Switzerland and Norway where DSR’s are relatively high in absolute terms and in relation to each economy’s history.
NFC credit snapshots
Excess NFC credit growth versus NFC debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of NFC RGF by country (Source: BIS; CMMP)
Similarly, out of the top-ten economies experiencing the highest rates of excess NFC credit, seven have NFC debt ratios above the threshold level (90% GDP) – Singapore, Chile, France, Canada, Japan, South Korea and Switzerland.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this second subset, the debt service ratios in absolute terms and in relation to respective 10-year averages are relatively high in France, Canada, Japan and South Korea. Despite lower rates of excess NFC credit growth affordability risks are also relatively high in Sweden, Norway and the US. (Note that the availability of sector DSRs is more restricted than overall private sector DSRs).
HH credit snapshots
Excess HH credit growth versus HH debt ratios as at end 3Q20 (Source: BIS; CMMP)Top ten ranking of HH RGF by country (Source: BIS; CMMP)
In contrast, out of the top-ten economies experiencing the highest rates of excess HH credit, only two have HH debt ratios above the threshold level – Hong Kong and Singapore. This is not surprising given that HH debt ratios are lower than NFC debt levels in general. Of the 42 BIS reporting countries, 11 have HH debt ratios above the 85% GDP HH threshold level whereas 20 have NFC debt ratios above the 90% GDP NFC threshold level.
Rolling HH RGFs for China and Russia (Source: BIS; CMMP)
That said, experience suggests that the current levels of excess HH credit growth in China and Russia indicate elevated risks, especially in the former economy. In “Too much, too soon?“, posted in November 2019, I highlighted the PBOC’s concerns over HH-sector debt risks – “the debt risks in the HH sector and some low income HHs in some regions are relatively prominent and should be paid attention to.” (PBOC, Financial Stability Report 2019). Excess credit growth remains a key feature nonetheless.
DSR and deviations from 10-year averages (Source: BIS; CMMP)
Within this third subset, the debt service ratio in absolute terms and in relation to respective 10-year averages is relatively high in South Korea. Again, despite lower rates of excess HH credit growth, affordability risks are also relatively high in Sweden and Norway.
Conclusion
This summary post extends the analysis of the level of global debt and debt ratios to include an assessment of the rate of growth in debt and its affordability. Together, these factors provide a more complete picture of the sustainability of current debt trends.
Risks associated with excess credit growth are re-emerging and will be a feature of the post-COVID environment going forward. The two key risks here are: (1) some of the highest rates of excess credit growth are currently occurring in economies where debt levels exceed threshold levels; and (2) affordability risks are increasing within (and outside) this sub-set despite the low interest rate environment.
To some extent, little of this is new news – I have been flagging the same risks in an Asia context for some time – and the implications are the same. Despite recent market moves, the secular support for rates remaining “lower-for-longer” remains, albeit with more elevated sustainability risks in the NFC sector.
Revisiting the level and structure of global debt six months on
The key chart
What are the implications of new highs in global debt and debt ratios? (Source: BIS; CMMP)
The key message
Global debt hit new highs in absolute terms ($211tr) and as a percentage of GDP (277%) at the end of 3Q20, driven largely by government ($79tr) and NFC debt ($81tr).
Public sector and NFC debt ratios both hit new highs above the maximum threshold level that the BIS considers detrimental to future growth.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability risks in the NFC sector.
The US and China account for nearly 50% of global debt alone and more than 75% with Japan, France, the UK, Germany, Canada and Italy – but only Japan and France are included in the top-ten most indebted global economies.
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio increased to 179% GDP.
China’s accumulation of debt has eclipsed the “EM catch-up story”. Chinese debt now accounts for just under 70% of EM debt and EM x China’s share of global debt has remained unchanged over the past decade.
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics.
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. From this more appropriate foundation, further analysis can be made of the growth and affordability of debt…
D…E…B…T, Part II
Breakdown of global debt and trend in debt ratio since 2008 (Source: BIS; CMMP)
Global debt hit new highs in absolute terms and as a percentage of GDP at the end of 3Q20, driven largely by public sector debt and NFC debt. According to the BIS, total debt rose from $193tr at the end of 1Q20 to a new high of $211tr. Within this:
Government, NFC and HH debt all hit new absolute highs of $79tr, $81tr and $51tr respectively
The global debt ratio increased from 246% GDP in 1Q20 to a new high of 278% GDP
The public sector debt ratio increased from 88% GDP to 104% GDP and the NFC debt ratio increased from 96% GDP to 107% GDP over the same period. In both cases, the debt ratio was a new high and above the maximum threshold level of 90% above which the BIS considers the level of debt to become a constraint on future growth
The HH debt ratio also increased from 61% GDP to 67% but remains below its historic peak of 69% (3Q09) and the respective BIS threshold level of 85% GDP.
These trends provide on-going support for the “lower-for-longer” narrative but also raise concerns about sustainability especially in the NFC sector.
3Q20 ranking of BIS reporting economies by total debt and cumulative market share (Source: BIS; CMMP)
The US and China account for nearly 50% of global debt, but neither is ranked in the top-15 most indebted economies. At the end of 3Q20, total debt reached $61tr (29% global debt) in the US and $42tr in China (20% global debt). In absolute terms, these two economies are followed by Japan $21tr, France $10tr, UK $8tr, Germany $8tr, Canada $6tr and Italy $tr. In other words, the US and China account for almost a half of global debt and together with the other six economies account for over three-quarters of global debt. Note, however, that only two of these eight economies rank among the top-ten most indebted global economies (% GDP).
3Q20 ranking of BIS reporting economies by total debt as % GDP (Source: BIS; CMMP)
The post-GFC period of private sector deleveraging/debt stability in advanced economies has ended as the private sector debt ratio rose to 179% GDP, close to its all-time-high. Following the GFC, the private sector debt ratio in advanced economies had fallen from a peak of 181% GDP in 3Q09 to 151% in 1Q15. It had then stabilised at around the 160% of GDP level.
Private sector debt in advanced economies in absolute terms and as % GDP (Source: BIS; CMMP)
As discussed in “Are we there yet?”, this had direct implications for the duration and amplitude of money, credit and business cycles, inflation, policy options and the level of global interest rates. In subsequent posts, I will examine the implications of these recent trends on the sustainability and affordability of private sector debt in advanced economies.
Trends in China’s private sector debt and share of EM private sector debt (Source: BIS; CMMP)
China’s accumulation of debt has eclipsed the “EM catch-up story”. Fifteen years ago, China’s debt was just under $3tr and accounted for 35% of total EM debt. At the end of 3Q20, China’s debt had increased to $33tr to account for 67% of total EM debt. The so-called EM catch-up story is in effect, the story of China’s debt accumulation. Excluding China, EM’s share of global debt in unchanged (12%) over the past decade.
China and EMx China’s share of global debt (Source: BIS; CMMP)
The traditional distinction between advanced/developed markets and emerging markets is increasingly irrelevant/unhelpful, especially when analysing Asian debt dynamics. The BIS classifies Asian reporting countries into two categories: three “advanced” economies (Japan, Australia and NZ) and eight emerging economies (China, Hong Kong, India, Indonesia, Korea, Malaysia, Singapore and Thailand).
Asian NFC and HH debt ratios (Source: BIS; CMMP)
The classification of Japan, Australia and New Zealand as advanced economies is logical but masks different exposures to NFC (Japan) and HH (Australian and New Zealand) debt dynamics.
The remaining grouping is more troublesome as it ignores the wide variations in market structure, growth opportunities, risks and secular challenges. I prefer to consider China, Korea, Hong Kong and Singapore as unique markets. China is unique in terms of the level, structure and drivers of debt and in terms of the PBOC’s policy responses. Korea and Hong Kong stand out for having NFC and HH debt ratios that exceed BIS maximum thresholds. Hong Kong and Singapore are distinguished by their roles as regional financial centres but have different HH debt dynamics. Malaysia and Thailand can be considered intermediate markets which leaves India and Indonesia as genuine emerging markets among Asian reporting countries (see “Sustainable debt dynamics – Asia private sector credit”).
Global NFC and HH debt ratios (Source: BIS; CMMP)
New terms of reference are required for analysing global debt trends that distinguish between economies with excess HH and/or corporate debt and the rest of the world. In this case, excess refers to levels that are above the BIS thresholds. Among the BIS reporting economies (and excluding Luxembourg) there are:
Eight economies with excess HH and NFC debt levels: Hong Kong, Sweden, the Netherlands, Norway, Denmark, Switzerland, Canada and South Korea
Eleven economies with excess NFC debt levels: Ireland, France, China, Belgium, Singapore, Chile, Finland, Japan, Spain, Portugal, and Austria
Three economies with excess HH debt levels: Australia, New Zealand, the UK
The RoW with HH and NFC debt levels below the BIS thresholds
These classifications provide a more appropriate foundation for further analysis of the other, key features of global debt – its rate of growth and its affordability. These will be addressed in subsequent posts.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The key message
The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow of funds between the different sectors of the economy.
The UK government issued £227bn gilts in the first three quarters of 2020 to finance the support given to HHs and NFCs (and increased it net liability position by £130bn).
The BoE purchased a similar quantity of gilts in the secondary market (via APF) and financed this through the issuance of reserves. These reserves form liquid assets for the rest of the financial sector, counterbalanced by additional deposits from HHs and NFCs. Note that the net asset/liability positions of the money sector (the BoE and FIs) remained broadly unchanged at this point.
HHs increased their deposits by £102bn and their net asset position increased by £111bn. This increase in HH savings was intermediated to the UK government via the money sector, meaning that UK HHs have been the most important source of additional lending during the pandemic.
In contrast, the net lending position of NFCs and the RoW remained broadly unchanged.
Understanding how these flows will be unwound in the post-COVID period is the key to determining the speed and duration of the recovery in the UK economy. My next post will examine the HH sector dynamics in more detail.
Recall that the financial sector balances approach reognises that any net borrowing by one sector must be accompanies by net lending from another sector(s). The table below illustrates this balance in practice during the COVID-19 pandemic.
£ bn
C Bk reserves
Curr. & dep’s
Gilts
Loans and debt
Other
Total
Gov
0
-13
-227
44
65
-130
BoE APF
-259
0
231
28
0
0
FIs ex-APF
259
-204
47
-47
-47
8
HHs
0
102
1
26
-18
111
NFCs
0
123
1
-79
-30
16
RoW
0
-9
-53
27
30
-5
Balance
0
0
0
0
0
0
Net borrowing by one sector must be accompanied by net lending from another sector(s) (Source: OBR; BoE; ONS; CMMP)
COVID-19 and the UK flow of funds
The OBR’s “Economic and fiscal outlook – March 2021” provides valuable insights into the impact of the COVID-19 pandemic on the flow or funds between the different sectors of the economy. The analysis compares the patterns of financial flows between the five key sectors in the economy – HHs, NFCs, FIs, government and the RoW – in the first three quarters of 2020 and the final three quarters of 2019.
Recall that the financial sector balances approach recognises that any net borrowing of one sector must be accompanied by net lending from another sector(s).
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
As highlighted in my previous post, the UK government has provided unprecedented support to HHs and NFCs during the COVID pandemic. According to the OBR, this was financed (in net terms) by issuance of £227bn in gilts in the first three quarters of 2020. This compares with £34bn issuance in the final three quarters of 2019. The net liabilities of the government increased by £130bn over the period.
A similar quantity of gilts (£231bn) was purchased on the secondary market by the BoE’s Asset Purchase Facilty (APF) as part of quantitative easing (QE). The BoE financed this purchase by issuing an equivalent amount of its own liabilities (reserves). As a result the Bank’s net asset/liability position was unchanged.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The reserves issued by the BoE constitute assets for the rest of the UK financial sector. The counterpart/balance to these reserves is mainly the additional deposits from HH and NFCs that arose from the government’s support measures. Note again, that the net lending position of the financial sector remained broadly unchanged at this point.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The rise in HH deposits has been a consistent message from the money sector in 2020. The OBR notes that HH deposits increased by £102bn in the first three quarters in 2020. These savings have been intermediated to the government via the financial sector and the BoE through the flows described above. The net assets of the HH sector increased by £111bn.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
The NFC sector also increased its deposits by £123bn over the period, while increasing net loans and other liabilities by £109bn. In aggregate, the net lending of NFCs changed little as a result but this masks significant differences in the experience of firms in different sectors.
Change in net aquisition of assets between first 3Qs 2020 and final 3Qs 2019 (£bn) (Source: OBR; BoE; ONS; CMMP)
Foreign investors have played a limited role in the financing the increase in UK government borrowing over the period. The net lending positions changed little over the first nine months of 2020.
Conclusion
The COVID-19 pandemic and the associate responses from the UK government led to significant changes in the flow of funds between the key economic agents. The composition of these flows changed for most sectors but the main changes in net assets and liabilities were recorded by the HH and government sectors.
UK HHs represent an important source of additional lending over this period, with the increase in their liquid savings being intermediated to the government via the money sector (financials and the BoE).
The OBR is forecasting a 4% increase in real GDP in 2021 from a fall of 9.9% in 2022, followed by growth of 7.3%, 1.7%, 1.6% and 1.7% in the next four years out to 2025 respectively. The pace and sustainability of these forecasts depend on how the financial flows described above are unwound. In the next post, I will examine the outlook for the HH and NFC sectors in more detail.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
