Have US consumers finally read the recession script?
The key message
Quarterly US consumer credit flows (Source: FRED; CMMP)
The key message
Have US consumers finally read the recession script?
Quarterly US consumer credit flows slowed to only $4bn in 3Q23, down from $26bn in 2Q23 and $52bn in 1Q23 (see key chart above). These latest quarterly flows are the weakest since 2Q20, and represent only a very small fraction of the pre-pandemic average quarterly flow of $45bn.
Monthly US consumer credit flows (Source: FRED; CMMP)
Monthly flows were volatile during the 3Q23 (see chart above). The flow of consumer credit recovered in September to £9bn after repayment of $16bn in August, but remained below July’s flow of $11bn. Three-month moving average flows fell steadily, however, from $7.8bn in July to $2.8bn in August and $1.8bn in September. These smoothed flows compare with the pre-pandemic average of $14.8bn.
So what?
In recent quarters, we noted the sharp moderation in US consumer credit demand. Weakness in the 3Q23 and revised figures for 2Q23 (revised lower) indicate much weaker dynamics and elevated risks to US consumption and the growth outlook.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
European banks set to reduce their reliance on public sector funding further
The key chart
Trends in monthly flows (EUR bn) of bank issuance of debt securities (Source: ECB; CMMP)
Happier times ahead for FIG DCM bankers as European banks reduce their reliance on public sector sources of funding…
So what is happening?
European banks’ reliance on public sector sources of funding is falling as TLTRO funds reach maturity. Banks plan to issue more debt to (1) compensate for the expected decline in central bank funding and (2) to comply with minimum requirements for own funds and eligible liabilities (MREL).
What does the data say?
From the latest ECB “Monetary developments in the euro area, July 2023” release we can see positive monthly flows of debt securities with a maturity of over twelve month (counterparts to M3) in every month since October 2022. Cumulative 12-month flows turning positive in December 2022 and reached €198bn in the 12 months to July 2023, their highest level since October 2007 (see chart above).
Happier times for FIG DCM bankers…
The increasingly “commoditised” FIG DCM space can be a rather soulless place for issuers and bankers alike (in my experience). The good news is that issuance is recovering and is expected to remain positive in 2023-24 (see also the European Bank Authority’s annual funding plans report, July 2023). Happier times….
The impact of ECB policy seen through 12-month cumulative flows
The key chart
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) highlight the elevated risks of ECB policy errors and their potential, negative impact on financing flows to the EA economy.
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over.
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. Narrow money (M1) fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit slowed to 1.6% YoY, the slowest annual rate of growth since May 2016. The warning signs are there…
Within broad money, arbitrage continues in favour of the highest remunerated deposits – depositors are actively seeking higher returns – but this is insufficient to compensate for outflows from overnight deposits. The very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing very sharply on a cumulative 12-month basis, however (see next post for details).
In short, cumulative financing flows to the EA economy were -€96bn in the 12-months to July 2023, compared with flows of €1,574bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising with negative implications for financing flows to the EA economy. How will the “data-dependent” ECB respond in September?
The impact of ECB policy on financing flows to the EA economy
Headline YoY growth numbers for broad money and its key component (narrow money) and counterpart (private sector credit) highlight the speed at which EA money and credit cycles are rolling over (see chart below).
Growth rates (% YoY) in M3, M1 and PS credit (Source: ECB; CMMP)
Broad money (M3) fell -0.4% YoY, the first annual decline since May 2010. The outstanding stock of money (€15,957bn) has fallen -1.6% from its September 2022 peak (€16,214bn). Narrow money, the key component of broad money, fell -9.2% YoY, driven by a 10.5% YoY decline in overnight deposits. Growth in private sector credit, the key counterpart to broad money, slowed to 1.6% YoY, its slowest annual rate of growth since May 2016.
Recall that monetary aggregates are derived from the consolidated balance sheet of MFIs. The key components are found on the liabilities side of the balance sheet – narrow money (M1) which comprises currency in circulation, other short-term deposits (M2-M1) and marketable instruments (M3-M2). Note that longer-term liabilities are not part of M3 as they are regarded more as portfolio instrument than as a means of carrying out transactions. The key chart above presents 12-month cumulative flows in the form of a stylised consolidated balance sheet.
Growth rates (% YoY) in M1 and M2-M1 (Source: ECB; CMMP)
Within broad money, arbitrage continues in favour of the highest remunerated deposits but this is insufficient to compensate for outflows from overnight deposits. The annual growth rate in other short-term deposits (M2-M1) was 24% YoY in June and July 2023, the highest rate of growth since the start of the EMU. In contrast, the -9.2% YoY decline in narrow money was the sharpest contraction since the start of EMU (see chart above).
Monthly flows (EUR bn) in EA monetary aggregates (Source: ECB; CMMP)
The EA banking system has seen eleven consecutive months of outflows in overnight deposits (see chart above). The outflow of narrow money totalled -€1,072bn (see key chart above), overshadowing the positive inflows of €852bn and €153bn into other short-term deposits (M2-M1) and marketable securities (M3-M2) and, outside broad money, the €262bn inflow into longer-term financial liabilities (mainly debt securities issued by banks).
Note that the very slow/limited pass through from higher policy rates to the cost of overnight deposits has been one of the unique features of the current hiking cycle.
Trend in 12-month cumulative monthly flows of loans to the private sector (Source: ECB; CMMP)
Financing flows to the private sector, largely in the form of loans, remain positive in absolute terms. They are slowing sharply on a cumulative 12-month basis, however (see chart above and next post for details).
12-month cumulative financing flows (EUR bn) presented in stylised consolidated balance sheet format (Source: ECB; CMMP)
In short, cumulative financing flows were -€96bn in the 12-months to July 2023, compared with flows of €1,576bn, €1,014bn and €92bn in the 12-months to July 2020, July 2021 and July 2022 respectively.
The risks of significant policy errors are rising. How will a data-dependent ECB respond in September?
Please note that the summary charts and comments above are abstracts from more detailed analysis that is available separately.
UK aggregate and delayable goods card payments in relation to pre-pandemic levels (Source: ONS; CMMP)
The key message
UK households (HHs) are delaying their spending on so-called “delayable” goods such as clothing and furniture. This matters for two reasons:
First, spending on delayable goods is our preferred proxy for the return of the excess savings built up during the pandemic to productive use;
Second, a key assumption in the latest OBR forecasts for the UK economy and public finances is that HHs will run down their excess savings (and increase their borrowing) to fuel consumption in the face of declining real wages.
The message from the money sector so far this year is that UK aggregate spending is recovering steadily but the sustainability of consumption remains unproven. HHs are spending more on getting to work, for example, but less on buying clothes, furniture and other durable goods.
In short, the accumulation of excess savings may have slowed but we await further evidence that these savings are being run down to support sustained consumption as the OBR expects.
Delaying the delayable in charts
Delayable goods payments in relation to pre-pandemic levels (Source: ONS; CMMP)
UK households (HHs) are delaying their spending on so-called “delayable” goods such as clothing and furniture. According to the latest ONS real-time indicators, credit and debit card purchases on delayable goods in the week to 17 March 2022 were 82% of their February 2020 average (see chart above). This means that delayable spending is currently the weakest segment of HH spending. Spending on work-related, staples, and social goods and services are currently 17%, 9% and 5% above pre-pandemic levels (see chart below).
UK card spending in relation to pre-pandemic levels (ppt) broken down by type (Source: ONS; CMMP)
This matters for two reasons. First, spending on delayable goods is our preferred proxy for the return of the excess savings built up during the pandemic to productive use. Second, and related to this, a key assumption in the latest OBR forecasts for the UK economy and public finances is that HHs will run down their excess savings (and increase their borrowing) to fuel consumption in the face of declining real wages (see “Good news for Rishi, but…”).
Aggregate UK card spending in relation to pre-pandemic levels (Source: ONS; CMMP)
The message from the money sector so far this year is that UK aggregate spending is recovering steadily (see chart above) but the sustainability of consumption remains unproven. HHs are spending more on getting to work, for example, but less on buying clothes, furniture and other durable goods (see chart below).
Delayable versus work-related card spending in relation to pre-pandemic levels (Source: ONS; CMMP)
In short, UK HH’s accumulation of excess savings may have slowed but we await further evidence that these savings are being run down to support sustained consumption as the OBR expects.
Please nore that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Historic and forecast trends in HH net savings (% GDP, rolling annual average) (Source: OBR; CMMP)
The key message
UK households (HHs) play a vital role in the UK economy and in the demand for credit. Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again?
Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open. If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c.6% to consumption in 2021 and 2020. Such a bullish scenario is unlikely for three reasons:
HHs typically save most unanticipated sources of wealth rather than spend them
The rise in savings is skewed towards high-income households who typically have lower marginal propensities to consume;
History suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock.
That said, the scale of accumulated HH savings provides support for a more rapid re-adjustment than after the GFC (the central OBR forecasts is consistent with HHs on average spending 5% of the extra deposits) and suggests that the UK has a higher level of gearing to a recovery than the euro area (EA). Potentially good news for suppliers of consumer durables…
Riding to the rescue
HHs matter
UK households (HHs) play a vital role in the UK economy and in the demand for credit. HH consumption accounts for 65p in every pound of UK GDP and lending to HHs accounts for 66p in every pound of M4 Lending. HHs are important investors in financial and non-financial assets (mainly property), with balance sheets skewed towards financial assets. The sector is typically a net saver/net lender in the UK (and other developed economies). However, notable shifts in the HH net financial balances have occurred in the post-GFC period and during the COVID-19 pandemic. A key theme in the analysis below it that the unwinding of HH savings built up during the pandemic will play an important role in determining the scale, pace and sustainability of any economic recovery.
Disappoint or ride to the rescue?
Looking forward, the key question is will the HH sector ride to the rescue or is it poised to disappoint again? The sector was poised to disappoint at the start of 2020 with risks to official forecasts tilted clearly to the downside.
HH debt (LHS, £bn) and debt/GDP ratio (RHS, %) (Source: BIS; CMMP)HH gross savings (LHS, £bn) and savings rate (RHS, %) (Source: ONS; CMMP)
HH debt levels peaked at 96% GDP in 1Q10 and, after a period of “passive deleveraging”, stabilised at c.85% GDP from 2Q14 onwards (note that 85% GDP is the maximum threshold level above which the BIS assumes that debt becomes a constraint on future growth). Despite low debt servicing costs, HHs chose to fund consumption by slowing their rate of savings (and accumulation of net financial assets) rather than by increasing their debt levels. With real growth in disposable income slowing, however, and with the savings rates still close to historic lows, the risks to HH consumption and GDP growth were tilted clearly to the downside before COVID-19 hit.
2019
2020e
2021e
2022e
2023e
2024e
2025e
GDP (%)
1.4
-9.9
4.0
7.3
1.7
1.6
1.7
HH cons. (ppt)
0.7
-7.1
1.8
7.0
0.8
1.1
0.8
Forecasts for GDP growth and contribution from HH consumption (Source: OBR; CMMP analysis)
Official forecasts assume a strong recovery in HH consumption over the 2H21 as the economy starts to open (see table above). After falling 11% in 2020, HH consumption is forecast to recover 2.9% in 2021, contributing 1.8ppt to GDP growth of 4.0% and then to grow 11.1% in 2022 contributing 7.0ppt to GDP growth of 7.3% (OBR, March 2021 forecasts).
What if?
If all the additional savings accumulated during the pandemic were spent over the next four quarters, it would add c6% to consumption in 2021 and 2020. In recent posts, I have noted the increase in HH deposits (“COVID-19 and the flow of financial funds in the UK”).
HH money monthly flows and 2019 average monthy flow (Source: BoE; CMMP)
HHs increased their deposits by £100bn in the first three quarters of 2020 and by a further £53bn in the 4Q20 alone. The OBR expects the level of “additional deposits” to reach £180bn by the middle of 2021. In the unlikely scenario that all these additional deposits were spent over the next four quarter, the OBR estimates that it would add c6% to consumption in 2021 and 2020.
Not so fast…
Such a positive scenario is unlikely for three key reasons. First, HHs typically save most unanticipated sources of wealth rather than spend them. Traditional consumption theory suggests that rather than spending all of an unanticipated increment to their wealth immediately, HHs are instead more likely to save most of it to allow for higher consumption in the future. An autumn 2020 BoE survey supports this theory. Only 10% of HHs planned to spend the additional savings built up during the pandemic. In contrast, around 66% planned to retain them in their bank account. (Note, that the first of the CMM three key charts for 2021 measures monthly HH deposit flows in relation to past trends).
NMG survey responses on what HHs plan to do with additional savings built up during the pandemic (Source: BoE; OBR; CMMP)
Second, the rise in savings is skewed towards high-income HHs. Another recent BoE survey notes that 42% of high-income HH were saving more and 16% saving less, compared to 23% of low-income HHs saving more and 24% saving less. This matters because high-income HHs typically have lower marginal propensities to consumer than low-income HHs. Empirical evidence suggests that annual spending typically rises by between 5-10% of unanticipated, incremental increases in wealth.
HH net savings (%GDP) 2007-2017 (Source: ONS; CMMP)
Third, history suggests that HHs (and NFCs) typically take time to re-adjust after periods of significant financial and/or economic shock. In the aftermath of the GFC, for example, the net savings of the HH sector peaked at 6.1% GDP in 2Q10. It took 26 quarters before net savings fell below 2% GDP (4Q16).
How COVID-19 altered the OBR’s forecasts for HH net savings (Source: OBR; CMMP)
The COVID-19 pandemic was a greater financial, economic (and mental) shock than the GFC. In response, the HH sector’s net savings increased from 0.4% at the end of 2019 to 7.0% in 3Q20. OBR forecasts indicate that net savings increased to 8.7% at year-end and are expected to peak at 10.4% GDP in 1Q21 (4.3ppt higher than post-GFC). Their forecasts also assume a rapid re-adjustment by HHs as vaccination levels rise and the economy re-opens with HH net savings falling below 2% by 3Q22 (ie, in six quarters) and remaining below 0.5% out to 1Q26. In my view, risks to these assumptions lie to the downside ie, HH net savings will remain higher than forecast here as HHs maintain larger precautionary savings.
But, what if size does matter…
The scale of accumulated HH savings provides support, however, for a more rapid re-adjustment than after the GFC and suggest that the UK has a higher level of gearing to a recovery than the euro area (EA).
The central OBR forecasts is “consistent with HHs on average spending 5% of the extra deposits accumulated during the pandemic each year, but somewhat front loaded into 2H21 and 1H22.” In other words, the OBR forecasts suggest that c.25% of the total stock of £180bn built up during the pandemic will have been used for consumption by 1Q26. This seems a reasonable assumption, in my view.
UK and EA HH monthly deposit flows expressed as a multiple of 2019 average monthly flows (Source: BoE; ECB; CMMP)
Note also that the “messages from the money sector” indicate that the scale of additional deposit flows in the UK, in relation to past trends, is higher in the UK than in the EA. In December 2020, for example, the monthly flow of HH money (£20bn) was 4.5x the average monthly flow recorded in 2019. In the EA, the respective multiple was 1.8x.
Potential beneficiaries?
If correct, the rebound in HH consumption is potentially good news for suppliers of consumer durables. So-called “social consumption” will naturally benefit too, but there is only so much lost time that can be made up (you can only eat so many meals in one day!). It is reasonable to assume, therefore, that a large proportion of additional expenditure is directed towards durable goods whose consumption is more likely to have been delayed during lockdown (eg, car sales).
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Trends in UK M4ex – is this a different form of monetary expansion? (Source: Bank of England, CMMP analysis)
“Money sitting idle in a savings account does not contribute to GDP”
Dirk H. Ehnts, Modern Monetary Theory and European Macroeconomics
The key message
UK money supply (M4ex) increased 13.9% YoY in November 2020. Does this mean that investors positioned for a pick-up in UK inflation should be getting excited?
No, not yet (if at all).
As mentioned in previous posts, the message from the money sector is very different now from previous periods of rising money supply. The key 2020-21 messages remain:
heightened household uncertainty
weak household consumption
subdued overall credit demand
None imply ST inflationary pressures.
Household uncertainty – the chart that matters
Monthly flows in UK households sterling money holdings in £bn (Source: Bank of England; CMMP analysis)
Household M4 accounts for 64% of total M4ex. In November 2020, UK households increased their sterling money holdings by £17.6bn, up from £9.4bn in October. This represents the second highest monthly flow after May 2020’s £25bn and was almost 4x the size of the average monthly flow in 2019. Uncertainty reigns in the UK household sector.
Weak household consumption – the chart that matters
Monthly flows in UK consumer credit in £bn – a negative figure indicates net repayments (Source: Bank of England; CMMP analysis)
Households also made net repayments in consumer credit for three consecutive months between September and November 2020 of £0.8bn, £0.7bn, and £1.5bn respectively. The -6.7% YoY decline in consumer credit in November was the weakest level since the series began in 1994.
Subdued credit demand – the charts that matter
YoY growth rates in the BoE’s headline money (M4) and credit (M4 Lending) series – out of synch! (Source: Bank of England; CMMP analysis)YoY growth rate in lending minus YoY growth rate in money – abnormal money and credit cycles (Source: Bank of England; CMMP analysis)
Finally, the gap between growth in M4 (13.9%) and ML lending (4.5%) remains at a record high of 9.4ppt. In other words, this is not a normal cycle with synchronised money and credit trends (albeit with traditional leading and lagging relationships). Consequently, and with credit demand remaining subdued, investors should be wary of assuming normal relationships between money supply and inflation (to the extent that such relationships exist at all).
Conclusion
“Monetary policy effectiveness is based on certain stable relationships between monetary aggregates.”
Richard Koo, The Holy Grail of Macroeconomics
To repeat the penultimate lesson from the money sector in 2020 – periods of monetary expansion differ in terms of their drivers and implications. The message in the pre-GFC period was one of over-confidence and excess credit demand. In contrast, the current message is one of elevated uncertainty, weak consumer demand and subdued overall credit demand (with the added uncertainty regarding the extent to which rising savings are forced or precautionary).
It is too early for UK investors who are positioned for a pick-up in inflations to get excited.
[Note that this post was drafted before the announcement of further UK lockdown restrictions on 4 January 2020]
Please note that the summary comments above are extracts from more detailed analysis that is available separately.
Trends in EA financial sector balances since 2008 (Source: Eurostat; CMPP analysis)
Lesson #2
CMMP analysis focuses on the relationship between the financial sector and the wider economy i.e., households (HHs), corporates (NFCs), government and the rest of the world (RoW). The second lesson is that the core services provided by banks – payments, credit and savings – produce a stock of contracts that can be represented by financial balance sheets. These balance sheets link each of these economic agents over time and form a quantitative, objective and logical analytical framework.
A fundamental principle of accounting is that for every financial assets (FA) there is an equal and offsetting financial liability (FL). By definition, net financial wealth (NFW) is therefore equal to the sum of FAs less the sum of FLs. If we take all private sector FAs and FLs, it is also a matter of logic that the sum of all the assets must equal the sum of all the liabilities.
The key implication here is that for the private sector to accumulate NFW it must be in the form of claims against another sector i.e., governments, the RoW, or a combination of the two.
In the current climate of rising government deficits, this insight is crucial to debates over whether deficits: (1) are evidence of overspending; (2) a burden on future generations; and/or (3) crowd out private investment. The fact that the answers given to these questions are generally incorrect only goes to show how poorly the relationship between the financial sector and the wider economy is understood. It also explains why official economic forecasts can/often do fail common sense tests (lesson #3).
