Tag: MCBC

“Still tightening as stresses mount”

Three warning signs from the rolling over in EA money and credit cycles

The key chart

Trends in nominal YoY growth rates in M3, M1 and private sector credit
(Source: ECB; CMMP)

The key message

As growth in euro area (EA) money supply in February 2023 falls to its slowest rate (2.9% YoY) since October 2014, the “message from the money sector” includes three key warning signs for the ECB and for investors in the region:

  • Warning sign #1: banks’ top-line growth. Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin (this is not just a US story). At the same time, credit growth is slowing i.e. negative price and volume effects.
  • Warning sign #2: house prices and household consumption. Monthly flows of mortgage and consumer credit have slowed sharply, to well-below pre-pandemic levels.
  • Warning sign #3 (re-enforced): weakening economic growth outlook. Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive.

On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.

Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as quickly as money and credit cycles are falling…

Still tightening as stresses mount

Trends in broad money growth since 2003 (% YoY, nominal terms)
(Source: ECB; CMMP)

According to the latest ECB “Monetary Developments in the euro area” data release (27 March 2023), growth in broad money (M3) fell to 2.9% YoY in February 2023, down from 3.5% in January 2023 and 4.1% in December 2022. February’s growth rate was the slowest since October 2014.

Trends in broad money growth (% YoY) and breakdown of contribution (ppt)
(Source: ECB; CMMP)

The sharp slowdown in narrow money (M1) is a key driver here. Recall that at the point of the January 2021 peak in M3 growth (12.5%), M1 contributed 11.3ppt to this total growth in broad money (see chart above).

This reflected the fact that households (HHs) and corporates (NFCs) were hoarding cash, largely in the form or overnight deposits, despite the fact that they were only earning a return of 0.01%. In stark contrast, narrow money fell -2.7% YoY in February 2023 as overnight deposits fell -2.7% YoY.  

As money supply growth slows sharply, the message from the money sector behind these headline figures contains three key warning signs for the ECB and for investors in the region.

Warning sign #1 – banks’ top line growth

Monthly flows of ST liabilities by type (EUR bn)
(Source: ECB; CMMP)

Banks continue to experience net outflows of ST liabilities and a substitution away from low-cost overnight deposits to more expensive “other ST deposits”, at the margin. Continuing the theme from “Competing for funding”, EA banks have experienced outflows of ST liabilities in four of the past five months. This reflects six consecutive months of overnight deposits outflows (the blue columns in the chart above). Inflows in other ST deposits (within M2-M1 above) and, to a lesser extent, marketable securities (within M3-M2) have not been able to compensate. They also come at a higher cost.

Trends in private sector credit growth (% YoY) and breakdown of contribution (ppt)
(Source: ECB; CMMP)

At the same time, credit growth is slowing. Adjusted private sector credit (PSC) growth peaked recently at 7.1% YoY in September 2022. NFC credit grew 8.9% at this point and made the largest contribution to total loan growth (3.5ppt). HH credit grew 4.4% and contributed 2.3ppt.

By February 2023, PSC growth had slowed to 4.3% YoY. NFC credit growth slowed to 5.7%, but remained the largest contributor to total PSC growth (2.2ppt). HH credit growth slowed to 3.2% YoY, a 1.7ppt contribution to total PSC growth.

Warning sign #2: house prices and household consumption

Trends in monthly mortgage flows (EUR bn)
(Source: ECB; CMMP)

Monthly flows of mortgage and consumer credit have slowed sharply to below pre-pandemic levels.Monthly mortgage flows slowed to €5.1bn in February 2023, from €13.7bn a year ago (see chart above). Note that the growth in the outstanding stock of EA mortgages peaked at 5.8% in August 2021 and slowed noticeably after June 2022. February’s growth rate was 3.7% YoY, the slowest growth rate since November 2019.

Trends in monthly consumer credit flows (EUR bn)
(Source: ECB; CMMP)

Monthly consumer credit flows fell to €1.9bn in February 2023 from €3.4bn a year earlier (see chart above). Note that while consumer credit flows have recovered, they have remained below the average pre-pandemic flows of €3.4bn throughout the post-pandemic period. This is in contrast to trends observed in the US and the UK.

Monthly mortgage and consumer credit flows as a multiple of pre-pandemic average flows (Source: ECB; CMMP)

With monthly mortgage and consumer credit flows falling to 0.30x and 0.33x their respective pre-pandemic average monthly flows(see chart above), the EA money sector is sending clear warning signs for future house prices and HH consumption in the region.

Warning sign #3 (re-enforced): weakening economic growth outlook

Trends in real M1, HH credit and NFC credit (% YoY, real terms)
(Source: ECB; CMMP)

Leading, coincident and lagging monetary variables are slowing sharply and in a coordinated fashion at a time when access to finance is becoming more difficult and more expensive. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. The sharp and coordinated slowdown in these variables has been sending warning signs from some months now. If historic relationships between these variables continue, this suggest that economic activity will decelerate over the next quarters.

Conclusion

On 16 March 2023, ECB President Lagarde commented that, “we are beginning to see the transmission of our monetary policy.” Eleven days later, the money sector is adding the important detail – increased stresses for banks, households and the economic outlook for the euro area.

Will the “data dependent” central bank listen to its money sector and, if so, how will it respond? The risks of policy mistakes are rising as sharply as money and credit cycles are falling…

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

“Completing the transition”

The end of “pandemic-era” economics

The key chart

Growth rate in M3 (% YoY) and contribution (ppt) of M1 and private sector credit
(Source: ECB; CMMP)

The key message

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. Three important, positive developments lay behind the headline growth figures.

  • First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended.
  • Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.
  • Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately.

Monetary trends adjusted from inflation, are sending very different and consistently negative messages. Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate.

If historic relationships between these variables continue, this suggests a deceleration in overall economic activity over the next quarters.

Completing the transition

Monetary developments in the euro area (EA) indicate a clear transition away from “pandemic-era” economics.

Growth rates (% YoY) in broad (M3) and narrow (M1) money
(Source: ECB; CMMP)

Growth rates in broad money (M3) recovered during 3Q22 but remained well below pandemic levels. M3 rose 6.3% YoY in September, up from 6.1% YoY in August and 5.7% YoY in July. Despite this, broad money growth was 6.2ppt below its 12.5% YoY January 2021 peak (see chart above).

Narrow money (M1), a key component of broad money, rose only 5.6% YoY, however, down from 6.8% YoY in both August and July. Narrow money growth was 10.9ppt below its 16.5% YoY January 2021 peak.

Behind the headline YoY growth figures lie three important, positive developments.

Growth rate (% YoY) in M3 and contribution (ppt) of ON deposits and other components
(Source: ECB; CMMP)

First, the period of heightened uncertainty and subdued demand for credit that reached a peak during the pandemic has ended. Recall that the hoarding of cash by HHs and NFCs, largely in the form of overnight deposits at banks, was the main driver of the spike in broad money during the pandemic (see graph above). M3 growth peaked at 12.5% YoY in January 2021. At the same time, M1 and overnight deposits grew 16.5% YoY and 17.1% YoY and contributed 11.3ppt and 10.1ppt to total broad money growth respectively.

With heightened levels of uncertainty, HHs were increasing their forced and precautionary savings. The key point here is that money sitting idly in overnight deposits at banks contributed to neither economic growth nor inflation.

Growth rate (% YoY) in M3 and contribution (ppt) of private sector credit
(Source: ECB; CMMP)

Note also, that at the point of maximum M3 growth, private sector credit grew only 4.5% YoY and contributed only 5.4ppt to the 12.5% YoY growth in broad money (see graph above).

Fast forward to September 2022, and private sector credit grew 6.9% YoY in September, up from 6.8% YoY in August and 6.3% YoY in July. At the end of 3Q22, private sector credit contributed 5.4ppt to the total 6.3% YoY growth rate in broad money. This represents a clear break from the monetary dynamics seen during the pandemic (see key chart above).

Growth rates (% YoY) in M3 and private sector credit
(Source: ECB; CMMP)

Second, and following on from this, EA money and credit cycles are re-synching with each other as the demand from credit recovers to levels last seen in December 2008.

As noted in “Don’t confuse the messages”, monetary aggregates and their counterparts move together in typical cycles. 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.

Growth rate (% YoY) in private sector credit minus growth rate in M3
(Source: ECB; CMMP)

The “pandemic-era” relationship between money and credit cycles was far from typical, however. In January 2021, the gap between the YoY growth rate in M3 (12.5% YoY) and private sector credit (4.5% YoY) reached a historic high of 8ppt (see chart above).

During 2021, CMMP analysis focused on this dynamic as one of the three key signals to monitor. In September 2022, private sector credit grew faster (6.9% YoY) than money supply (6.3% YoY) for the fourth consecutive month as money and credit cycles re-synched with each other.

Trends in the outstanding stock of private sector credit (EUR bn) with breakdown between COCO-based and FIRE-based lending (Source: ECB; CMMP)

Third, and perhaps most importantly, the breakdown of private sector credit is shifting back towards increased demand for productive (COCO-based) lending – corporate credit is accelerating while mortgage demand is moderating slowly.

Recall that the outstanding stock of loans that support production and income formation in the euro area (COCO-based loans) only recovered to the GFC period peaks in November 2021 (see chart above). Nearly all of the aggregate growth in euro area lending since the GFC has been in the form of less-productive FIRE-based lending (see “Fuelling the FIRE” and “It’s a record of sorts”).

Growth (% YoY) in PSC and contribution (ppt) of COCO-based and FIRE-based lending
(Source: ECB; CMMP)

In September 2022, COCO-based and FIRE-based lending both contributed 3.3ppt to the total 6.6% YoY growth in (unadjusted) private sector credit (see graph above). This contrast sharply with the situation a year earlier in September 2021 when COCO-based and FIRE-based lending contributed 0.7ppt and 2.5ppt to the total 3.2% YoY growth rate.

Growth rates (% YoY) in mortgages and loans to NFCs
(Source: ECB; CMMP)

Significantly, the growth rate in lending to NFCs (the largest element of COCO-based lending) grew faster (8.0% YoY) and contributed more to total lending (3.1ppt) than mortgage lending (the largest element of FIRE-based lending) which grew 5.1% YoY and contributed 2.1ppt to total lending.

So far, so good.

Rising inflation is outweighing each of these positive developments, unfortunately. Monetary trends adjusted from inflation, are sending very different and consistently negative messages.

Growth rates (% YoY in real terms) in M1, HH credit and NFC credit
(Source: ECB; CMMP)

Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP. Each indicator is falling at an increasing rate (see chart above). If historic relationships between the variables continue, this suggests a deceleration in overall economic activity over the next quarters.

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

“Still in-synch?”

Are the UK and EA money sectors still sending consistent messages?

The key chart

Trends in UK and EA broad money (Source: BOE; ECB, CMMP)

The key message

The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?

Growth in broad money rose sharply in both regions during the pandemic, peaking in 1Q21. Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. UK and EA households (HHs) were increasing savings and delaying consumption – deflationary rather than inflationary forces. Note, in this context, that growth in private sector credit (key assets of banks) did not match the growth in broad money (key ST liabilities of banks). Indeed the gap between money growth and lending growth reached historically high levels in 1Q21. These were atypical money and credit cycles.

Broad money growth has slowed down to pre-pandemic levels now. UK and EA HHs are no longer hoarding cash. The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other. In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. The contribution of productive COCO-based lending has also increased in both regions. In the EA, for example, NFC lending grew faster than mortgages in June 2022.

In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The money sectors are still sending consistent messages, albeit with slightly different areas of emphasis.

The UK is more geared towards a recovery in consumer credit and has benefited from a stronger recovery here. Overall credit growth is slowing in the UK, however. The EA has seen a more promising recovery in lending to NFC and credit growth is still accelerating (in nominal terms).

As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments in the EA and the UK, however. Credit growth is negative in real terms in both regions, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.

The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…

Still in-synch?

The messages from the UK and euro area (EA) money sectors were remarkably consistent during the COVID-19 pandemic. Are they still sending consistent messages now?

The impact of the COVID-19 pandemic

The impact of COVID-19 on UK and EA broad money growth (Source: BoE; ECB; CMMP)

Growth in broad money rose sharply in both regions to peak in 1Q21 (see chart above). In the UK, the YoY growth rate in M4ex rose from 7.5% in March 2020 to a peak of 15.4% in February 2021. In the EA, the growth rate in M3 rose from 7.5% in March 2020 to a peak of 12.5% one month earlier in January 12.5%.

Narrow money as %age of broad money in the UK and EA (Source: BoE; ECB; CMMP)

Growth in narrow money (M1), and overnight deposits with banks within this, was the main driver of broad money growth. M1 currently accounts for 69% of UK M3 and 73% of EA M3, up from 48% and 51% respectively a decade earlier. This means that UK and EA households (HHs) were increasing savings and delaying consumption during the pandemic – deflationary rather than inflationary forces.

Put simply, money sitting idly in bank deposits contributes to neither growth nor inflation.

The gap between UK and EA lending and money supply growth (Source: BoE; ECB; CMMP)

Note that the growth in broad money (bank’s ST liabilities) was not matched by growth in private sector credit (banks’ assets). Indeed the gap between growth in money and growth in lending reached historic highs in 1Q21. In short, the money and credit cycles had moved out-of-synch with each other, and to a record extent.

The recovery from COVID-19

Trends in UK and EA broad money (Source: BOE; ECB, CMMP)

Broad money growth has slowed down to pre-pandemic levels now (see chart above). In June 2022, growth in M4ex had slowed to 4.4% in the UK and growth in M3 had slowed to 5.7% in the EA. These represent the slowest rates of growth since January 2020 and February 2020 respectively.

Monthly HH money flows as a multiple of pre-pandemic average flows (Source: BoE; ECB; CMMP)

HHs are no longer hoarding cash. In the UK, monthly HH money flows fell to £1.5bn in June 2022, 0.3x the average pre-pandemic flow of £4.7bn. In the EA, monthly HH deposit flows fell to €8.5bn, again this is 0.3x the average pre-pandemic flow of €33bn (see chart above).

Quarterly consumer credit flows (Source: BoE; ECB; CMMP)

The demand for consumer credit has recovered with the largest quarterly flows since the recovery began in 2Q21. At the peak of the crisis in 2Q20, UK and EA HHs repaid £13.2bn and €12.9bn in consumer credit respectively. More recently, we have seen five consecutive quarters of positive consumer credit flows (see chart above).

Consumer credit demand has returned to pre-pandemic levels in the UK but has still to recover fully in the EA. In the 2Q22, UK consumer credit flows recovered to £4.2bn, above the pre-pandemic average of £3.6bn. EA consumer credit flows also recovered to €7.5bn, but they remain below the pre-pandemic average of €10.8bn.

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

Annual growth rates in consumer credit have also recovered to post-pandemic highs, to 6.5% in the UK and 3.3% in the EA in June 2022. Note the relative gearing of the UK here (see chart above). Consumer credit growth slowed faster and recovered stronger in the UK than in the EA.

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

Growth rates in money supply and private sector credit have also re-aligned as money and credit cycles have re-synched with each other (see chart above). In the EA, lending growth exceeded money supply growth in June 2022 for the first time since October 2011. In the UK, lending growth still lagged money supply growth by 2.1ppt in June 2022, but this is much narrower than the peak gap of 11.5ppt seen in February 2021.

Trends in UK and EA bank lending by type (Source: BoE; ECB; CMMP)

The contribution of productive COCO-based lending has increased in both regions. In the EA, NFC lending grew faster (5.9%) than mortgages (5.3%) in June 2022. Less productive, mortgage lending remains resilient in the EA, but its growth is slowing in the UK (see chart above).

Conclusion

In short, the key signals that I have been following consistently since early 2021 are all sending broadly positive messages for the economic outlook in both the UK and EA. The UK has benefited from a stronger recovery in consumer credit. The EA has seen a more promising recovery in lending to NFC.

As highlighted in the previous two posts, rising inflation has overshadowed all of these positive developments, however (see “Accounting for inflation” and “Accounting for inflation – part 2”).  Credit growth is negative in real terms in both the UK and EA, and leading, coincident and lagging monetary indicators are slowing sharply and in a coordinated fashion.

The synchronisation in the messages from the UK and EA money sectors extends to both the good and the bad news. Plenty for optimists and pessimists to debate here…

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

“Accounting for inflation – part 2”

Inflation also distorts the 2Q22 message from the UK money sector

The key chart

Nominal and real growth rates in UK M4Lex (Source: BoE; CMMP)

The key message

In my previous post, I explained how rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly. The same is true for the UK too.

Ignore inflation and the messages from the UK’s money sector are broadly positive for the economic outlook. The three key signals from the UK money sector that I have been following consistently since early 2021 are all sending broadly positive messages – UK HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. Growth rates in COCO-based consumer credit and NFC lending are also rising in the UK while the growth in FIRE-based mortgage lending is slowing. Does this sound familiar?

Rising inflation is over-taking these positive trends, however. Lending to private sector companies and households (M4Lex) is falling sharply in real terms (-6.5% YoY). Trends in real HH credit and real NFC credit are slowing sharply and in a coordinated fashion. This matters because these factors typically display coincident and lagging relationships with real GDP.

As in the EA, plenty of information for optimists and pessimists to debate here but with increasing ammunition for the pessimists…

Accounting for inflation – part 2

In the previous post, I explained how rising inflation distorts the 2Q22 messages from the euro area’s (EAs) money sector significantly. The same is true for the UK too.

The good news

Ignore inflation and the messages from the UK’s money sector are broadly positive for the economic outlook.

Trends in monthly HH money flows (Source: BoE; CMMP)

Monthly HH money flows have moderated slowly, reflecting lower levels of uncertainty. The monthly flow fell from £5.2bn in May 2022 to £1.5bn in June 2022. This is well below the average pre-pandemic flows of £4.6bn and the peak flow of £26bn recorded in May 2020 when HH uncertainty levels peaked at the height of the pandemic crisis (see chart above).

Quarterly trends in HH money flows (Source: ECB; CMMP)

The quarterly HH money flow in 2Q22 was £12.2bn (see chart above). This compares with the average pre-pandemic flows of £11.7bn. The message here is the same – HHs in the UK are no longer hoarding cash in the form of bank deposits. This is reflected, in turn, in the slowdown in broad money growth (see below).

Trends in monthly consumer credit flows (Source: ECB; CMMP)

The demand for credit has recovered. Monthly consumer credit flows rose to £1.8bn in June 2022 from £0.9bn in May 2022, well above the pre-pandemic average flows of £1bn. The YoY growth rate of 6.5% was the highest rate of growth since May 2019. Within this, the annual growth rate of credit card borrowing was 12.5% while other forms of consumer credit grew 4.1%. These were the highest rates of growth since November 2005 and March 2020 respectively.

Quarterly trends in consumer credit (Source: BoE; CMMP)

The quarterly flow of consumer credit rose from £3.1bn in 4Q21 and £3.6bn in 1Q21 to £4.2bn in 2Q22 (see chart above). The 2Q22 flow was the largest quarterly flow since 2Q18 and was above the pre-pandemic average of £3.6bn. There have now been five consecutive quarters of positive consumer credit flows, with current flows in-line or slightly above pre-pandemic levels.

Growth trends in broad money (M4ex) and lending (M4Lex) (Source: BoE; CMMP)

After the recent and unprecedented de-synchronisation of money and credit cycles, growth rates in UK money supply and private sector credit are converging (see chart above). The YoY growth rate in money (M4ex) slowed from 5.4% in May 2022 to 4.4% in June 2022. At the same time, the YoY growth rate in lending (M4Lex) fell from 3.9% to 2.3%. While the gap between the two growth rates widened slightly from 1.5ppt to 2.1ppt, it has narrowed considerably from its peak of 11.5ppt in February 2021.

Growth trends in mortgages, consumer credit and NFC lending (Source: BoE; CMMP)

Growth rates in COCO-based consumer credit and NFC lending are rising in the UK while the growth in FIRE-based mortgage lending is slowing (see chart above).

As described above, consumer credit is growing at the fastest rate since May 2019. NFC lending has also recovered to 2.0% YoY, marking five consecutive months of positive YoY growth.

Of course, mortgages remain the largest segment of UK private sector credit (89% of total HH credit and 61% of total PSC). The relative stability of mortgage demand has been a key feature of the messages from the UM money sector for some time. However, net borrowing of mortgage debt decreased from £8.0bn in May 2022 to £5.3bn in June 2022. The YoY growth rate also declined from 4.6% in May 2022 to 3.8% in June 2022, the slowest rate of growth since February 2021. Approvals for house purchases, an indicator of future borrowing, decreased to 63.700 in June 2022 from 65,700 in May. This is below the pre-pandemic average of 66,700.

The bad news

Nominal and real growth rates in UK M4Lex (Source: BoE; CMMP)

Take inflation into account and the messages are very different, however. Lending to private sector companies and HHs (M4Lex) slowed from 3.9% YoY in May 2022 to 2.3% YoY in June 2022 (see chart above). In real terms, M4Lex fell -6.5% YoY in June 2020, with all forms of lending declining in real terms.

Growth trends (real terms) in HH and NFC credit (Source: BoE; CMMP)

Furthermore, trends in real HH credit and real NFC credit are slowing sharply in a coordinated manner. This matters because these factors typically display coincident and lagging relationships with real GDP over time (see “Look beyond the yield curve” for more details).

Conclusion

The three key signals from the UK money sector that we have been following consistently since early 2021 are all sending broadly positive messages – UK HHs have stopped hoarding money, they are borrowing more to fund consumption, and money and credit cycles are re-synching. Growth rates in COCO-based consumer credit and NFC lending are also rising in the UK while the growth in FIRE-based mortgage lending is slowing.

Rising inflation is over-taking these positive trends, however. Lending to private sector companies and households (M4Lex) is falling sharply in real terms (-6.5% YoY) and traditional coincident and lagging monetary indicators have turned down sharply and in a coordinated fashion. Plenty of ammunition here for pessimists.

The format and presentation of this post mirrors that of the previous post deliberately. Why? Because the messages from the UK and EA money sectors have been very similar during the pandemic. The next post will compare and contrast these trends more closely.

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

“Euro area re-synching – part 2”

The implications for asset allocation

The key chart

The sharp and co-ordinated slowdown in EA money and private sector credit (% YoY, real)
(Source: ECB; CMMP)

The key message

What are the implications of the re-synching of euro area money and credit cycles for asset allocation and what are the current messages from the money sector telling us?

Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore.

The recovery in money and credit cycles in the post-GFC period broadly followed this stylised pattern. Other macro-factors complicated the wider interpretation of these trends, however. Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example. At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector.

Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits, and will be encouraged by the resilient HH and recovering NFC credit demand (in nominal terms).

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms with be a far more alarming message, especially for those positioned for economic recovery.  

Euro area re-synching – part 2

As a macro strategist, economist and global investor, I have always been interested in the relationship between money, credit and business cycles and the implications for asset allocation.

Growth rates in narrow money (M1) and loans to the private sector display relatively robust relationships with the business cycle over time. M1, household (HH) and corporate (NFC) credit also enjoy leading, coincident and lagging relationships with GDP respectively and can be very useful inputs into asset allocation processes, therefore. Note that these relationships tend to be stronger with reference to turning points than to the amplitude of growth.

The recovery in money and credit followed the stylised pattern post-GFC (% YoY, real)
(Source: ECB; CMMP)

The recovery in money and credit cycles followed this stylised pattern in the post-GFC period (see chart above). Real M1 bottomed in July 2011 (-1.4%) and turned positive in May 2012. Real HH credit bottomed next in September in 2012 (-2.3%) and turned positive in December 2014. Finally, real NFC credit bottomed in June 2013 (-4.6%) and turned positive in November 2015. Other macro-factors complicated the wider interpretation of these trends, however.  

Trends (% YoY) in real GDP and real M1 (Source: ECB; CMMP)

Interest rate effects (initially) and the COVID-19 pandemic (more recently) had a more important impact on narrow money growth than cyclical factors, for example (see chart above). 

Interest rate and cyclical effects are typically the main factors affecting trends in narrow money, with the latter being more relevant for asset allocation purposes.

While real M1 continued to exhibit leading indicator qualities, strong demand for overnight deposits (within M1), driven by their increasing low opportunity cost, suggest that interest rate effects had a greater impact than cyclical factors over much of the past decade. The COVID-19 pandemic also resulted in dramatic increases in forced and precautionary savings, again largely in the form of overnight deposits. This compounded the challenges of interpreting these dynamics (see “Don’t confuse the message”).

Trends (% YoY) in real GDP and real HH credit (Source: ECB; CMMP)

At the same time, extended periods of private sector deleveraging resulted in HH and NFC credit growth lagging GDP growth for much of the past decade.

The chart above illustrates how real HH credit has enjoyed a broadly coincident relationship with GDP for most of the period. That said, it also shows that the EA HH sector was engaged in an extended period of passive deleveraging between March 2010 and March 2019 with real growth in HH credit lagging real growth in GDP.

Similarly, the chart below illustrates how NFC credit has also enjoyed a broadly lagging relationship with real GDP growth. Again, the analysis and interpretation is challenged by an extended period of NFC deleveraging. Growth in NFC credit lagged behind real GDP growth from December 2009 to May 2016 and to July 2018, in a more sustained fashion.

Trends (% YoY) in real GDP and real NFC credit (Source: ECB; CMMP)

That said, the overall message has been clear – while money growth has exceeded GDP growth over the past decade, credit growth has lagged it. The consequences for macro policy choices of this extended dynamic was clear, even before the pandemic hit.

Monthly HH deposit flows as a multiple of pre-pandemic levels (Source: ECB; CMMP)

With money and credit cycles re-synching now, inflation is the key challenge in interpreting current messages from the money sector. Optimists might note that the slowdown in monetary growth reflects a sharp moderation in deflationary money flows into overnight deposits (see chart above), and will be encouraged by the resilient HH and recovering NFC credit demand, in nominal terms (see chart below).

Growth trends (% YoY, nominal) in HH and NFC credit (Source: ECB; CMMP)

In contrast, pessimists might prefer the more traditional approach described above. For them, the very sharp and co-ordinated slowdown in money and credit growth in real terms (see chart below) will be a far more alarming message, especially for those positioned for economic recovery. 

The alarming and coordinate slowdown in real money and credit growth (Source: ECB; CMMP)

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

“A desynchronised decade”

Created challenges for policy makers, banks and investors alike

The key chart

Lending growth (% YoY) minus money growth for the UK and EA since 2012 (Source: BoE; ECB)

The key message

Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike.

Growth in money supply has also exceeded growth in private sector credit in the euro area and for much of the period in the UK. The effectiveness of monetary policy, the dominant macro policy, has diminished dramatically as a result.

The gap between growth in money supply and private sector credit hit a historic high during the COVID-19 pandemic. More recently, however, these growth rates have converged as the build-up of excess savings has slowed and the demand for credit has recovered (at least in nominal terms).

This means that three key signals from the UK and EA money sectors have turned more positive: monthly HH money flows have fallen back below pre-pandemic levels; quarterly consumer credit flows have been positive since 2Q21 and have returned to pre-pandemic levels in the UK; and the gap between money supply and private sector credit growth has narrowed.

Macro challenges remain, but the message from the UK and EA money sectors is less bearish than consensus investment narratives.

A desynchronised decade

Growth rates (% YoY) in EA money and lending (Source: ECB)
Growth rates (% YoY) in UK money and lending (Source: BoE)

Money and credit cycles have been desynchronised for much of the past decade. In typical cycles, monetary aggregates and their key counterparties, such as private sector credit, move together. Put simply, 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. However, the two charts above show the extent to which, and the periods when, UK and EA money and credit cycles have diverged since March 2012.

EA money flow minus credit flow (rolling quarters) since Mar 2012 (Source: ECB)

Growth in money supply has also exceeded growth in private sector credit in the euro area and for much of the period in the UK. The charts above (EA) and below (UK) illustrate trends in the gap between money and credit flows (rolling quarters) for both regions. The build-up of liquidity in both regions is clear to see. Increases in the supply of money have not been matched by equivalent increases in private sector demand for credit.

UK money flow minus credit flow (rolling quarters) since Mar 2012 (Source: BoE)

The effectiveness of monetary policy, the dominant macro policy, has diminished dramatically as a result. Broadly speaking, monetary policy is effective if “central bank accommodation increase money and credit for the private sector to use” (Koo, 2015). Not only has credit growth lagged money supply growth, it has also been predominantly the “wrong type of credit” ie, less productive FIRE-based lending. As noted in previous posts, this has hidden risks in terms of leverage, future growth, financial stability and income inequality.

Loan growth (% YoY) minus money growth (Source: BoE; ECB)

The gaps between growth in money supply and private sector credit hit historic highs during the COVID-19 pandemic (see chart above). In the UK, loan growth exceeded money growth between August 2018 and December 2019. During the pandemic, however, the gap between money growth (15.4%) and credit growth (3.9%) widened to 11.5ppt in February 2021. In the EA, money growth (4.9%) exceeded credit growth (3.7%) by 1.2ppt at the end of 2019. The gap peaked at 8ppt in January 2021 – money growth of 12.5% versus credit growth of 4.5%.

More recent YoY growth trends in UK and EA money and lending (Source: BoE; ECB)

More recently, these growth rates have converged as the build-up of excess savings has slowed and credit demand has recovered (at least in nominal terms). At the end of 1Q22, money growth had slowed to 5.5% YoY in the UK while credit growth had risen to 3.7% YoY, a narrowing of the gap to only 1.8ppt. Similarly, in the EA, money growth at the end of 1Q22 had slowed to 6.3% YoY while credit growth was 4.7% YoY, a gap of 1.6ppt (see chart above).

Conclusion

What does this mean? Three key signals from the UK and EA money sectors have turned more positive: monthly HH money flows have fallen back below pre-pandemic levels; quarterly consumer credit flows have been positive since 2Q21 and have returned to pre-pandemic levels in the UK; and the gap between money supply and private sector credit growth has narrowed.

Macro challenges remain, but the message from the UK and EA money sectors is less bearish than consensus investment narratives.

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

“Crocodile jaws”

Resilient demand masks tough times for UK mortgage providers

The key chart

Resilient mortgage demand masks tough times for UK mortgage providers (% YoY) (Source: Bank of England; CMMP analysis)

The key message

The relative stability/resilience of mortgage markets in the UK (and in the euro area) has been a consistent theme in the “messages from the money sector” during the COVID-19 pandemic.

UK mortgages grew 2.9% YoY in August, unchanged from July, and monthly flows have been steadily increasing from their April 2020 lows. This recovery has also been the main driver in the rebound in overall household borrowing, with mortgages accounting for £3.1bn in August’s £3.4bn increase in total lending to individuals. Looking forward, the number of mortgage approvals for house purchases also increased sharply in August to 84,700, the highest number since October 2007.

So far, so good – but there is always a “but”…

Current mortgage demand is very subdued in relation to past cycles despite the low cost of borrowing. One factor here is that, despite the deleveraging seen since 1Q10, the UK household debt-to-HDP ratio remains at 85%, the threshold level above with the BIS believes that debt becomes a drag on future growth. Unsurprisingly, the CAGR in HH debt (primarily mortgages) has trended between only +/- 1% nominal GDP growth since early 2016 – not much of a “growth story” here.

More concerning for mortgage providers, the effective rates on new and outstanding mortgages have fallen 28bp and 32bp respectively over the past 12 months to new lows of 2.14% and 1.72% respectively. The gap between the rate on outstanding and new mortgages was 38bp in August, indicating further downward pressure on net interest margins and income.

With subdued growth and further NIM compression ahead, mortgage providers will need to embrace digitalisation to deliver effective market segmentation/client knowledge, alternative revenue sources, further efficiency gains and more effective liquidity and risk management.

Seven charts that matter

The relative stability/resilience of mortgage markets in the UK (and euro area) has been a consistent theme in the “messages from the money sector” during the Covid-19 pandemic. Outstanding mortgage balances grew 2.9% YoY in August, unchanged from July but slightly below the 3.1% growth recorded in June. In contrast, the growth in consumer credit hit a historic low (-3.9% YoY) while corporate lending grew 9.7% YoY (see key chart above).

Monthly flows have recovered steadily since their April 2020 lows (Source: Bank of England; CMMP analysis)

The recovery in monthly HH borrowing flows since April’s lows (see chart above) has been the key driver in the recovery in overall household lending (see chart below). In August, for example, mortgages accounted for £3.1bn out of a total £3.4bn monthly flow.

Mortgages are driving the recovery in household lending (Source: Bank of England; CMMP analysis)
Approvals suggest positive momentum (Source: Bank of England; CMMP analysis)

Looking forward, the number of mortgage approvals for house purchases also increased sharply in August to 84,700, the highest number since October 2007. This partially offsets the March-June weakness – there have been 418,000 approvals YTD, compared with 524,000 in the same period in 2019.

So far, so good – but there is always a “but”…

Current demand is very subdued in relation to past cycles in nominal and real terms (Source: Bank of England; CMMP analysis)

Current mortgage demand is very subdued in relation to past cycles (see chart above), despite the low cost of borrowing. One factor here is that, despite the deleveraging seen since 1Q10, the UK household debt-to-HDP ratio remains at 85%, the threshold level above with the BIS believes that debt becomes a drag on future growth (see chart below).

HH debt ratios remain elevated at the BIS threshold level (Source: BIS; CMMP analysis)

Unsurprisingly, the CAGR in HH debt (primarily mortgages) has trended +/- 1% nominal GDP growth since early 2016. The chart below comes from CMMP Relative Growth Factor (RGF) analysis, which considers the rate of growth in debt in relation to GDP on a three-year compound growth basis with the level of debt expressed as a percentage of GDP. This graph illustrates the UK HH RGF on a rolling basis. There is little to get excited about in this chart.

An unexciting “relative growth” story – rolling 3-year CAGR in HH debt versus rolling 3-year CAGR in nominal GDP (Source: BIS; CMMP analysis)

More concerning for mortgage providers, the effective rates on new and outstanding mortgages have fallen 28bp and 32bp respectively over the past 12 months to new low of 2.14% and 1.72% respectively. The gap between the rate on outstanding and new mortgages was 38bp in August, indicating further downward pressure on net interest margins and income.

The challenge of delivering top-line growth (Source: Bank of England; CMMP analysis)

Conclusion

With subdued growth and further NIM compression ahead, mortgage providers will need to embrace digitalisation to deliver effective market segmentation/client knowledge, alternative revenue sources, further efficiency gains and more effective liquidity and risk management.

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

“Europe versus the UK”

How do the messages from the money sectors compare?

The key chart

Broad money growth is accelerating in both regions, but how do the messages behind these trends compare and what do they mean? (Source: ECB; Bank of England; CMMP analysis)

The key message

Broad money growth is accelerating in both the euro area (EA) and the UK but how do the messages behind these trends compare and what do they mean for investors?

M1 dynamics are the key growth drivers here as EA and UK households and corporates maintain high preferences for holding liquid assets despite negative real returns. Above trend corporate credit and resilient mortgage demand is offsetting weakness in consumer credit in both regions but with more volatile YoY credit dynamics in the UK. The growth gap between the supply of money and the demand for credit has reached new 10-year highs.

The overriding message here is one of uncertainty and deficient credit demand, a more nuanced message than some inflation hawks suggest.

Looking at ST dynamics, uncertainty peaked in May in both regions, HHs have stopped repaying consumer credit and the NFC “dash-for-cash” has also peaked.

From an investment perspective, 2020 is seen best as a year when an extreme event (Covid-19) engulfed weak, pre-existing cyclical trends. The negative impacts of this event have peaked, at least from a monetary perspective. However, adverse (over-arching) LT structural dynamics that have their roots in excess levels of private sector debt remain with negative implications for money, credit and business cycles and future investment returns.

The charts that matter

The key chart above illustrates how growth in broad money (M3) is accelerating in both the EA and UK. In the EA, M3 grew 10.2% in nominal and 9.8% terms YoY in July, the highest rates of growth since May 2008 and July 2007 respectively. In the UK, M3 grew 11.9% in nominal and 10.8% in real terms in July, the highest rates of growth since April 2008 and June 2008 respectively (n.b. I am using M3 here for comparison purposes rather than the Bank of England’s preferred M4ex measure referred to in other posts). These trends have helped to ignite the “inflation versus deflation” debate which, in turn, requires investigation of trends in the components and counterparts of broad money growth.

M1 is playing an increasing role in M3 in the EA and the UK despite negative real returns from overnight deposits (Source: ECB; Bank of England; CMMP analysis)

From a components perspective, narrow money (M1) is playing an increasing role in this growth despite negative real returns as EA and UK households (HHs) and corporates (NFCs) maintain high preferences for liquid assets. In the EA, M1 now accounts for 70% of M3 compared with only 42% twenty years ago. In the UK, M1 now accounts for 65% of M3 versus only 48% twenty years ago (see chart above). In both cases, the share of narrow money in broad money is at a historic high – potentially negative news for inflation hawks as HH and NFCs continue to save in the face of high uncertainty levels. The key unknown here is the extent to which these savings are forced or precautionary. Forced savings can be released relatively quickly to support economic activity. In contrast, precautionary savings are unlikely to move straight into investment or consumption.

Similar NFC, mortgage and consumer credit trends but with more volatile YoY growth dynamics in the UK (Source: ECB; Bank of England; CMMP analysis)

From a counterparts perspective, above trend NFC credit and resilient HH mortgage demand is offsetting weakness in consumer credit, with the UK demonstrating more volatile YoY growth dynamics than the EA. The graph above illustrates YoY growth trends in NFC credit (green), mortgages (blue) and consumer credit (red) for the EA (dotted lines) and the UK (full lines) over the past 5 years.

NFC credit is growing well above trend in both regions, but below May’s recent peak levels. In the EA, NFC credit grew 7.0% in July versus 7.3% in May. In the UK, NFC credit grew 9.6% in July versus 11.2% in May. Mortgage demand has remained resilient in both regions growing 4.2% in the EA and 2.9% in the UK. Weakness in consumer credit appears to be stabilising (see monthly trends below). In the EA consumer credit grew 0.2% in July unchanged from June, but still a new low YoY growth rate. In the UK, consumer credit declined -3.6% YoY compared with a decline of -3.7% in June.

Counterparts versus components – new peak gaps in the growth of private sector credit and money supply (Source: ECB; Bank of England; CMMP analysis)

Diverging trends between the components and counterparts of broad money tell an important story – the gap between the growth in money supply and the growth in credit demand is at new 10-year peak levels. In the EA, the gap between M3 growth (10.2%) and adjusted loans to the PSC growth (4.7%) was 5.5ppt (or minus 5.5ppt in the graph above). This is a 10-year peak and the largest gap since 2001 (not shown above). In the UK, the gap between M4ex growth (12.4%) and M4Lex (5.5%) was 6.9ppt, again a new 10-year peak. In “normal cycles”, money supply and the demand for credit would move together but current trends are indicative of a basic deficiency in credit demand and a second potentially negative piece of news for inflation hawks.

Uncertainty proxies for EA HHs and NFCs (Source: ECB; CMMP analysis)

Looking at ST dynamics, “uncertainty” appears to have peaked at the same time (May 2020) in both the EA and the UK but remains very elevated against historic trends. In this context, trends in monthly flows into liquid assets offering negative real returns are used a proxy measure for uncertainty. In July, deposits placed by EA HHs totalled €53bn, below April 2020’s peak of €80bn but still above the 2019 average monthly flow of €33bn. NFC deposits increased by €59bn in July. Again this was below May 2020’s peak flows of €112bn but still well above the 2019 average monthly flow of €13bn (see chart above).

Uncertainty proxies for UK HHs and NFCs (Source: Bank of England; CMMP analysis)

In the UK, HH deposit flows totalled £7bn in July, down from the May 2020 peak of £27bn but above the 2019 monthly average flow of £5bn. NFCs deposits in July rose from £8bn in June to £ 12bn in July. These were also below the May 2020 peak of £26bn but well above the £0.8bn 2019 average (see chart above).

Monthly consumer credit flows in the EA (Source: ECB; CMMP analysis)

HHs have stopped repaying consumer credit and monthly flows have bounced back to just below (EA) or just above (UK) 2019 monthly average. In July, EA consumer credit totalled €3.2bn and €3bn in June and July respectively. This followed repayments of €-12bn, €-14bn and €-2bn in March, April and May respectively. The last two months’ positive monthly flows compare with the 2019 average of €3.4bn.

Monthly consumer credit flows in the UK (Source: Bank of England; CMMP analysis)

After four consecutive months of net repayments, UK consumer credit turned positive in July. The £1.2bn borrowed in July was above the average £1.2bn recorded in 2019. As noted above, the recent weakness in consumer credit means that the average growth rate (-3.6% YoY) is still the weakest since the series began in 1994.

Conclusion

In “August snippets – Part 1”, I highlighted the importance of disciplined investment frameworks and followed this in “August snippets – Part 2” by revisiting the foundations of my CMMP Analysis framework that incorporates three different time perspectives into a single investment thesis. How do July’s trends fit into this framework?

The overriding message here is one of uncertainty and deficient credit demand, a more nuanced message than some inflation hawks suggest. Looking at ST dynamics, uncertainty peaked in May in both regions, HHs have stopped repaying consumer credit and the NFC “dash-for-cash” has also peaked. From an investment perspective, 2020 is seen best as a year when an extreme event (Covid-19) engulfed weak, pre-existing cyclical trends. The negative impacts of this event have peaked, at least from a monetary perspective. However, the negative (over-arching) LT structural dynamics that have their roots in excess levels of private sector debt remain with negative implications for money, credit and business cycles and future investment returns.

If you go down to the woods today…

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

“The long and uncertain road to recovery”

July’s message from the EA money sector

The key chart

Unusually high monthly flows into O/N deposits (despite negative real rates of return) indicate elevated levels of uncertainty among HHs and NFCs in the euro area (Source: ECB; CMMP analysis)

The key message

July’s monetary developments in the euro area suggest that the road to recovery will be long and uncertain. Broad money (M3) is growing at the fastest rate (10.2% YoY) since May 2008. Growth rates in the components of M3 indicate that uncertainty remains very elevated at the start of 3Q20. Overnight deposits, for example, contributed 8.3ppt to the growth in broad money alone (despite negative real returns). July’s overnight deposit inflow of €151bn was the second largest inflow after March’s €249bn and was 3x the 2019 average. In contrast, growth rates in the counterparts to M3 indicate that HH consumption is recovering and the NFC’s record “dash-for-cash” has peaked. However, before anyone gets too excited – the gap between subdued PSC growth (debt overhang?) and rapid M3 growth (elevated uncertainty?) hit a twenty-year peak in July.

In short, July’s message from the EA money sector is simple: the peak of the crisis may have passed but the road to recovery is likely to be long and uncertain.   

The long and uncertain road in charts

Growth rates in broad (M3) and narrow (M1) money in the euro area (% YoY) – July’s M1 growth rate exceeded 2009 and 2015 peaks (Source: ECB; CMMP analysis)

July’s monetary developments in the euro area (EA) suggest that the road to recovery will be a long and uncertain one. Broad money (M3) grew by 10.2% YoY in July from 9.2% in June, the fastest rate of growth since May 2008.

Drivers of M3 growth (percentage points) – overnight deposits (8.3ppt) remain the key driver of M3 (Source: ECB; CMMP analysis)

Narrow money (M1) grew by 13.5% YoY in July from 12.6% in June, faster than the 13.1% (Aug 09) and 11.7% (July 15) peak growth rates recorded during the GFC and after the euro crisis. M1 growth contributed 9.2ppt to the total 10.2% growth in broad money. Within M1, overnight deposits grew 14.1% YoY and contributed 8.3ppt to the overall growth in M3 alone.

Growth rates in mortgage, consumer and corporate credit – passed the crisis peaks and troughs? (Source: ECB; CMMP analysis)

Adjusted loans to the private sector grew 4.7% YoY, slightly below the 4.8% recorded in June. The annual growth rate in loans to households (HHs) was unchanged at 3.0% while the equivalent growth rate in loans to corporates (NFCs) fell very slightly to 7.0% from 7.1%. No surprises here – above trend NFC credit and resilient HH mortgage demand continue to offset weakness in HH consumer credit.

An “old favourite” chart – the gap between the growth rates in PSC and M3 is at a new twenty-year peak (Source: ECB; CMMP analysis)

The gap between the growth in money supply (M3) and the growth in private sector credit (PSC) increased to 5.5ppt, a twenty year high. This reflects the combination of extraordinary uncertainty (driving M3) and the limited progress in dealing with the debt overhang in the EA (subduing PSC).

Monthly flows into O/N deposits since January 2019 – a surprise jump in July? (Source: ECB; CMMP analysis

The monthly flow data once again provides a more nuanced picture than the headline annual growth trends. Overnight deposits, which contributed 8.3ppt to the overall growth in M3 alone, rose by €151b. This represents the second largest monthly inflow of overnight deposits (after €249bn in March 2020).

Monthly deposit flows from HHs and NFCs since January 2019 (Source: ECB; CMMP analysis)

July’s data includes a €58bn swing from negative to positive flows from non-monetary financial corporations – n.b. these flows are typically more volatile than HH and NFC flows. That said, monthly flows by HHs and NFCs also increased MoM to levels 24% and almost 50% above the average 2019 inflows. Put simply, these trends suggest that HH and NFC uncertainty levels remain very elevated.

Monthly trends in HH credit demand – passed the low point? (Source: ECB; CMMP analysis)

On a more positive note, mortgage demand remains resilient and consumer credit has recovered. Loans for house purchase increased by €19b in July versus 9€10bn in June and above the average €14bn monthly flow recorded in 2019. After record repayments between March and May 2020, monthly flows of credit for consumption have exceeded €3bn for two months in a row, closing on the €3.4bn monthly average in 2019. NFC lending data suggests that we passed the peak “dash for cash” in March and April, although July’s monthly flow of almost €16bn remains above the 2019 average of €12bn.

Putting the NFC “dash-for-cash” into an historic context (Source: ECB; CMMP analysis)

Conclusion

The message from the money sector at the start of the 3Q20 is a mixed one. Growth rates in the components of M3 indicate that uncertainty remains very elevated. In contrast, growth rates in the counterparts to M3 indicated that HH consumption is recovering and the NFC dash-for-cash has peaked. In short, while the peak of the crisis appears to have passed, the road to road to recovery is likely to remain a long and uncertain one.

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

“August Snippets – Part 2”

Revisiting the foundations of CMMP analysis

The key message

In “August snippets – Part 1”, I highlighted the importance of disciplined investment frameworks. In this second snippet, I revisit the foundations of my CMMP Analysis framework. I start by describing how I combine three different time perspectives into a consistent investment thesis (“three pillars”). I then explain how the core banking services (payments, credit and savings) link different economic agents over time to form an important fourth pillar – financial sector balances. Finally, I present examples of how these four pillars combine to deliver deep insights into policy options and responses.

The central theme is my belief that the true value in analysing developments in the financial sector lies less in considering investments in banks but more in understanding the implications of the relationship between banks and the wider economy for corporate strategy, investment decisions and asset allocation.

Three perspectives – one strategy

  • As an investor, I combine three different time perspectives into a single investment strategy
  • My investment outlook at any point in time reflects the dynamic between them
  • My conviction reflects the extent to which they are aligned

Pillar 1: Long-term investment perspective

Example chart 1: growth trends in PSC illustrate how global finance is shifting East and towards emerging markets ($bn) (Source: BIS; CMMP analysis )

My LT investment perspective focuses on the key structural drivers that extend across multiple business cycles. Given my macro and monetary economic background, I begin by analysing the level, growth, affordability and structure of debt. These four features of global debt have direct implications for: economic growth; the supply and demand for credit; money, credit and business cycles; policy options; investment risks and asset allocation. My perspective here reflects my early professional career in Asia and experience of Japan’s balance sheet recession. The three central themes are (1) global finance continues to shift East and towards emerging markets, (2) high, “excess HH growth rates” in India and China remain a key sustainability risk, and (3) progress towards dealing with the debt overhang in Europe remains gradual and incomplete. The following four links provide examples of LT investment perspectives:

Example chart 2: China’s HH debt ratio continued to rise sharply in 1Q20 – too much, too soon? (Source: National Bureau of Statistics; CMMP analysis)

Pillar 2 – Medium-term investment perspective

Example chart 3: growth rates in M1 and private sector credit demonstrate robust relationships with the business cycle through time and have proved more reliable indicators of recessions risks than the shape of the yield curve (Source: ECB; CMMP analysis)

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 perspective, supported by detailed analysis provided by the ECB. A central MT theme here is the fact that monetary developments: (1) have proved a more reliable indicator of recession risks than the shape of the yield curve; and (2) provide important insights into the impact, drivers and timing of the Covid-19 pandemic on developed market economies. The following four links provide examples of my analysis of MT investment perspectives:

Example chart 4: headling figures mask a more nuanced message from monthly flow data (Source: ECB; CMMP analysis)

Pillar 3: Short-term investment perspective

Example chart 5: banks played catch up from May 2020, but what kind of rally was this and was it sustainable? (Source: FT; CMMP analysis)

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. This perspective is influences 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. I was able to demonstrate the “proof of concept” of this approach when I returned to the sell-side in 2017 as Global Head of Banks Equity Research at HSBC, most notably when challenging the consensus investor positioning towards European banks in 3Q17. A central ST theme is the importance of macro-building blocks in determining sector profitability and investment returns. The following four links provide examples of ST investment perspectives:

Example chart 6: why it was correct to question the conviction behind the SX7E rally during 2Q20 (Source: FT, CMMP analysis)

Pillar 4 – Financial Sector Balances

Example chart 7: Financial sector balances (and MMT!) can be understood easily by starting with the core services provided by banks to HHs and NFCs (Source: Bank of England; CMMP analysis)

In January 2020, I presented a consistent, “balance sheet framework” for understanding the relationship between the financial sector and the wider economy and applied it to the UK. I chose the UK deliberately to reflect the relatively large size of the UK financial system and the relatively volatile nature of its relationship with the economy. I extended this analysis to the euro area later. I began by focusing on the core services provided by the financial system (payments, credit and savings), how these services produce a stock of financial balance sheets that link different economic agents over time, and how these balance sheets form the foundation of a highly quantitative, objective and logical analytical framework. Central themes here were the large and persistent sector imbalances in the UK, why the HH sector in the UK was poised to disappoint and why a major policy review was required in the euro area even before the full impact of the COVID-19 pandemic was felt. The following four links provide examples of FSB analysis:

Example chart 8: Pre-Covid, the UK faced large and persistent sector imbalances and was increaingly reliant on the RoW as a net lender (4Q sum, % GDP) (Source: ONS; CMMP analysis)

Policy analysis

Example chart 9: “Fuelling the FIRE” – split in EA lending over past twenty years between productive (COCO) and less productive (FIRE) based lending (% total loans) (Source: ECB; CMMP analysis)

These four pillars provide a solid foundation for analysing macroeconomic policy options and choices. Since September 2019, I have applied them to identifying the hidden risks in QE, to arguing why the EA was trapped by its debt overhang and out-dated policy rules, and to assessing the policy responses to the COVID-19 pandemic. Central themes have included: (1) the hidden risk that QE is fuelling the growth in FIRE-based lending with negative implications for leverage, growth, stability and income inequality; (2) why the gradual and incomplete progress towards dealing with Europe’s debt overhang matters; (3) why Madame Lagarde was correct to argue that the appropriate and required response to the current growth shock “should be fiscal, first and foremost”; and (4) how three myths from the past posed a threat to the future of the European project. The following four links provide examples of policy analysis:

Example chart 10: failing the “common sense test”. What was the point of running tight fiscal policies when the private sector was running persistent financial surpluses > 3% GDP (Source: ECB; CMMP analysis)

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