How will the “data-dependent” ECB respond to slowing money and credit cycles?
The key chart
Growth rates in EA broad money, narrow money and private sector credit (% YoY, nominal) (Source: ECB; CMMP)
The key message
The message from the euro area (EA) money sector is increasingly challenging for the “data-dependent” ECB.
The EA money and credit cycles are rolling over rapidly – the annual growth rate in narrow money fell -0.7% YoY in January, for example. Leading, coincident and lagging monetary variables are all sending negative messages for the region’s growth outlook.
Monthly household (HH) lending flows are slowing sharply for both mortgages and consumer credit. A clear warning sign for future house prices and HH consumption in the region.
With inflation still running well above target at 8.6% YoY in January 2023, the ECB remains committed to a further 50bp increase in rates in March, however. The ECB’s foot remains firmly on the brake pedal as the money sector warns of slowing economic growth.
Positive “cold-water therapy” is increasing looking like a less attractive cold shower.
Rolling over, rapidly
The EA money and credit cycles are rolling over rapidly (see key chart above). The annual growth rate in broad money (M3) fell to 3.5% YoY in January 2023, from 4.1% in December 2022 and 6.5% a year earlier. The annual growth rate in narrow money (M1) actually declined -0.7% YoY in January 2022, from 0.6% in December 2022 and 9.2% a year earlier.
Trends in broad money growth (% YoY) and contribution from overnight deposits (ppt) (Source: ECB; CMMP)
Recall that growth in narrow money was the key driver in the recent expansion in total EA money supply (see chart above). This reflected the hoarding of cash, largely in the form of overnight deposits at banks, by the regions household (HH) sector. Note, however, that monthly flows of HH overnight deposits have been negative since October 2022.
Trends in annual growth rates of M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Leading, coincident and lagging monetary variables are all sending negative messages for the region’s growth outlook. Real growth rates in M1, HH credit and corporate (NFC) credit typically display leading, coincident and lagging relationships with real GDP growth over time. Growth rates in all of these variables peaked some time ago and are current negative in real terms: -8.6% YoY for real M1; -4.6% YoY for real HH credit; and -2.3% YoY for real NFC credit.
Monthly household (HH) lending flows are slowing sharply for both mortgages and consumer credit. Monthly mortgage flows slowed to €1.9bn in January 2022, down from €26.7bn a year earlier and a recent peak of €30.1bn in June 2022 (see chart above). Similarly, monthly consumer credit flows fell to €0.3bn in January 2023, down from €1.1bn a year earlier and a recent peak of €3.4bn in February 2022 (see chart below). A clear warning sign for future house prices and HH consumption in the region.
With inflation still running well above target at 8.6% YoY in January 2023, the ECB remains committed to a further 50bp increase in rates in March, however. The ECB’s foot remains firmly on the brake pedal as the money sector warns of slowing economic growth.
Positive “cold-water therapy” is increasing looking like a less attractive cold shower.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Atypical foundations for a bull market in European equities
The key chart
Trends in YoY growth rates in real M1, real HH credit and real NFC credit (Source: ECB; CMMP)
The key message
Monetary developments in the euro area (EA) present atypical foundations for a bull market in European equities.
The good news is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Two (of three) key signals from the money sector suggesting a normalisation of economic activity.
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. This matters because these three variables (real M1, HH credit and NFC credit) typically display leading, co-incident and lagging relationships with real GDP over time. If historic relationships continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
The key question for asset allocators, therefore, is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Cold water therapy or cold shower?
Trends in broad (M3) and narrow (M1) money (% YoY, nominal terms) (Source: ECB; CMMP)
Monetary developments in the EA present atypical foundations for a bull market in European equities. Growth in broad money (M3) fell to 4.1% in December 2022, down from 4.8% in November 2022. This represents the slowest rate of growth since January 2019 (see chart above). Growth in narrow money (M1) slowed sharply to 0.6% in December 2022, down from 2.4% in November 2022. This represents the slowest rate of growth since August 2008. At the same time, the SXXE index closed at 449.17 on Friday 27 January 2023, up 26% from its early 4Q22 low.
Growth rate in M3 (% YoY) and contributions from ON deposits and other sources (ppt) (Source: ECB; CMMP)
The good news from the money sector is that EA households have stopped hoarding cash and the region’s money and credit cycles have resynched with each other. Recall that cash hoarding by HHs and NFCs in the form of overnight deposits was the key driver of the rapid expansion in broad money during the pandemic – a combination of forced and precautionary savings (see light blue columns in the chart above).
In the 4Q22, the flow of HH deposits fell to €26bn, the lowest quarterly flow since the pandemic began and well below the 2Q20 peak of €190bn and the pre-pandemic average flow of €91bn (see chart above). Recall also that a moderation in HH deposit flows was one of our three key signals for a normalisation of economic activity post-COVID. A second was a re-synching of money and credit cycles (see below).
Trends in M3 and PSC (% YoY) (Source: ECB; CMMP)
Money and credit cycles have been desynchronised for much of the past decade, creating major challenges for policy makers, banks and investors alike. The gap between the growth in money supply and the growth in private sector credit (PSC) hit a historic high during the COVID-pandemic (see chart above). As the region emerged from the pandemic, these growth rates have converged as the build-up in excess savings has slowed and the demand for credit has recovered (at least in nominal terms). A positive sign.
Trends in M3 and PSC (% YoY) since December 2017 (Source: ECB; CMMP)
The bad news is that the money and credit cycles are rolling over, credit demand is slowing in nominal terms, and growth rates in M1, HH credit and NFC credit are negative in real terms. Growth in adjusted PSC, for example, slowed to 5.3% in December 2022, down from 6.2% in November 2022 and down from the recent September 2022 peak of 7.0% (see chart above).
Trends in monthly mortgage flows (EUR bn) (Source: ECB; CMMP)
The monthly flow of mortgages, for example, fell to €4.5bn in December 2022, down from €8.9bn in November 2022 and down from the recent peak of €30.1bn in June 2022. The latest monthly flow was the lowest recorded since March 2020 (see chart above). The YoY growth rate in mortgages also fell to 4.4% in December 2020 down from 5.8% YoY in August 2021.
Monthly consumer credit flows also remain subdued in absolute terms and in relation to trends seen in the US and the UK. The monthly flow fell to €0.5bn in December 2022 from €2.1bn in November 2022 and €2.4bn in October 2022. As noted in “Clues from consumer credit”, the risks to EA economic growth lie more in the lack of demand for consumer credit and on-going household uncertainty.
Trends in real M1, HH credit and NFC credit (% YoY, real terms) (Source: ECB; CMMP)
Real growth rates in M1, HH credit and NFC credit typically display leading, coincident and lagging relationships with real GDP over time. Each indicator has peaked and is falling in real terms – -7.9% YoY, -4.9% YoY and -2.7% YoY respectively in December 2022 (see chart above). If historic relationships between these variables continue, this suggests a deceleration rather than an acceleration in economic activity over the next quarters.
In short, the key question for asset allocators is – do current monetary trends represent a form of positive, cold water therapy or simply a less-attractive cold shower?
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Interpreting 1Q21 monetary trends in the UK and EA
The key chart
Trends in YoY growth rates for UK and EA broad money (Souce: BoE; ECB; CMMP)
The key message
Trends in monetary aggregates provide important insights into the interaction between the money sector and the wider economy. Headline growth figures can easily be misinterpreted, however, leading to false narratives regarding their implications for investment decisions and asset allocation.
To avoid this, CMPP analysis has identified three key signals that help to interpret current trends in the UK and euro area (EA) effectively: monthly household (HH) deposit flows (behaviour); the synchronisation of money and credit cycles (policy context); and consumer credit (growth outlook).
The UK and EA money sectors have provided consistent, if subdued, messages regarding HH behaviour, the policy context and the consumption/growth outlook during 1Q21:
HHs in the UK and EA continue to increase their money holdings at very elevated rates, despite earning negative returns. Such behaviour contributes to neither growth nor inflation – a challenge for inflation hawks
The unprecedented desynchronization of money and credit cycles continues to limit monetary policy effectiveness
HHs are still repaying consumer credit and YoY growth rates hit historic lows during 1Q21
Investment narratives, like endurance athletes, require consistent refuelling to maintain performance. The best returns from equities are typically when economies are still weak but the rate of growth is either inflecting upwards or looking less weak. If such trends are accompanied by rising bond yields then cyclical sectors/stocks will typically outperform defensive sector/stocks (Oppenheimer, 2020).
The key messages from the money sectors (summarised above) have provided only limited nourishment for those positioned for sustained inflation and/or cyclical recovery in the UK and EA to date.
March data provided tentative encouragement in terms of the direction of travel but more substantive support may be required in 2Q21 to sustain recent performance.
Rather than focusing on headline growth numbers in broad money, investors should look instead for a more noticeable moderation in HH deposit flows, a resynchronisation in money and credit cycles and a recovery in consumer credit over the coming months.
Making sense of monetary aggregates
The CMMP approach
Trends in monetary aggregates provide important insights into the interaction between the money sector (central banks, FIs and NBFIs) and the wider economy. Headline YoY growth figures can easily be misinterpreted, however, leading to false narratives regarding their implications for investment decisions and asset allocation.
To avoid this, CMPP analysis has identified three key signals that help to interpret current trends in the UK and EA effectively: monthly HH deposit flows (behaviour); the synchronisation of money and credit cycles (policy context); and consumer credit (growth outlook).
A review of 1Q21
The UK and EA money sectors have provided consistent, if subdued, messages regarding household (HH) behaviour, policy effectiveness and the consumption/growth outlook during 1Q21.
Monthly HH deposit flows as a multiple of 2019 average monthly flows (Source: BoE; ECB; CMMP)
HHs in the UK and EA continue to increase their money holdings at elevated rates, despite earning negative returns. UK and EA monthly flows of HH deposits are still 3.5x and 1.9x the levels seen in the pre-COVID periods. These latest data points for March 2021 are below the respective peaks of 5.8x (May 2020) and 2.4x (March 2020) for the UK and EA respectively. Nonetheless, they show that HHs are still preferring to hold highly liquid assets (overnight deposits), despite earning negative real returns.
High levels of precautionary and forced savings indicate that HH uncertainty remains elevated and consumption delayed (see below). The challenge here for inflation hawks is that money sitting idly in overnight deposits contributes to neither GDP growth nor inflation.
Gap between lending growth and money growth in the UK and EA (Source: BoE; ECB; CMMP)
The unprecedented desynchronization of money and credit cycles continues to limit monetary policy effectiveness. The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11.4ppt in the UK in February and 8.0ppt in the EA in January. This matters because the effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates.
The latest data for March 2021, indicates that the gaps have narrowed slightly to 10.8ppt in the UK and 6.5ppt in the EA. Again, inflation hawks will be disappointed, however, by the slowdown in the growth rates in private sector credit. In the UK, this fell from 3.9% YoY in February to only 1.5% YoY in March and in the EA, from 4.5% YoY in February to 3.6% in March.
Monthly flows in UK and EA consumer credit (Source: BoE; ECB; CMMP)
HHs are still repaying consumer credit and YoY growth rates hit historic lows during 1Q21. In the UK, HHs have repaid consumer credit for seven consecutive months. In the EA, they have repaid consumer credit in five of the past seven months.
YoY growth rates in UK and EA consumer credit (Source: BoE; ECB; CMMP)
In both regions, the YoY growth rate hit a historic low in February of -10.0% in the UK and -2.8% in the EA before. In March the rate of decline slowed to -8.6% and -1.7% in the UK and EA respectively.
Investment implications
Investment narratives, like endurance athletes, require consistent refuelling to maintain performance. The best returns from equities are typically when economies are still weak but the rate of growth is either inflecting upwards or looking less weak. If such trends are accompanied by rising bond yields then cyclical sectors/stocks will typically outperform defensive sector/stocks (Oppenheimer, 2020). The key messages from the money sectors (summarised above) have provided only limited nourishment for those positioned for sustained inflation and/or cyclical recovery in the UK and EA in 2021 to date.
What to watch for in 2Q21
March data provided tentative encouragement in terms of the direction of travel but more substantive support may be required in 2Q21 to sustain recent performance. Rather than focusing on headline growth numbers in broad money, investors should look instead for a more noticeable moderation in HH deposit flows, a resynchronisation in money and credit cycles and a recovery in consumer credit over the coming months.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
What do 1Q21 results say about 2021’s investment themes?
The key chart
YoY changes (%) in customer lending and customer accounts by region (Source: HSBC; CMMP)
The key message
As a shareholder, I was relieved to see the 4% bounce in HSBC’s share price today, but as a global investor I was far more interested in what this morning’s 1Q21 results said about wider investment themes.
The results clearly illustrate the desynchronization of global money and credit cycles with customer accounts growing 15% YoY while customer lending was flat. The same trend was seen across all regions on an annual basis and across HSBC’s wealth and personal banking (WPB) and commercial banking (CMB) divisions. Asia bucked the trend over the most recent quarter, however, as customer lending rose 2% QoQ while customer accounts fell marginally, but lending fell QoQ in Europe and the UK.
1Q21 change ($bn) in customer lending and customer accounts by region (Source: HSBC; CMMP)
Credit investors may welcome HSBC’s strong capital position (CET1 15.9%) and abundant liquidity (LDR 63%) but other investors should note the broader message with respect to the so-called “reflation trade”.
1Q20 and 1Q21 loan-deposit ratios by region (Source: HSBC; CMMP)
The top-down and bottom-up messages from the money sector remain the same: (1) money and credit cycles remain out of synch with each other, and (2) money sitting idly in deposit accounts contributes to neither GDP nor inflation.
UK policy responses seen from a money sector perspective
The key chart
UK private sector and general government net lending/borrowing positions from the capital account expressed as a percentage of GDP (Source: ONS; CMMP analysis)
Large and persistent sector imbalances, an over-reliance on the RoW as a net lender and a household sector that was already poised to disappoint were challenging the economy even before Covid-19 hit. The immediate “Covid-19” response from the private sector was to increase its net lending position to a record 22% of GDP, almost 3x the equivalent response after the GFC. The HH savings ratio increased to a record 29% and HH consumption fell by the largest amount ever recorded (£81bn). In direct response to this negative shock, the UK government increased its net borrowing position to negative 23% of GDP – a timely and appropriate response.
Since then, the message from the UK money sector has remained one of high uncertainty and slowing consumption even before the latest round of restrictions began. Hence, the latest coordinated responses are also timely, necessary and appropriate. Looking ahead, current trends also suggest that: (1) the UK government will maintain an increasingly interventionist role; (2) the Bank of England will remain committed to keeping nominal and real rates “lower for longer”; and (3) investors hoping for a shift away from long duration fixed income and equity trades may require considerable patience.
Seven charts that matter
On 5 November 2020, the UK government and the Bank of England coordinated a larger-than-expected fiscal and monetary response to the latest Covid-19 wave and the second national lockdown. Rishi Sunak, the Chancellor of the Exchequer announced the extension of the furlough scheme until March 2021 and the Bank of England increases its bond-buying programme by £150bn. In the latest CMMP analysis, I consider this joint policy response in the context of (1) UK financial sector balances and (2) recent messages from the money sector.
The challenging starting point – trends in net lending/net borrowing expressed as a % GDP before the Covid-19 pandemic hit (Source: ONS; CMMP analysis)
Large and persistent sector imbalances, an over-reliance on the RoW as a net lender (see graph above) and a household sector that was already poised to disappoint were challenging the economy even before Covid-19 hit. Up until the 4Q19, the UK private and public sectors were running net borrowing positions at the same time that were offset by the RoW’s persistent net lending. The HH sector was funding consumption by dramatically reducing its savings rate and accumulation of net financial assets. With real growth in disposable income slowing and the savings rare close to historic lows, the risks to the UK economy already lay to the downside and at odds with previous government forecasts.
Trends in private sector net lending comparing the early-1990s recession and the GFC with 2020 (Source: ONS; CMMP analysis)
The immediate “Covid-19” response from the private sector was to increase its net lending position to a record 23% of GDP in 2Q20. In other words, the amount of money that the private sector had “left over” after all its spending and investment in 2Q20 was approximately 3x the equivalent amounts after the GFC and the recession of the early 1990s (expressed as a % of GDP).
Trends in HH gross savings and the HH savings ratio (Source: ONS; CMMP analysis)
The HH sector was the main driver here. HH gross savings rose to £104bn in 2Q20 and the savings rate increased to a record 29% compared with 10% in 1Q20 and 7% a year earlier. HH consumption fell by the largest amount ever recorded (£81bn), driven by large declines in spending on hotels, restaurants, travel, recreation and cultural services. The HH net lending position accounted for 20ppt of the total 23% private sector net lending in 2Q20, another record.
Trends in HH final consumption expenditure – the largest quarterly decline ever (Source: ONS; CMMP analysis)
In direct response to this negative shock, the UK government increased its net borrowing position to negative 23% of GDP – a timely and appropriate response. The main drivers here were the continuation of the Coronavirus Job Retention Scheme (CJRS), the introduction of the Coronavirus Self Employment Income Support Scheme (SEISS) and the Small Business Grant Fund.
A timely and appropriate response from the UK government (Spurce: ONS; CMMP analysis)
Since then, the message from the UK money sector has remained one of high uncertainty and slowing consumption even before the latest round of restrictions began. The latest Bank of England data showed that HH deposits increased by £7bn in September 2020. While this flow was below the £14bn, £16bn and £27bn monthly flows seen at the peak of uncertainty in March, April and June respectively it was still 1.5x the average 2019 monthly flows. Co-incidentally, September’s YoY growth rate in consumer credit was the weakest since records began (-4.6% YoY).
Monthly HH deposit flows since January 2019 (Source: Bank of England; CMMP analysis)
2020 trends in HH consumer credit – flows and growth rates. (Source: Bank of England; CMMP analysis)
Conclusion
In summary, the latest coordinated fiscal and policy responses are timely, necessary and appropriate. Looking ahead, current trends also suggest that: (1) the UK government will maintain an increasingly interventionist role; (2) the Bank of England will remain committed to keeping nominal and real rates “lower for longer”; and (3) investors hoping for a shift away from long duration fixed income and equity trades may require considerable patience.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
What messages can be derived from the components and counterparts of current money growth and how do they compare with past cycles? (Source: ECB; CMMP analysis)
The key message
Broad money (M3) in the euro area (EA) is growing at its fastest rate since early 2008. However, CMMP analysis of the components and counterparts of this growth suggests that the associated “messages from the money sector” and their implications are very different.
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. In contrast, the current message is one of heightened uncertainty and subdued credit demand. Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary).
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Seven charts that matter
Broad money (M3) in the euro area (EA) is growing at the fastest rate since early 2008. M3 grew 10.4% YoY in September, up from 9.5% in August. This is the fastest rate of YoY growth since April 2008 when M3 grew 10.6% YoY. However, CMMP analysis of the components and counterparts of these two growth phases suggests that the associated “messages from the money sector” are very different. Current trends are not a repeat of 2008 dynamics.
Different drivers and implications of monetary expansion – 2008 versus 2020 (Source: ECB; CMMP analysis)
Note that the components and counterparts of M3 provide different perspectives and explanations of changes in broad money. Monetary aggregates are derived from the consolidated monetary financial institutions (MFI) balance sheet and comprise monetary liabilities of MFIs and central government vis-à-vis non-MFI euro area residents.
The Eurosystem defines narrow (M1), intermediate (M2) and broad (M3) aggregates. They differ with respect the degree on “moneyness” or liquidity of the instruments included. M1, for example, comprises only currency in circulation and balances that can be converted into currency or used for cashless payments. Relative high holdings of M1 indicate a relatively high preference for liquidity and can be used as an inverse proxy for the level of private sector confidence.
The consolidated MFI balance sheet also provides the basis for analysing the counterpart of M3. All items other than M3 on the consolidated balance sheet can be rearranged to explain changes in broad money. The relationship between M3 and its counterparts rests on a simple accounting identity. What this means is that we have two identities that can be used to provide different perspectives on changes in broad money:
Components: Broad money equals M1 plus M2-M1 plus M3-M2
Counterparts: Broad money equals credit to EA residents plus net external assets minus longer term financial liabilities plus other counterparts (net)
What was the message from the money sector in the pre-GFC period? (Source: ECB; CMMP analysis)
The message in the pre-GFC period was one of (over-) confidence and excess credit demand. From a components perspective, for example, M1 was growing only 2.7% YoY in April 2008 and contributing just 1.2ppt to the overall 10.6% growth in total money. At this point M1 accounted for 43% of the outstanding stock of money. From a counterparts perspective, private sector credit was growing at 11.2% and contributing 17.6ppt to the growth in total money (offset by negative contributions from net external assets and LT financial liabilities). Credit to general government was contributing just 0.1ppt to broad money growth.
What is the message from the money sector now? (Source: ECB; CMMP analysis)
In contrast, the current message is one of heightened uncertainty and subdued credit demand. M1 grew 13.8% YoY in September 2020, up from 13.2% in August and contributed 9.4ppt to the overall 10.4% growth in broad money (versus 9.0ppt in August). M1 now accounts for 70% of the outstanding stock of money. The private sector is holding higher levels of the most liquid assets despite negative real returns on those instruments. This suggests high levels of uncertainty that have been exacerbated by the Covid-19 pandemic. (Note in passing that monthly flows showed a divergence between rising and above 2019-average household deposit flows and falling and below 2019-average NFC flows in September).
Uncertainty reigns – very different drivers of money growth (Source: ECB; CMMP analysis)
Private sector credit grew 4.6% YoY in September, unchanged from August. As before, relatively robust demand for NFC credit (7.1%) and resilient (and rising) mortgage demand (4.5%) continue to offset relative weakness in consumer credit (0.1%). However, private sector credit contributed only 5.2ppt to the overall 10.4% growth in broad money.
A key point here is that, in typical cycles, monetary aggregates and their counterparts move together. Money supply indicates how much money is available for use by the private sector. Private sector credit indicates how much the private sector is borrowing. The current relationship between money and credit cycles is far from typical, however. Indeed the gap between M3 and PSC is at a historic high reflecting the fact that the euro area is only emerging very gradually from a period of debt overhang.
Counterparts to M3 – the alternative view of what is driving money growth (Source: ECB; CMMP analysis)
Today’s money growth reflects fiscal and monetary easing in response to weak private sector demand and rising savings (with added uncertainty regarding the extent to which rising savings are forced or precautionary). Credit to general government and credit to the private sector contributed 6.8ppt and 5.2ppt respectively to the 10.4% growth in broad money (see graph above). This is in direct contrast to the pre-GFC period when money expansion was driven primarily by strong, or excess, private sector credit demand (see graph below).
Contrasting contributions of private sector credit and messages for the outlook for aggregate demand (Source: ECB; CMMP analysis)
Conclusion – don’t confuse the messages
The implications for inflation and policy options are clear. Inflationary pressures are likely to remain weak during the current cycle. Madame Lagarde may well signal more monetary support before the end of 2020 at this week’s ECB meeting, but the over-riding message from the EA money sector is that the route to economic recovery and higher inflation remains “fiscal, first and foremost.”
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
