UK spending recovery is steady rather than dramatic
The key chart
Aggregate credit and debit card purchases versus February 2020 (pre-COVID) average (Source: ONS; CMMP)
The key message
ONS real-time indicators continue to point to a steady recovery in UK credit and debit card purchases but may disappoint those hoping for a rapid recovery in consumption.
The charts that matter
Aggregate card purchases fell from 106% of average February 2020 spending (pre-Covid) on 5 May 2021 to 95% on 27 May 2021 (see key chart above). Spending on so-called “delayable” and “staple” goods also fell during May (MTD). In contrast, “social” spending rose from 76% to 85% and “work-related” spending increased from 100% to 104%.
May 2021 versus the start of the year – a recovery across the board (Source: ONS; CMMP)
Spending across all categories is higher in relation to pre-COVID levels than in January 2021 but only staples and work-related spending are above pre-COVID levels (see chart above).
CMMP estimates of excess HH savings built up during the COVID-19 pandemic (Source: CMMP)
Spending on delayable goods (eg, clothing, furniture) is a useful indicator of the extent to which the c.£160bn of excess savings built up during the pandemic (see chart above) is returning to the economy via consumption.
Recovery in delayable spending has lost momentum (Source: ONS; CMMP)
These purchases recovered strongly following the reopening on non-essential stores (12 April) to reach recent highs of 122% (19 April) and 112% (5 May) of pre-COVID spending. Momentum has slowed since then, however, with the latest data indicating delayable spending at 91% of pre-COVID levels (see chart above).
Change in index of card purchases YTD (Source: ONS; CMMP)
It is reasonable to expect volatility in faster-indicators and dangerous, therefore, to draw too many conclusions from short-term movements. The core message remains that the consumption is recovering but at a steady rather than rapid pace. Unsurprisingly, the strongest recovery YTD has been in work related spending (see chart above).
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Synchronised messages from the UK and EA money sectors
The key chart
Don’t misread the messages from macro variables – this is an atypical cycle (Source: BoE; ECB; CMMP)
The key message
It is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.
Headline growth figures in key macro variables, including monetary aggregates, have been open to misinterpretation, leading to many false narratives regarding their implications for investment decisions and asset allocation. In this context, CMMP analysis has gone beyond the headlines to identify three key signals that help to interpret current trends in the UK and EA effectively. These signals focus on HH behaviour, the consumption/growth outlook and the policy context.
The messages from the UK and EA money sectors are remarkably consistent in direction if not in magnitude.
Monthly HH deposit flows are moderating in both regions (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (n.b. the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however (key signal #3). The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.
Sustained recoveries require further moderations in HH deposit flows, a recovery in consumer credit, and a resynchronisation in money and credit cycles. The UK displays higher gearing than the EA to each of these key drivers but is lagging the EA in terms of positive signals so far…
Consistent messaging through atypical cycles
The UK and euro area (EA) money sectors have provided consistent messages regarding household (HH) behaviour, the consumption/growth outlook and the policy context in their respective regions throughout the COVID-19 pandemic.
HH monthly money flows as a multiple of 2019 average monthly flows (Source: BoE; ECB; CMMP)
Monthly HH deposit flows provide important insights into HH behaviour. During the pandemic, HHs in both regions increased their money holdings at elevated rates, despite earning negative returns. This behaviour contributed to neither growth nor inflation.
Deposit flows declined in both regions at the start of 2Q21 (see chart above). In the EA, monthly flows fell to €19bn in April 2021 from €62bn in March 2021. This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019. In the UK, monthly flows fell to £11bn in April 2021 from £16bn in March 2021, the smallest net flow since September 2020. While the direction of travel is the same in both regions, monthly money flows in the UK remain 2.3x above their 2019 average of £5bn.
YoY growth rates in consumer credit (Source: BoE; ECB; CMMP)
While uncertainty is falling in both regions, consumption remains subdued. On a positive note, the YoY growth rate in consumer credit in the EA turned positive (0.3%) for the first time since August 2020 (see chart above). In contrast, growth remained negative in the UK (-5.7%) albeit less negative than the historic low of -10% recorded in February 2021.
That said HHs in both regions repaid consumer credit during April 2021 (see chart below). While this is not a positive signal for growth, the scale of repayments is slowing at least. In the UK, for example, net repayments of £0.4bn was less than seen on average each month over the previous year (£1.7bn).
Monthly flows in UK and EA consumer credit (Source: BoE; ECB; CMMP)
The policy context remains challenging, however, especially for central bankers. The effectiveness of monetary policy relies, in part, on certain stable relationships between monetary aggregates. The desynchronization of money and credit cycles during the pandemic was unprecedented in both the UK and the EA.
Trends in the gap between growth in lending and growth in money supply (Source: BoE; ECB; CMMP)
The gap between YoY growth rates in private sector lending and money supply hit historic highs of 11ppt in the UK in February 2021 and 8ppt in the EA in January 2021. These gaps narrowed to 9ppt and 6ppt respectively in April. Nevertheless, they remain very wide in a historic context (see chart above).
Conclusion
To repeat, it is important not to confuse the decline and recovery in economic activity over the past twelve months with typical economic cycles.
The messages from the UK and EA money sectors are remarkable consistent in direction if not in magnitude. Monthly HH deposit flows are moderating (key signal #1), especially in the EA, suggesting that uncertainty levels are falling. That said, HHs are still repaying down consumer credit (key signal #2), albeit at a slower pace (and the YoY growth rate in consumer credit turned positive in the EA for the first time since last summer). Policy makers still face considerable challenges due to the on-going desynchronization of money and credit cycles, however. The resilience in mortgage demand and on-going house price rises bring additional challenges that complicate policy choices further.
Sustained recoveries require further moderations in HH deposit flows, a recovery in consumer credit, and a resynchronisation in money and credit cycles. The UK displays higher gearing than the EA to each of these key drivers but is lagging the EA in terms of positive signals so far…
Please note that the summary comments and charts above are summaries from more detailed analysis that is available separately.
An important first step in the road to euro area recovery
The key chart
HH monthly money flows as a multiple of 2019 average monthly flows (Source: ECB; CMMP)
The key message
The key message from the money sector at the start of 2Q21 is that the euro area (EA) has taken an important first step in the road to a sustained recovery.
Trends in M3 growth (% YoY) and contributions (ppt) from M1 and private sector credit over the past twenty years (Source: ECB; CMMP)
Recall that the rapid expansion in monetary aggregates during the COVID-19 pandemic was a reflection of DEFLATIONARY forces not inflationary ones, as some argue. Households (HHs) increased their money holdings (boosting M1 and M3) while simultaneously slowing consumption and repaying consumer credit. The key point here was that money sitting idly in overnight deposits contributed to neither growth nor inflation. This time, it really was different (see chart above)!
Trends in monthly HH deposit flows since January 2021 (Source: ECB; CMMP)
At the start of 2Q21, monthly HH deposits flows fell to €19bn in April 2021 from €62bn in March 2021 (key signal #1).
This is the first time since March 2020 that these flows have fallen below the €33bn average monthly flows seen during 2019.
A sustained reduction in monthly deposit flows would indicate reduced uncertainty/improved confidence with positive implications for future consumption and economic growth.
Trends in HH consumer credit since January 2020 (Source: ECB; CMMP)
On a more cautious note, HHs repaid another €1bn of consumer credit (key signal #2) in April 2021, suggesting that the path to recover is still at a very early stage. The YoY growth rate in consumer credit turned positive (0.3%) for the first time since August 2020, but this was due to base effects and was despite the negative monthly flow (see chart above). HHs have repaid consmer credit in six of the past nine months.
The widening gap between growth in lending and growth in money supply (Source: ECB; CMMP)
Similarly, while the gap between money growth and credit growth (key signal #3) has narrowed from its recent historic high of 8ppt in January 2021 to 6ppt in April, it remains very high in a historic context (see chart above). Note that the YoY growth rate in adjusted loans to the private sector decreased to 3.2% in April 2021 from 3.6% in March 2021. Loans to NFCs fell from 5.3% to 3.2% while loans to HHs increased from 3.3% to 3.8% over the month (see chart below).
Trends in mortgage, consumer credit and NFC lending since January 2019 (Source: ECB; CMMP)
In short, one of the three key signals for 2021 has turned positive, while the other two are “less negative.” Not time for Meatloaf to re-release an old hit yet, but welcome signs nonetheless since investment narratives require consistent refuelling.
In my next post, I will explore how and where investment risks may have shifted in the meantime.
Please note that the summary comments and charts above are summaries from more detailed analysis that is available separately.
Faster indicators vs. key signals from the UK money sector
The key chart
Change (ppt) in credit and debt card spending versus February 2020 levels (Source: ONS; CMMP)
The key message
Investment narratives, like endurance athletes, require consistent refuelling to sustain their performance particularly as they transition between phases in market cycles. It may take some time before the three key signals for 2021 – a moderation in household savings, a recovery in consumer credit, and a re-synching of money and credit cycles – provide sustained nourishment. In the meantime, so-called “faster indicators” such as estimates for UK spending on credit and debit cards take on greater prominence.
These indicators show a steady increase in spending since the start of the year led by a recovery in spending at stores selling “work-related” and “delayable” goods and services. The latest data release from the ONS (27 May 2020) indicates a loss of momentum in this recovery, however, particularly in the case of delayable goods. With the exception of spending on “staples”, credit and debit card purchases have fallen back/remain below their pre-COVID levels.
The risk with volatile data series (such as faster indicators) is that short term “sugar rushes” are mistaken for more sustainable nourishment. The direction of travel is clearly positive but the recovery in UK consumption remains tentative still. As equity markets transition between their “hope” and “growth” phases, investors who have already paid for expected future growth in cash flows may well pause at this stage and wait for more concrete evidence of sustained growth…
Sugar rushes vs sustained nourishment
Recovery in spending YTD (ppt) versus February 2020 levels (Source: ONS; CMMP)
UK spending on debit and credit cards has increased steadily since the start of the year led by a recovery in “work-related” and “delayable” spending. In the week to 20 May 2021, the aggregate CHAPS-based indicator of credit and debit card purchases was at 96% of its pre-COVID, February 2020 average. This represents a 31ppt increase since early January 2021. The largest increases in spending over this period have been seen in “work-related” spending (eg, public transport, petrol) which has risen 45ppt and in “delayable” spending (eg, clothing, furnishings) which has risen 41ppt (see chart above).
Recent trends in aggregate and delyable spending showing impact of store reopening on 12 April (Source: ONS; CMMP)
The latest data release from the ONS (27 May 2021) indicates a loss of momentum in this recovery, however, particularly in the case of delayable goods. Aggregate spending peaked at 106% of February 2020 levels in the week to 5 May 2021 and has fallen back to 96% in the week to 20 May 2021. Spending on delayable goods rose sharply in April following the reopening of non-essential retail stores (12 April 2021). In the following week, spending was 22ppt above the February 2020 levels and remained above them until the week to 11 May 2021. Since then, it have fall back to 94% in the week to 20 May 2021.
Where are we now? Spending versus February 2020 levels (Source: ONS; CMMP)
With the exception of spending on “staples”, purchases have fallen back/remain below their pre-COVID levels. Other data sources (eg, Barclaycard payments data) indicate an immediate boost in spending in the hospitality sector following the relaxation of lockdown restrictions on 17 May 2021 but these trends are only partially captured here and social spending remained 16ppt below February 2020 levels in the week to 20 May 2021. Aggregate, delayable and work-related spending remain 4ppt, 6ppt and 1ppt below February 2020 levels respectively.
Conclusion
The risk with volatile data series (such as faster indicators) is that short term “sugar rushes” are mistaken for more sustainable trends. The direction of travel is clearly positive but the recovery in UK consumption remains tentative still. As equity markets transition between their “hope” and “growth” phases, investors who have already paid for expected future growth in cash flows may well pause at this stage and wait for more concrete evidence of sustained growth…
Please note that the summary comments and charts above are extracts from more detailed analysis that is available separately.
Estimated growth in excess UK money holdings in £mn (Source: CMMP)
The key message
UK households (HHs) were already “poised to disappoint” before COVID-19 hit as post-GFC consumption drivers proved unsustainable. During the pandemic, consumption fell much faster than incomes as savings increased markedly. HHs continued to accumulate money holdings at rates well in excess of the pre-COVID period in 1Q21 while YoY declines in consumer credit hit historic levels.
Monthly money flows followed the timing of lockdown restrictions and relaxations closely. This suggests a relatively large element of “forced” savings that could be released relatively quickly to support economic activity. That said, much of these accumulated savings have accrued to HHs that already have sizable savings, have higher incomes, and are older – such HHs typically spend less from any extra savings they accumulate.
Excess money holdings reached £139bn at the end of 1Q21 (CMMP estimates) and could total £164bn by the end of 1H21 (below the OBR’s forecast of £180bn). The latest Bank of England forecast suggests that 10% of these excess money holdings will be spent over the next three years, compared with 5% previously (and current OBR forecasts). This c£16bn spending boost is likely to be front loaded into 2H21 and 1H22.
It is reasonable to assume that a large proportion of this will be directed towards durable goods whose consumption was delayed during lockdown (eg, car sales). So-called “social consumption” will naturally benefit too, but there is only so much time that can be made up – you can only eat so many meals in one day!
Please note that the summary comments above and charts below are extracts from more detailed analysis that is available separately.
The key message in six charts
Post-GFC/Pre-Covid: HH consumption funded initially by slowing rate of savings
Trends in HH savings and savings ratio since 4Q07 (Source: ONS; CMMP)
During COVID: HH savings increased markedly
Impact of COVID pandemic on HH savings rate (Source: ONS; CMMP)
1Q21 – HHs accumulate money holdings at c.4x pre-COVID levels
Monthly flows of HH money holdings in £bn (Source: BoE; CMMP)
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.
Money growth peaked, but the message remains unchanged
The key chart
What are the messages from the money sector as money growth peaks? (Source: ECB; CMMP)
The key message
At the end of 1Q21, the cyclical and structural messages from the EA money sector remain unchanged. In terms of ST tactical trends and the outlook for 2021, we are looking for evidence of: (1) a moderation in HH deposit flows; (2) a resynchronisation of money and credit cycles; and (3) recovery in consumer credit. In terms of LT secular trends, we focus on the split between more productive COCO-based and less productive FIRE-based lending and the hidden risks of QE.
HH deposit flows remain almost double the levels seen pre-COVID and the enduring preference for holding highly liquid assets (despite their negative real returns) indicates persistently high levels of HH uncertainty. The gap between the money and credit cycles (evidenced in banks’ 1Q21 earnings) has stopped widening but remains very significant. Finally, consumer credit is still falling (and HHs repaid credit again in March) but at a slower rate than earlier in the quarter. In short, investors positioned for a sustained upturn in EA inflation will need to be patient still.
Resilient mortgage demand has been a key feature in an otherwise lacklustre retail banking sector (as in the UK). The 5.0% YoY increase in EA mortgages in March was the fastest rate of growth since May 2008. Mortgages are the largest segment of FIRE-based lending, which reached a new high of €5,891bn at the end of March, up 28% from its January 2009 level, and represented almost 52% of total lending. More productive COCO-based lending totalled €5,478bn, lower than its January 2009 peak of €5,517bn. COCO-based lending’s share of total lending has fallen from 55% to 48% of total lending over this period. The ECB is correct to highlight the positive impact of unorthodox monetary policy in terms of keeping borrowing affordable and supporting access to credit for NFCs and HHs. That said, the hidden risks of QE in “fuelling the fire” and their negative implications for leverage, growth, financial stability and income inequality in the EA should not be overlooked.
Money growth may have peaked, but the core messages from the money sector remain unchanged.
The core messages in six key charts
Key signals for 2021
Persistent HH uncertainty reflected in monthy deposit flows (Source: ECB; CMMP)The gap between the money and credit cycles has narrowed slightly, but remains significant (Source: ECB; CMMP)HHs are repaying consumer credit but YoY declines are slowing (Source: ECB; CMMP)
FIRE-based lending and the hidden risks of QE
FIRE-based lending hits a new high at the end of 1Q21 (Source: ECB; CMMP)COCO-based lending is still lower than its 2009 peak (Source: ECB; CMMP)By fuelling the fire, QE brings hidden risks that investors should not forget (Source: ECB; CMMP)
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.
Investment narratives are like endurance athletes…
The week ahead…
Like endurance athletes, investment narratives require consistent refuelling to maintain performance.
This week represents an important, potential refuelling period for three popular 2021 trades: long reflation, value and financials/banks.
Losing momentum, part 1 – 10Y bond yields (Source: Koyfin; CMMP)
Despite delivering positive performance YTD, each of these trades have lost momentum over the past month. US and UK 10Y bond yields are 12bp and 8bp lower over the past month, while German 10Y yields are essentially unchanged.
Losing momentum, part II – US value versus growth and momentum (Source: Koyfin; CMMP)
In the US, value has underperformed growth and momentum by 3% and 4% over the past month and US and EA financials have underperformed by 1% and 4% respectively. Given the downbeat messages from the money sector so far YTD, this loss of momentum comes as little surprise.
Losing momentum, part III – relative performance of US and EA banks (Source: Koyfin; FT; CMMP)
Looking forward, the ECB and the Bank of England publish monetary statistics for March 2021 on Thursday (29 April) to complete the top-down picture for 1Q21.
It is too early, in my view, to expect much “refuelling” in terms of the three key signals for 2021: a moderation in monthly deposit flows; a resynching of money and credit cycles; and a recovery in consumer credit.
Instead, look to see whether each signal has stopped getting worse! Attention may focus more, therefore, on the bottom-up perspectives and outlooks provided by leading European FIs as they report their latest results – HSBC and UBS (Tuesday), Deutsche Bank (Wednesday), Barclays and BNP Paribas (Friday) and Soc Gen next week. Watch this space…
Total debt levels and cumulative market share as at the end of 3Q20 (Source: BIS; CMMP)
The key message – seven perspectives
First, the US has the highest outstanding stock of debt in the world but deeper analysis is required to determine whether it has a “debt problem”
Second, in terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies across the government, household (HH) and corporate (NFC) sectors
Third, the US is also one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds
Fourth, the current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH to government debt
Fifth, this changing structure reduces associated risks since the government faces different financial constraints to the HH and NFC sectors and cannot, as a currency issuer, become insolvent
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms
Seventh, risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US.
In short, risks associated with US debt are concentrated rather than systemic. Moreelevated risks exist in other developed and emerging economies where some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are rising despite the low interest rate environment. Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie elsewhere.
Does the US have a debt problem?
Outstanding US debt and market share by sector (Source: BIS; CMMP)
The US has the highest outstanding stock of total, government, HH and NFC debt in the world but deeper analysis is required to determine whether it has a “debt problem”.
The US has outstanding total, government, NFC, and HH debt of $61tr, $27tr, $18tr and $16tr respectively (as at end 3Q20). The US accounts for 29% of global debt alone and almost 50% together with China (see key chart above) and has market shares of 34%, 22% and 32% of global government, NFC and HH debt respectively (see chart above).
To understand the implications here and consider whether the US has a debt problem, CMMP analysis considers the stock of debt in the context of the level of GDP (debt ratios), its structure, its rate of growth and affordability.
Ranking of BIS reporting economies by total debt/GDP (Source: BIS; CMMP)
In terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies in all sub-sectors. It is ranked only #18 in terms of total debt ratio for example (see chart above), and #22 and #12 in terms of NFC and HH debt ratios. In the case of government debt (129% GDP), the US is ranked higher, however, at #10 after Japan (235%), Greece (212%), Italy (172%), Portugal (146%), Belgium (137%), France (134%), UK (133%) and Spain (132%).
NFC and HH debt ratios plotted against BIS maximum threshold levels (Source: BIS; CMMP)
The US is one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds. The BIS considers HH and NFC debt ratios of 85% and 90% GDP to be threshold levels above which debt becomes a constraint on future growth. The BIS provides debt ratios for 22 developed and 21 emerging economies. As can be seen in the scatter diagram above, the US sits in the lower LH quadrant with a HH debt ratio of 78% and a NFC debt ratio of 84%. Germany, Greece and Italy are the only other developed economies to sit within the same quadrant.
Breakdown of outstanding US debt by sector (Source: BIS; CMMP)
The current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH debt to government debt. The share of HH debt peaked at 44% total debt in 2Q07 and fell to 27% by end 3Q20. In contrast, the share of government has risen from 26% to 44% over the same period.
As the Federal Reserve Bank of St Louis noted back in 2018, “The fall in household debt was primarily driven by the fall in mortgage debt that followed the housing crash. The surge in public debt, on the other hand, was partly driven by the large fiscal stimulus packages that were deployed to fight the Great Recession.”
The changing structure of US debt reduces associated risks since the government faces different financial constraints and cannot, as a currency issuer, become insolvent. HHs, NFCs and financial institutions are all “currency users” who face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020). In contrast, the US government, as a currency issuer, cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
In the seventh lesson from the money sector, I highlighted an article published by David Andolfatto of the Federal Reserve Bank of St Louis (4 December 2020). In line with my preferred financial sector balances approach, Andolfatto questions the “government as a household” analogy and notes that, “to the extent that government debt is held domestically, it constitutes wealth for the private sector.” From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Trend in HH debt/GDP ratio over past 20 years (Source: BIS; CMMP)
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms. High levels of household indebtedness were an important contributing factor to the GFC and subsequent recession. The HH debt ratio rose to a peak of 99% GDP in 1Q08 well above the 85% BIS threshold level. This ratio is 78% GDP today. Not only was the level of HH debt a matter of concern, but the pace of growth was sending clear warning signals too.
Rolling 3-year RGF for US HH sector over past 20 years (Source: BIS; CMMP)
CMMP analysis uses a relative growth factor to analyse the rate of growth in debt. This compares the 3-year CAGR of debt with the 3-year CAGR in nominal GDP. As can be seen in the chart above, the RGF for the US HH sector peaked at 7% in 1Q04, fell and then remained negative for 41 consecutive quarters from 2Q10 until the last reporting quarter (3Q20).
HH RGFs plotted against HH debt ratios for advanced BIS economies (Source: BIS; CMMP)
In the context of other developed economies, the risks of excess HH credit growth are much lower in the US than in Norway, Sweden, Canada, Switzerland, New Zealand and the UK. Each of these economies are experiencing excess HH credit growth (ie, RGF > 1) despite relatively high debt ratios that exceed the BIS threshold level of 85% GDP.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
In terms of affordability risk, the debt service ratio for the US HH sectors is low in absolute terms (7.6%) and in relative terms against its own 10Y average of 8.3% and against other developed economies.
Trend in NFC debt ratio over past 20 years (Source: BIS; CMMP)
Risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US. The NFC sector experienced 33 consecutive quarters of a rising debt ratio since 1Q12 and at 84% GDP is very marginally below the recent peak in 2Q20. Note however, that while the current NFC debt ratio is high in the context of the US, it remains below the 90% BIS threshold.
Rolling 3-year RGF for US NFC sector over past 20 years (Source: BIS; CMMP)
Of more concern is the current 4ppt rate of excess NFC credit growth. As can be seen, the current RGF is close to previous peaks. This is despite fact that the absolute level of NFC debt is higher than at previous peaks in excess growth. The current RGF places the US among a group of seven developed economies experiencing excess NFC credit growth of more than 4ppt. Within this sample, Sweden, France, Canada, Switzerland and Japan are experiencing higher rates of excess growth despite having higher levels of NFC debt that exceed the BIS maximum threshold level of 90%.
NFC RGFs plotted against NFC debt ratios for advanced BIS economies (Source: BIS; CMMP)
Finally, the highest level of concern relates to the affordability of NFC debt. The current NFC debt service ratio of 47% is only marginally below its all-time high and is 8ppt above its 10-year average of 39%. Among developed economies, this places the US NFC sector among the higher risk sectors, albeit it below the NFC sectors in France, Canada and Sweden.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
Conclusion
The risks associated with US debt are more concentrated than systemic and relate mainly to the rate of excess NFC credit growth and its affordability.(Further incentive for the Federal Reserve to keep rates lower for longer?) From a global perspective, debt risks are more elevated in other developed and emerging economies. Some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are increasing within and outside this sub-set despite the low interest rate environment.
Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie eslewhere.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available seperately.
