Category: Money Moves Markets

Monetary and financial statistics for May released today are encouraging in three respects.

First, the Bank of England’s proxy measure for M4 excluding money holdings of financial intermediaries probably grew respectably, following a hefty 1.0% gain in April. The Bank currently has insufficient information to produce a firm estimate but headline M4 rose by 0.2% in May and was again depressed by intra-banking-group transactions – excluded from the proxy measure. Based on available evidence, the proxy may have risen by 0.5% or more last month.

Secondly, M4 lending – excluding the effects of securitisations and loan transfers – bounced back to show 0.9% growth in May after a rare 0.3% decline in April. As with M4, the rise would have been larger but for a decline in intra-group business. At the margin, this should lessen MPC concerns that lending constraints will be a major impediment to an economic recovery. (The Bank’s latest Trends in Lending survey, also released today, is gloomy but Lending Panel banks report an ongoing modest recovery in mortgage approvals and a small net rise in corporate loan facilities in May.)

Thirdly, consistent with quantitative easing improving companies’ access to non-bank finance, private non-financial firms raised a net £4.1 billion from issues of bonds, shares and commercial paper in May, up from £3.1 billion in April and well above the monthly average of just £400 million over 2003-08 – see chart. Companies have raised a net £13.6 billion in these markets so far in 2009, equivalent to 2.7% of outstanding sterling bank borrowing at the end of 2008.

The Monetary Policy Committee has been encouraged by recent better economic news and a pick-up in “adjusted” M4 but retains the view expressed in the May Inflation Report that further easing is likely to be required to prevent inflation from undershooting the target over the medium term, according to minutes of the June meeting released today.

This suggests that the odds slightly favour the MPC expanding asset purchases to the £150 billion current maximum at its July meeting, while simultaneously seeking Treasury authority for a higher limit. However, the Committee could yet choose to suspend QE at £125 billion if forthcoming business surveys and monetary data show further improvement. (The Governor’s Mansion House speech this evening may provide more information.)

Labour market statistics also released today continue the recent pattern of better-than-expected news. The monthly rise in claimant-count unemployment slowed to 39,000 in May, down from a peak of 137,000 in February and the smallest increase since July 2008. This slowdown should soon be reflected in the lagging Labour Force Survey unemployment measure – see first chart.

Labour demand appears to holding up better than many feared. The monthly number leaving the claimant count has risen steadily so far this year (admittedly partly reflecting some claimants exhausting entitlements), while the rate of decline of job vacancies has eased. Indeed, the 6% drop in vacancies in the three months to May is consistent with other evidence that the economy has stopped contracting – second chart.

The “best” measure of the UK broad money supply – M4 excluding money holdings of financial intermediaries – grew by 1.0% in April, according to a monthly proxy made available by the Bank of England today. Chain-linking this increase to “official” first-quarter numbers, adjusted M4 is estimated to have risen at a 7.8% annualised rate in the first four months of 2009, up from 3.0% during the second half of 2008. This suggests that QE is working and supports economic recovery hopes.

The 1.0% rise in the adjusted measure in April compares with an increase of just 0.1% in M4 holdings of households and non-financial corporations. The big gap implies that cash balances of financial institutions, excluding intermediaries, rose strongly, probably reflecting the direct and indirect impact of Bank of England asset purchases. Reinvestment of this cash should boost asset prices and money holdings of corporations, as institutions subscribe for new equity and bond issues.

The April broad money rise would have been larger but for a contraction of 0.1% in bank and building society lending to households and non-financial corporations – the first monthly fall since 1993. Lending to households slowed to £2.2 billion, the lowest since August, while corporations repaid £4.7 billion of bank debt, partly out of the proceeds of recent capital issues (sterling issuance totalled £13.7 billion in the three months to April).

Bank of England gilt purchases of £29 billion in April offset £18 billion of DMO (Debt Management Office) issuance, reducing the market-held stock by £11 billion. Sectoral figures show that gilt holdings of overseas and UK non-bank investors fell by £11 billion and £3 billion respectively, while banks and building societies bought £3 billion – see table.

When the Bank buys from a UK non-bank investor, M4 rises as the investor’s bank account is credited; there is no such first-round effect with a purchase from a foreign investor, since overseas deposits are excluded from M4. Foreigners, however, appear to have used cash from gilt sales to buy assets from UK institutions and subscribe to new issues, thereby boosting M4 and allowing UK companies to repay bank debt.

Annual growth in adjusted M4 appears to have remained stable at 4.2% in April, since there was an identical 1.0% monthly rise in April 2008. In real terms, i.e. relative to retail prices, the annual rate of change has recovered from a low of -0.7% in September last year to 5.5%. Narrow money trends have also improved, with the annual change in real M1 – currency and sight deposits – up from -5.8% in October to 1.4% in April.

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COMMENT:
AUTHOR: simon slater
EMAIL: sslater7@aol.com
IP: 195.72.179.234
URL:
DATE: 06/16/2009 01:23:13 PM

Where is this monthly ‘proxy’ for adjusted M4 from? I thought the BoE were only starting to publish monthly data for this in the autumn, with only only quarterly figures available until then?

The smaller-than-expected fall in UK annual consumer price inflation in May partly reflects the continuing after-effects of sterling’s plunge during 2008, discussed in earlier posts (e.g. here). With the exchange rate recovering recently, however, inflation prospects are improving, although the MPC’s forecasts are too optimistic.

Headline CPI inflation edged down from 2.3% in April to 2.2% in May but remains above target and would be significantly higher but for December’s VAT cut. Assuming retailers passed on half of the VAT reduction, “true” inflation is probably 2.7-2.8%. (The CPI at constant tax rates shows a larger rise, of 3.3%, but assumes unrealistically that the cut was passed on in full.)

As well as the VAT change, slowing food and energy prices have contributed to the recent decline in the headline rate. Core trends, however, remain sticky: the annual increase in the CPI excluding unprocessed food and energy moved up from 2.0% in April to 2.1% in May and would be an estimated 2.7% without the VAT reduction (again assuming 50% pass-through).

The impact of the lower exchange rate is evident in less favourable price trends for such categories as clothing and footwear, audio-visual goods and package holidays. Currency weakness has also reduced the benefit of lower global commodity prices: a 7.8% annual rise in the UK CPI for food and non-alcoholic beverages in May compares with an increase of just 0.3% in the Eurozone.

Sterling’s recent rally, however, will curb import price pressures. The chart shows annual rates of change of manufactured import prices and the effective exchange rate, plotted inverted. Import cost inflation has already slowed from an annual 15% in December to 10% in April and prices are likely to fall later in 2009 if the effective rate remains at its current level.

The MPC appears once again to have underestimated current-quarter inflation in its latest Inflation Report: the 2.25% April / May average compares with a central projection of 1.9%. The MPC was forecasting a fall to just 0.4% by the fourth quarter but is likely to revise this up in the August Report, reflecting recent higher-than-expected outturns, better economic data and higher oil prices.

The recent sharp rise in US Treasury yields may partly reflect supply pressures and investor worries about longer-term inflationary risks from quantitative easing (QE) but the key driver has been a recovery in economic momentum.

The first chart shows three-month changes in the 10-year Treasury yield and the Institute for Supply Management (ISM) manufacturing new orders index – a good summary measure of economic momentum. A positive correlation is apparent, with the recent yield surge coinciding with the largest three-month rise in the new orders index since 1983.

The relationship suggests that the direction of yields depends not on the rate of economic growth but on whether it is accelerating or decelerating. When the new orders index reached a record low of 23 last December, it was clearly much more likely to rise than fall, implying that Treasuries were high risk. The bearish case is now less clear-cut – even though the ISM index is back above 50, signalling economic expansion.

To assess Treasury market prospects, therefore, it is helpful to have an idea where the new orders index could be heading. The second chart compares the recent revival with an average of five prior recoveries from troughs when the index fell below the 40 level. (The troughs occurred in January 1958, December 1974, June 1980, January 1991 and January 2001.)

The historical pattern suggests that the new orders index could rise further to 55-60 in the short term. Interestingly, however, the average registers a peak in August 2009, treading water over the autumn before a further move up around year-end. If the current cycle follows this template, Treasuries could enjoy a short-term rally later this summer, even in the context of an ongoing economic recovery.

First-quarter flow of funds accounts released yesterday by the Federal Reserve show a further decline in non-financial companies’ borrowing requirement, defined here as their “financing gap” – capital spending minus domestic retained earnings – plus share purchases net of issuance. The borrowing requirement is a leading indicator of credit spreads – see chart and previous post.

The borrowing requirement amounted to 1.5% of GDP in the first quarter, down from a high of 9.5% in the fourth quarter of 2007. In the late 1980s and early 2000s, borrowing peaked eight quarters before the high-yield spread over Treasuries. Credit has rallied much earlier in this cycle, possibly because spreads reached more extreme levels in late 2008 than in the prior two bear markets. The historical two-year lead suggests that further significant spread compression could be delayed until 2010.

At 1.5% of GDP, the first-quarter borrowing requirement was below its average of 2.3% since 1985. The further fall last quarter mainly reflected a large cut in capital spending as companies slashed fixed investment and ran down stocks. A decline in net share buying also contributed, while firms offset profits weakness by reducing dividends, resulting in stable retained earnings.

Looking forward, an end to destocking should contribute to a significant rebound in capital spending over the remainder of 2009. The impact on the borrowing requirement, however, may be offset by a recovery in profits as economic growth resumes and a further fall in net share purchases, with companies using the opportunity provided by better markets to step up issuance.

Critics of the banks accuse them of boosting margins by failing to pass on Bank rate cuts to borrowers. The banks’ last trading statements, however, complain of downward pressure on net interest income. Who is right?

The chart below shows estimates of average interest rates charged on M4 lending and paid on M4 deposits, derived from disaggregated Bank of England data. (The M4 data cover banks’ and building societies’ sterling business with UK households and corporations.) The difference between the average lending and deposit rates is a measure of banks’ net interest margin.

The critics are factually correct to complain of a measly decline in lending rates. Between November 2007 and April 2009 Bank rate was cut by 525 basis points but the average interest rate on M4 lending fell by only 310 basis points. This implies much lower pass-through than during the last big easing of monetary policy, in 2001-03, when Bank rate fell by 250 basis points and the M4 lending rate by 220 basis points.

The benefit to banks of a higher margin on lending, however, has been entirely offset by the disappearance of their deposit margin. In November 2007, the average interest rate on M4 deposits stood at 4.6%, 115 basis points below Bank rate of 5.75%. By April 2009, it was 110 basis points higher – 1.6% versus 0.5%.

In other words, the M4 deposit rate fell by only 300 basis points between November 2007 and April 2009 – slightly less than the average lending rate. Far from bolstering their profits at the expense of hard-pressed borrowers, banks have actually suffered a further decline in their net interest margin over this period – see chart.

Why has the average deposit rate proved so sticky? Clearly the maximum possible fall would have been 460 basis points – its level in November 2007. In practice, banks have been forced to continue to offer interest on sight (i.e. instant access) deposits in order to retain funds – not least because of competition from state-run savings. Meanwhile, the unforeseen collapse in Bank rate has left them temporarily saddled with high term funding costs: the average interest rate on household bank time deposits was still 4.6% in April 2009.

As term funding matures and is refinanced at lower rates, banks should be able to reduce the M4 deposit rate towards Bank rate. Coupled with higher margins on new lending, this should allow a significant recovery in the lending / deposit rate spread. As the chart shows, the spread is currently at an historical low – even a 100 basis point rise would simply return it to the average over 1999-2005, before the recent credit bubble.

Banks are already being accused of profiteering despite a further squeeze in their net interest margin; imagine the furore if they succeed in boosting their profitability. Such a development, however, is needed to speed capital rebuilding and support future lending growth. Moreover, restoration of the margin to a normal level is the mirror-image of an appropriate repricing of credit risk – spread compression in 2006-07 contributed to the lending bubble.

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COMMENT:
AUTHOR: Peter
EMAIL:
IP: 86.156.240.52
URL:
DATE: 06/11/2009 10:39:11 AM

HSBC have increased the interest charges on private overdrafts to between 16% and 18% depending on whether the customer has an account that charges a monthly fee, or has investments with the bank of £50,000 or more.

This compares with interest rates of 12% a year or two ago, and 2 to 4 % over base in the slightly more distant past.

Sympathy for the banks is misplaced. I believe the rates currently charged to be usurious

Perhaps the banks are a good investment bet, because at this rate they should be in substantially increased profit very soon

The Bank of England’s Bankstats publication this month contains for the first time a table providing detailed figures for “adjusted” M4 and M4 lending – i.e. excluding banks’ business with financial intermediaries (“intermediate other financial corporations”). If these series had been made available 12-18 months ago, economists and the MPC would have been better able to anticipate the recession.

The Bank was aware of possible problems with its M4 and M4 lending measures in 2007: an article in the September Quarterly Bulletin proposed a redefinition to exclude intermediaries while the November Inflation Report warned that growth rates were being inflated by the financial crisis. Since May 2008, the Inflation Report has contained a chart showing the annual growth rate of adjusted M4; this was extended to M4 lending in August last year. The fuller data set published in the new Bankstats table could, in theory, have been made available at least a year ago.

The chart shows a measure of economic momentum based on the purchasing managers’ surveys – a weighted average of the services new business and manufacturing new orders indices – together with the six-month growth rate (not annualised) of real adjusted M4 (i.e. deflated by consumer prices). In contrast to the headline measure, real adjusted M4 slowed abruptly in late 2007 following Northern Rock’s implosion and contracted during the first half of 2008 as inflation spiked higher. This weakness warned of serious economic deterioration at least three months before the purchasing managers’ indicator fell below the key 50 level in May 2008.

The MPC reduced Bank rate in December 2007, February 2008 and again in April then held it at 5.0% until October. It is debatable whether members pay much attention to monetary trends but, had the adjusted data been available, there is at least a chance that the Committee would have cut further over the summer despite a surge in headline CPI inflation to a September peak of 5.2%. It might also have been swifter to heed external recommendations for quantitative easing.

Just as it led on the way down, the adjusted money measure also foreshadowed the recent improvement in economic news. The six-month rate of change troughed last September and has recovered steadily, currently running at about 3% – a level historically consistent with economic expansion. The purchasing managers’ indicator bottomed in November last year and the recent move back above 50 appears to confirm that the economy has stopped contracting.

Is the US labour market improving, or at least deteriorating less rapidly? Employees on non-farm payrolls dropped by 345,000 in May – lower than expected and down from an average of 612,000 over the prior three months. An alternative payrolls measure derived from the household survey, however, fell by 833,000, contributing to a further rise in the unemployment rate to 9.4%, a 26-year high.

The jury is out but two other indicators support the more hopeful message from the “official” payrolls series. First, a smoothed measure of employment taxes withheld at source (equivalent to UK PAYE) has edged higher since February – see first chart. Unsurprisingly, withheld taxes are a good coincident indicator of labour incomes and successfully delineated the last recession. (The numbers have been adjusted to take account of a cut in the withheld tax rate from April.)

Secondly, the outplacement firm Challenger, Gray & Christmas Inc’s monthly tally of job-cut announcements has fallen steadily from a peak of 234,000 (seasonally adjusted) in January, reaching 111,000 in May – the lowest since September. The series correlates with weekly initial unemployment claims and suggests that claims will extend their recent small decline – second chart. This, in turn, would be consistent with an imminent peak in the unemployment rate.

An earlier post made a case for comparing the recent decline in US share prices with the bear markets of 1906-07, 1919-21 and 1973-74. Like the 2007-09 bear, the falls in 1919-21 and 1973-74 occurred at or near the end of 30-year economic cycles. Meanwhile, the 1906-07 decline was associated with a financial panic with similar characteristics to the Lehman crisis.

The three earlier declines bear a close resemblance, with the Dow Industrials index falling by 45-49% over 22-23 months. The subsequent recoveries also look similar – three years after the start of its decline, the Dow had rallied to stand 17%, 17% and 13% respectively below its peak level.

The earlier post included a chart overlaying the 2007-09 decline on the three earlier bear markets and recoveries. This approach has been taken further in the chart below, which shows a “three-bear average” of the prior episodes. This average provides a template for comparison with current developments; it may also offer guidance on share price prospects.

The Dow peaked in October 2007 and followed the three-bear average closely until September last year, when the Lehman crisis led to a dramatic lurch down. The deviation widened in early 2009 as fears of banking system nationalisation exacerbated weakness. The rally since March, however, has closed the gap and the current level of the Dow is now only marginally below the template.

The average declines further over the summer, reaching a low about 10% below yesterday’s Dow close at the start of September. It then embarks on a sustained rise, climbing 25% from the September low by the end of 2009 and a further 27% during 2010.

Historical comparisons should be treated with caution but the shape of this “forecast” appears plausible. The recent rally has been driven by a reallocation of cash to equities by investors who had been underweight; a period of consolidation may be necessary before a further advance based on a recovery in corporate earnings – conditional, of course, on the global economy returning to growth later in 2009.