Supplement 06 Oct 24 - What a plaque
“Blue plaques are plaques that commemorate the lives of notable people and the places they lived, worked, or died. They can help to raise awareness of a building's historical significance and preserve it. Some say that blue plaques can also increase a property's asking price by up to 25%” - AI-powered google, October 2024 (welcome to the future)
More about the plaque later, although this week’s image might give you just a little clue…..
Before we get started, this week I wanted to just highlight the Boardroom Club with Rod Turner that I’ve been running alongside Rod for 4 and a half years now.?
The Boardroom Club is a group set up to help take property businesses to the next level. Rod and I often get asked about 1-2-1 mentoring and it isn’t something we provide or have the appetite to provide in the near future. However, there is a 1-2-1 element to the Club and it includes the following:
If you are interesting in joining - drop Rod or myself a message on LinkedIn:
So - an incredibly busy week with plenty of fulfilment at my end (including a great workshop which was very well received) - and more properties purchased too as this “purple patch” goes on. Every other email I receive is a portfolio for sale - there’s an incredible volume of deals out there at the moment. There’s also an incredible volume of dross - of course - and the number one skill, I’m always reminded at this time, is an ability to get to the nub of the deal very, very quickly in order to save everyone’s time. The key is motivation - what’s the reason for the sale. If people are being duplicitous - there’s just no time for that at the moment. They can wait.?
Onto the matters at hand, then, in a slightly puzzling week with some signals either way, and some concerns that have some investors feeling cautious. The VIX - the volatility Index in the USA - is always handy to quantify risk in weeks like this - it moved from 17-ish (a relatively low reading in the scheme of things, it has been down as low as 12 this year, but also spiked to 38.57 when the “August Wobble” happened) to around 20, and ended the week in-between at 18.5 or so.?
What does this mean? It means that the noises of all-out war in the Middle East are not being taken over seriously by the markets. The needle has been moved, but not much. Is the market always right? Of course not. But to form a different opinion needs research, historical precedent, data, or something else rather than catastrophizing, in an economic sense, of course.
Meanwhile there’s been other news about interest rates in a significant week that isn’t necessarily mirrored in the Macro. I’m going to use the deep dive to discuss the near-term path of interest rates in some more detail, this week, because that captivates so much investor attention at this time.
We start with the weekly props to Chris Watkin who delivers week in, week out on the property market insights; he asks the best “trappy” questions I know on the UK property market and skilfully exposes misconceptions again and again. This week was a great example when he asked what percentage of 25-34 year olds own their own home on LinkedIn (mortgaged or unencumbered). The answer is 35.5%, but only 9% of people voted for that option or 45.5%. The other 91% mostly voted for 15.5%, with 25.5% being the next guess. A great example of how the spectre of doom and gloom in the press - or the rhetoric used for political purposes - completely distorts what the public thinks it knows. Bearing in mind those on Chris’ LinkedIn are likely property professionals or at least close to the industry - this is even more incredible - but he delivers these truth bombs time and again.
He also tricked me last week by asking how many rentals we have lost since 2020 as a whole - and since 2020, we have actually gained 170,000 rental units (this takes us to 2023, I doubt we are still gaining units personally). It will be a few months before we have the “2024” figure which only takes us to March 2024 anyway - but the point is well made. We have also only gained 20,000 rental units since 2017 using the same graph (this is the English Housing Survey plus empty PRS units) whereas we’ve needed a lot more than that in the past 7 years, of course. It will be a year and a bit before we see what’s (to me anyway) clearly playing out in the markets just now be actually rubber-stamped in terms of the stats - at which point the politicians will finally realise their mistake, and then start conversations about what to do about it. 15 months before it even gets on their radar, I’m afraid.?
There isn’t a real-time stats episode this week - but hopefully those two polls give you something to think about and remind you to check facts and not suppose.?
Moving to the macro - this week of the month is always jam-packed. We need to talk about the Bank of England money and credit report, including money supply. We can’t avoid the final PMIs because we get better reports as the figures get finalised. Nationwide released some figures that surprised “almost” everyone apart from regular readers and listeners here of course - and then we have our “happy place” (or more realistically, the one that we just can’t let get away) - the gilts and swaps.?
So - the money and credit report. There’s lots that I like here. The press always concentrates on mortgage approvals - and it isn’t the worst single number to pick out of the report in the world, by any means. This covers August and the approval number was just 100 mortgages short of where the sweet spot really lies (the sweet spot being 65-70k approvals per month - meaning a functioning market moving along nicely at around about inflation, per year). 64,900 in a traditionally quiet month, though, is pretty big. It has been 2 years since a number like this - 72,000 in August 2022 which was, truly, the calm before the storm.?
Remortgaging improved a little but 27,200 from 25,200 is still not historically a big number as people are seeming to remortgage kicking and screaming a little (and far be it from me to point out that product transfer rates are pretty shocking at this time).?
The other important bits are the net debt expansion (￡2.9bn extra net mortgage debt added, which is good for the brokers particularly, but healthy enough for the sector at about 0.175% of balances (a steady percentage if annualised, low 2%s, basically, in terms of expansion).?
Consumer credit expanded by another ￡1.3bn which is a more worrying stat, a little above what’s sustainable let’s just say.?
Now here’s where we depart the headline-catching bits and get to the nitty gritty including a bit of a surprise, if I am honest. In August, the rate on drawn mortgages was 4.84%, up from 4.81% in July. This looks high. Those mortgages though were likely MOSTLY offered around April or May 2024 where the gilt yield was 4 - 4.3% for most of that time, so perhaps that isn’t as high as expected. We should see a lower number for September, October and November as yields then started to decay a fair bit (and a google trends search for “mortgage war” that we’ve seen popping up recently shows nothing on the needle until around 21st September, so those mortgages will complete more like December/January I’m sure).?
4.84% still feels pretty painful. The average rate on outstanding mortgages also climbed a weeny bit to 3.72%, so there’s still a healthy gap between those two figures, which I want to see cross back over before I really truly know we are completely out of the interest rate woods as far as the climb from late 2021 onwards goes, when it comes to rates.
The average rate for a new personal loan, in case you wondered, is 9.27% at this time. Ouch - that’s basically a wholesale bridging rate. It is unsecured I guess (if you don’t count your personal credit rating as security, anyway, which you really should!). The money supply also contracted again - slightly - which always helps to keep inflation into line. We are still above the trend line as far as where we would have been if Covid had never happened - but then of course we’ve also had plenty more inflation in that period, so in terms of stimulus etc. the “forced” inflation of money finding a home seems to have somewhat stopped as of now. This is pleasing.
US money supply has calmed comparatively as well but still doesn’t look like it has truly been absorbed in inflation in the US, which makes me more concerned for their “pandemic premium” on inflation than the UKs premium. This is a historical precedent observed in prior pandemics which tended to last 30-40 years and represent inflation 0.5-1% higher than it otherwise was in other (non-pandemic) longer wave cycles.
So the market looks healthy enough in terms of broader credit, although rates still haven’t really worked their way down in terms of rates that people are paying. I really didn’t expect that 4.84% for August I must say - people must also not have been working hard enough with their brokers to keep re-checking rates when they are already in a mortgage situation (and I say this a lot, but it always bears repeating). Keep checking for lower rates in the cycles where rates are dropping. I haven’t counted but my goodness I’ve saved a few quid over the past few years by doing that. Offers can be re-issued and every penny counts - pennies saved are better than pennies earned thanks to our old friend HMRC.
Moving on then to the PMIs, and things played out just as I said - from a flash estimate of 52.8, services dropped to 52.4 - and similarly the composite flash estimate of 52.9 which is healthy lost 0.3 points and printed 52.6 for September. Colder than we would like, hanging on in expansionary territory. We also get the construction PMI for September (there’s no flash estimate for it) - and let’s start there.
A fantastic headline - fastest upturn in construction output since April 2022. A really positive vibe. Why - well, down one level - steepest rise in civil engineering activity since June 2021. The slight dampener - cost pressures intensify in September. The actual index - 57.2 - smashed estimates of 53.1. 59.0 in civils was the leading reason - but 55.2 in commercial building and 54.3 in house building are both really positive, especially given how few housing starts we have had in the figures released this week as well (regarding Q2). Q3’s print will be a dramatic improvement, clearly.?
Input costs were the worst they have been for 16 months in spite of a “moderate” expansion of employment numbers and faster purchasing activity. Optimism went south - back down to April, just as in most other sectors of the economy, but “way above last October”. Rising sales, lower borrowing costs and the potential for stronger house building demand were all cited as supporting factors.
Things we didn’t learn from the other flash PMIs then? Business optimism increased compared to August - but only slightly - with the budget cited again as a reason to delay decision-making. Things improved but in a subdued fashion in terms of output, new work and employment - but still improved. The strapline “prices charged inflation lowest since February 2021” is a clear message to the rate-setters (more on that in the deep dive). The overall message in construction and manufacturing is that wage pressures have eased a lot, but materials are still coming in more expensive, especially if affected in any way by the Red Sea situation.
That’s enough on the PMIs, and I’m actually going to just take a sideways step into the growth figures released this week. What we had was a revision to the Q2 figures, down 0.1% from 0.6% to 0.5% (meaning 1.2% or a shade over in H1 this year). The Year on Year moved to 0.7% from 0.9%, BUT that’s because 2023 has been revised upwards from 0.1% to 0.3%, so we were 0.2% better off at this time last year than we thought we were - so we started from a higher base, if that makes sense. These revisions go on for up to 2 years after figures are first released, which can be frustrating, but then it is a case of the old “when the facts change, I change my mind sir - what do you do?”
This revised the RHDI figures also - Real Household Disposable Income. The 1.3% print for the quarter - and the last four quarters at 0.2%, 0.5%, 1.6% and 1.3% look particularly historically pleasing for households. You’d have to cherry pick four quarters in a row from Q2 2017 to Q1 2018 inclusive to get to figures that were so good for households - but of course, they took a kicking in 2021 and 2022 thanks to inflation that has taken its time to work through.?
Savings at 10% of household incomes have also been revised down, but are still historically high - between 5 and 6% was the 2019 figure and indeed between 2016 and 2019 we had a ratio of between 4% and 6% as the norm with very little variance to speak of. That consumer confidence or room to breathe just hasn’t come back yet. The published 10% is an improvement, however, from a consumption perspective as the forecasting bodies were talking more about 11% and a little above. Perversely this really should have contributed to revising the GDP figures UPWARDS, but yet they have moved downwards. Nothing is “done”, as yet, but these mysteries and anomalies appear in the ONS data on a regular basis. I’m not trying to imply they are incorrect - just that they are subject to change.
Nationwide’s house price index, then. This month included the quarterly regional breakdown as well as the national figures. 0.7% increase on the month (compared to a consensus of 0.1%) and 3.2% on the year, rather unlike the “single digit decline or remain broadly flat” prediction for 2024 that Nationwide came up with before the year began. They still see prices 2% off the highs of summer 2022, however.
The sharpest observation from their Chief Economist is that income growth continues to outstrip house price growth in recent months, and of course borrowing costs have edged lower in anticipation of lower interest rates in coming quarters - further improving affordability and underpinning a “modest” increase (actually, year on year, it is massive as the Watkin real time figures have proven again and again - and an increase on pre-pandemic activity) - their mistake is still claiming that activity and house prices are subdued by historic standards. It depends how historic you want to be, of course, but the market is doing more transactions and moving faster than 2019, for sure, at this point, or 2017-19. (Those years didn’t set the world on fire for growth, bear in mind, but ambled forward). I always feel that “slow and steady wins the race”.?
The regional breakdowns, then. It won’t surprise you to hear that Northern Ireland remains well in front at an 8.6% raise year-on-year; both Scotland and Wales moved the needle a fair bit (both were up 1.4% YOY last quarter) - 4.3% and 2.5% respectively. The North West continued its English regional dominance by moving up 5% year-on-year, in what can only be described as a healthy market.
East Anglia was the only region going backwards according to Nationwide at -0.8% per year. The midlands look fairly static - +1% West, +1.8% East, and London at +2%. The rest of the South in general limps forward at +0.6% per year; so the further south we go, the more the figures are kept in check. With a lot of overall noise about the larger corporates going back to office - particularly Amazon - then in spite of the noise from the business secretary Mr Reynolds, the likelihood is that this will reverse and the need to live nearer the office and the economic engine that is London (especially now that “levelling up” isn’t a phrase, any more, and whatever has replaced it really doesn’t look on the slate particularly in this administration), over the next few years, will likely start to perform strongly again especially as rates come downwards - in my view.
The “growth by type” is also an interesting breakdown - with terraces up 3.5% year on year but detached properties only up a little over 1.5%.?
Now my “real” favourite part of the Nationwide quarterly data. The “real” house price index…..for context, this looks at house prices and adjusts for RPI. That is not anyone’s (apart from a freeholder, perhaps) idea of “inflation” these days, as CPI took over from the early 2000s. However, their data goes back 50 years, and so RPI is appropriate - some also still think it represents more “real” inflation than CPI does, and is ALWAYS higher - they basically think CPI cooks the books a little. There isn’t really much substance to this allegation - but I prefer that we watch OOH, as regulars will know - the owner occupier cost of housing - and CPIH, which reflects the housing element - which from a numbers perspective looks a lot like RPI at the moment.
Q3 has, in spite of positive noises by Nationwide, delivered to us the lowest real house price on this measure since Q3 2013 - and not just that, but zooming out further shows that that was a particularly historic/decade long blip. Before THAT, the 2024 figure adjusted for RPI more represents house prices in Q1 2003 - MORE than 20 years ago. Now after 2003 we had a tear upwards - in real terms, after Q1 2003 prices moved up >28% in real terms in just 4.5 years (although that was an unsustainable boom, of course). The years after 2013 were much calmer - but in 3.5 years after that, real house prices still moved up >18% in real terms which did appear sustainable. That period also coincided with the end in meteoric growth in the PRS, however, and Georgie-boy and his “assassinator” budget of 2015. If we adjust for wages, we don’t see anything particularly different - and if we consider affordability, people are still crying wolf compared to historic situations. However, we have a few differences I think:
Firstly, we tend to look at “house prices as a multiple of income” and not household income, but individual median income. I think this is a false flag overall, and pretty much reject this as reasonable analysis. The number of incomes in an average property owning household has moved up from low 1.x times to higher 1.x times over the past several decades - as both participants have much more likelihood of having a full time job. Households with 0.x times a full time income - e.g single parents, much more reliant on the benefits system - it just isn’t realistic to expect them to be homeowners.?
?So - when we look at total pay in terms of average weekly earnings - the ONS measure - we see a 52.8% increase over the past 20 years. House prices are up 73.7% in the same time period. So how can prices progress from here? Well, partially because of that point above, and partially because credit has been a LOT cheaper (it is now a BIT cheaper than this point 20 years ago - the average from the Bank of England database for a 75% LTV product was 5.44% 20 years ago compared to that 4.84% from today - but the expectation is that high 4s will drift to mid-and low 4s based on what’s already happened with yields, and then below that in the medium term.?
Aside from the price of credit, the stretch of credit is also important - for example, Nationwide themselves have recently announced 6 x earnings as a criteria they will look at. There are also far more options around longer terms, guarantors, and the likes - all of which stretch out that possibility of using credit to buy houses, with a general focus on sustainability of credit growth (much more so than 20 years ago, that’s for sure). So overall conditions are actually MUCH kinder even though the overall scoring criteria is most definitely harder.
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You can also just look at it as “almost all of the bad news is out of the way” - and, don’t forget, with rents moving forward quite aggressively, many more are encouraged by the stick to get on with it and buy - if they have the support of the Bank of Mum and Dad. People aren’t stupid and - whilst they tend to make credit decisions like car loans based on what they can afford, rather than value - and the same can apply to house purchases - they aren’t going to sit and pay a massive rent premium for flexibility etc. unless they really need to. They are going to try and find a way to buy.?
Please note this isn’t the same as comparing rent to mortgage payments directly. I have a huge soapbox rant about this from time to time. Rent includes buildings insurance, maintenance, compliance, structural issues - and the time spent managing all of these issues. This represents somewhere between a 15 and 30% premium in my view depending on the location, and the age of the property - and so framing that sort of conversation in that context is much more realistic. That’s BEFORE we make any allowance for the average deposit - which sits at about 53-54k in the UK - getting returns somewhere in an ISA - let’s say net 4%. Another couple of thousand quid a year in opportunity cost which really should be considered and included - even if many wouldn’t make the decision based on that (and indeed, if reliant on Bank of Mum and Dad, the opportunity cost piece isn’t relevant unless BoMaD is offering the money with no strings attached, and giving you the choice of whether to invest it or spend it on a house deposit).?
So - one more insight there into why I think, over the next 5 year period or perhaps a little shorter, house prices have a bright future and will really start to tear upwards and surprise a few people.??
This will lead us nicely into the deep dive today, but before we get there - the gilts and swaps. Please prepare sad faces. So - if you’ve followed the headlines this week you’ll have seen mortgage wars, and the Governor of the Bank of England suggesting more “aggressive” rate cuts - however, be warned. The 5y gilt opened this week at 3.87% which was a “gap up” from the close and closed at 4.019%. The Thursday close was 3.874% so all the work, really, was done on Friday. What went wrong on Friday - blame the US. Hot job creation figures - a reversal of the August wobble based on July’s figures - and lower than expected unemployment - meant that instead we had headlines saying the Fed had made a mistake with their 0.5% cut. We therefore lost 15 basis points on Friday on the basis of more bearish chat about the pace of cutting rates.?
The swaps however offer much better news. The 5y swap still closed at 3.587% on Thursday night and both the 7 and 10 year money looks similarly cheap if anyone is thinking about fixing anything for longer at this time. That discount of 30 basis points being preserved is still a bit of a head scratcher for me but in absence of any further advances (boom boom) on my analysis from last week, we will just continue to remain positive about it. I suspect Friday’s moves will not have helped - but there’s no point worrying on a daily or hourly basis. It isn’t as though we have a lettuce as prime minister - more of a “Napoleon” style character (from the Animal Farm perspective, rather than the French emperor perspective).
Monitoring will - of course - continue. Into the deep dive and I just want to kick off with some modern history, as we mark a special moment. Two years post Kami-Kwasi budget and the very swift “career” of Mary Elizabeth Truss. She was, this week, commemorated in a Blue Plaque that I simply had to use as this week’s graphic. It made me chortle - although her cost to the economy and the reputation, internationally, of the United Kingdom, was no laughing matter. Her economic naivety, and overall lack of ability, was the single greatest example of the Peter Principle of all time that I’m aware of - promotion to your level of incompetence. She was several levels above that.
Blue plaques, as the quote says this week, increase the value of buildings - I am considering an annual pilgrimage to the site - Walthamstow Tesco, if you are interested. There are richer historical moments but that was a seriously important, and beautifully British, one. We can look with some further humour at this point as the rate landscape got a lot better, quickly, once she was gone - then deteriorated even further as market forces kicked back in. However, the early warning she gave things - whilst a costly jolt, especially to pension funds - was helpful in deflating the bubble that was inflating with some speed, and in many ways did us a bit of a favour. It might be a few years before we can look upon it charitably - but luckily the recovery from said situation put things back on a keel which could see decent growth in early 2024. The rest of this parliament and economic performance in general will be judged on its merits, rather than how many freebies it does or doesn’t take, and which freebies are OK and which aren’t, according to some arbitrary rules.
Onto the heavier stuff, then, now we’ve had the salad. A really interesting week for rates chatter - and possibly nothing like you’ve expected on the gilts front. It surprised me as I followed it throughout the week - apart from on Friday, of course, when the US figures only went one way.
Mr Bailey has only really said two things of interest this week (better than his usual average). Firstly - rate cutting could be “more aggressive”. This changed expectations for December’s meeting more than November’s - with the immediate market aftermath predicting a 61% chance of a December cut. November’s is seen as a “close-to-100% probability” which I’ve been criticising, more on an overly-optimistic basis than a real thought that we will hold rates in November.?
The other soundbyte was around the oil price and recent sharp rises. Brent Crude had dipped below $70, just about, and a stronger pound was really helping with prices at the pumps. Bailey’s comments put sterling down almost 2%, and Brent hit $78 by the end of the week in a 10% rise. All eyes are on Israel and Iran - it is as “simple” as that although there was a Houthi attack on an oil tanker in the Red Sea this week which also has nerves jangling further (but more on an ongoing basis). For context, in November ‘23 and April ‘24 Brent was above $90 a barrel - so it is a concerning and fast direction of travel, which has inflationary consequences, but at this time it isn’t shifting a paradigm unless we see another 20%+ go on the price in coming weeks (not impossible, of course).
I don’t speculate at all on the oil price, particularly - I am more a follower and reporter than anything. I knew when it was negative in the pandemic that it wouldn't last (duh) or when it was $20 a barrel in 2015 that that was unlikely to persist - inflation adjusted, however, it doesn’t look that expensive in real terms at the moment. $1.31 is still a positive exchange rate compared to - say - 2 years ago when the Lettuce lowered it to $1.03 briefly - but has dropped from the week’s high of $1.34 which I don’t expect to see again for a while, which affects oil, gold, bitcoin - everything priced in the mighty greenback. Again, though, the figure for the last few months has been more like $1.29, so we haven’t quite rowed backwards yet. Just a trend to be aware of.?
Bailey’s take was simply that the Bank is monitoring these events “extremely closely”. All of this would very much put me off betting the farm on a cut in November, let alone December - let’s see the economic news, because this post-election wobble is guaranteed to continue in October as businesses wait for the budget like lambs at the abattoir.?
Now - a reason to not get carried away expecting these cuts to just line up in an orderly fashion (aside from the upside risks in the Middle East which look at least as lively as they have as we approach one year since October 7th 2023 - but as I say, I watch the markets there rather than forming my own viewpoint unless we get to extreme panic situations). The Bank had to send out the chief economist to steady the ship, somewhat, after what Mr Bailey had said this week.
Mr Pill has been a lot more hawkish than some other members of the committee, without being a committed hawk. Like his predecessor, of whom I was and still am a massive fan, Andy Haldane, Huw Pill is regularly caught trying to do the right thing. His chat also shored up Sterling a bit. His actual words: “While further cuts in Bank rate remain in prospect should the economic and inflation outlook evolve broadly as expected, it will be important to guard against the risk of cutting rates either too far or too fast.”
A bit more meat than Mr Bailey. This is very much in line with what I think the “average” member of the Bank’s MPC committee thinks about rates at this time. We need lower risks (not happening within a few weeks I don’t think), lower inflation (currently coming in below expectations), some bad economic data to an extent (almost guaranteed for Sept and Oct, although it is relative - not “bad” but trending the wrong way), and the lack of any other crises.?
You can see there - even at this high level - the complexity of the task. And - once again - I remind you that really we care most about the swap rate, NOT the base rate. However - I wanted to expand on a point that I’ve made in a couple of presentations recently to different audiences.?
This is where we need to re-introduce R* which I have mentioned in the past. R-Star, they say. This concept is one of the “natural rate” of interest, and is normally reserved for economics textbooks - however, it is quite a simple one. R-star is simply the bank rate that would see the economy performing “normally” - not restricted by higher rates (as it currently is, nearly everyone agrees), but not assisted by lower rates (as happens in recessions etc.)
R-Star gets a bit of airtime, on occasion. The Deputy Governor before Ben Broadbent, Charlie Bean, in the earlier 2010s revealed that the Bank’s overall position on R-star was about 2.5% in the “new world” after the financial crash had played out, mostly. The Bank then proceeded to hold the rate under 1% for the whole decade, of course, and had a bit of egg-on-face when their forward guidance around rate rises only ever, once, got from 0.5 to 0.75% and there were instead several drops in the interim.?
The position now is more like 3-4% being “the number”. So - why care about all this when we don’t seem to move there anyway? Well, the inaction on base rate in the 2010s now looks rather weak, and the reputation of Mark Carney means that he gets away without much criticism at all now that we know the facts. I feel this lesson - we should have been closer to R-star - will be fresh in the minds of the current committee.
I also have some sympathy for another argument, which ties in to all of this. A lot of commentators, who are by their own admission not trained economists, saw the raising of interest rates in the face of supply side shocks as a pointless exercise. They were - as often, in these situations, right after a fashion - or at least they had a point. Rates going up would NOT address the root cause of supply-shocks.
However, what it did do is manage upside risk. It stopped the economy from taking off, which could have seen even higher inflation. That’s all well and good - but when can these risk management measures be removed, then? Well, back to one of the points above - when risks are lower. They were looking potentially lower, but not from a geopolitical perspective of course - and as a massive energy importer, we remain extremely dependent on the import of oil aside from other forms of fossil fuel.
Bailey’s comments were interesting. Were they simply a “follow the Fed” style approach? I worry, because I really don’t think he has a deep understanding of economics, and I’m generally pleased that he just seems to copy or at least be heavily influenced by the Deputy Governor. A cut in base rates would help the economy massively - but the expectation might just be enough. When the “moment in time” comes for the OBR - who, remember, write the script on what the entire budget is based on - then the path for expected rates will be a consideration. It isn’t necessarily as cross-sectional as that, but if everyone assumes a rate cut in November is a complete banker, and then thinks December is a strong probability, that will all be priced in. That helps Rachel Reeves massively as it lowers the debt burden on new debt creation particularly in the shorter term (which is a rather regular occurrence, of course).?
The 10-year gilt - the most liquid longer-term one - doesn’t look much different in profile than it did in March when the last OBR forecast was released - so perhaps there won’t be much in this - but the expectations for cuts have become much, much clearer since so I would be surprised if the outlook wasn’t improved. All of the recent language (for example in the PMIs) has been telling the rate-setters that sectors all around are ready for further cuts and that inflation is much more under control.?
Just the oil price and the Middle East to watch, then? To an extent. Any physical imports obviously remain still at risk. Yields are at or above their 52-week averages which is one of the indicators a technical analyst would look at.?
These sort of upside risks are exactly why I’ve remained fairly bearish about all of this when it comes to rate-cutting. I’ve been criticised time and again by brokers and commentators for suggesting rates will stay high - I think they largely misunderstand me. Few individuals have more skin in the game than I do on wanting interest rates to be lower than they currently are. That is a complete irrelevance when it comes to effective analysis. I have to predict what I think the Bank of England will do - which is relatively easy, especially as we approach the meetings, as long as the requisite amount of prep work is done. Then I have to predict the gilts and swaps markets which is much harder - and is, of course, one of the better remunerated skills in the world, so I’m trying to bat at one of the highest levels there.
What I do know when I look at the yield curve - remember, it puts together all the bond yields of bonds of all durations, from 3 months out to 50 years - is that it looks almost exactly the same shape as it did one year ago, but shifted downwards. It has moved down about 50 basis points - half a percent - in 12 months. The shape being exactly the same is anomalous, and tells us how the signals that normally come from the inverted curve have not been performing over the recent years as well (because we would expect the shape to have shifted to the left, not just downwards - because one year has passed, if that makes sense!)
This comes back to R-star. The R-star I would argue that we really care about is the 5-year R-star - which is not the same as the 5-year yield curve as at today. However, the 5-year particularly has been a low point on the curve - the low points as at today are actually at 3 and 7 years, but there isn’t much in it. Today is important for decisions as of today - the path over the next 5 years is what I really care about and am trying to predict, in terms of procurement and deployment of resources in general.
So - let me rephrase that. What the 5-year is trying to predict, in many ways, is the average base rate over the next 5 years, with certainty over the rate for the next month, and more uncertainty as the time goes on - because the base rate sets the immediate price of money in interest rate terms. Imagine it as 60 1-month yield predictions, if you like.?
What I’m trying to predict is how that 5-year prediction shifts as time goes on, and the idea is always that in the absence of other pressures/crises/pandemics and the likes, the interest rate should return to R-star. For those who did some economics moons ago, you will remember the concept of equilibrium - you’ll also appreciate that it is just that - a concept - rather than day to day reality. You’ll also appreciate that it is in the interests of the media to convince us all that we lurch from one crisis to the next - which is often why the best advice is not to read the news or engage in it.?
You can see why - though - if the yield curve is inverted but recession ISN’T on the horizon - what ends up happening. Hedge funds can borrow from the future at lower rates (like the 3, 5 or 7 year) and invest it at the shorter term rate. If you had done that (and many have done) 1 year ago, then you had a nice steep one-year set of returns, and you still have that same exact steep curve downwards in terms of returns for the next 1 year (the actual mechanics are far, far more complex than this. Please don’t try it!).
There are higher returns to be garnered in overnight markets, commercial paper and the likes. They sometimes lever these trades by 100x or 500x, and consider it as basically arbitrage (which it is close to, although not arbitrage in its purest form). So it might look like buttons in terms of the differences, but to an extent this keeps the yield curve honest.
Now - it isn’t honest at all points - because the very front end is set by the rate-setters - the central banks. So - if you think interest rates ARE well above R-star and recession isn’t on the horizon, then you are rewarded for the falsely high rates that have been on our plate ever since the risks were managed accordingly. THIS - whilst it is somewhat technical - is a better argument for aggressive rate cuts.
We also need to remember what message they send out, and what time frames we are talking over. It is always important to note that the 6-24 month time period is really what the rate-setters know they are influencing (although they influence things like the stock market, of course, today - not in 6-24 months time - even though stock prices are of course a function of future cash flows, when it comes to concepts like discounted cash flow analysis)
So what are the expectations in 6-24 months? It looks safe to say now that wages will be calming further and performing more normally - some sectors will still see aggressive price rises if reliant on minimum wage workers as the next rise kicks in in 6 months time. The pension triple lock will look after those claiming it in the way they have become accustomed (at the cost of the working population, of course, because the “scheme” is just that - a ponzi).?
I think we’ve fallen into the trap of not trying to get to R-star quickly, or efficiently, enough. We manage where we are, rather than being willing to cut rates but be open about the fact - if the facts change, we might need to change them. Should rates go up and down like a yoyo - no - but when we amend in quarter point increments (or even smaller, in crises - an approach that has been recommended and one I would support, interestingly, is changes of 0.1%).
Why would 0.1% changes make a difference - because it would make it SO MUCH EASIER to send signals to markets and firms - imagine if this year we could have cut by 0.1% as soon as inflation hit 2%, even in the knowledge it might creep back up (thoughts were that it would creep back up more than it has, but almost all the measures other than headline CPI are still above 3% anyway). An earlier signal, more positivity, better investment - what’s not to like?
I am not advocating for employing a neurodiverse MPC who would change the rate once a week. That wouldn’t help. But smaller increments would be great for messaging and confidence building. Making the meeting monthly, rather than 6 or 7-weekly - given the combined several million quid a year salary of the members of said committee - might also offer a bit better value and more regular guidance on rates.?
Where does that leave us - theoretically dazzled but with no further idea about the path of rates? Well, I think we’ve got a pretty good idea, actually. Listen to the Chief Economist, not the Governor. Downwards - almost certainly. Slow and steady is likely to win the race. Down 1% from here, on base rate in the next 12 months. Gilts - down 0.5% from here, perhaps 0.75%, on yields in the next 12 months. Resultant mortgage rates - perhaps down 0.5% from here, in the 5% region for limited company 5-year buy to let - in 12 months time, with us seeing more like 4.5% in a couple of years.
That’s on the basis of nothing going wrong - but remember. 90%+ of the time, things really aren’t going wrong. They seem like they are, but it is just push and pull factors in markets. It isn’t a pandemic. It isn’t a total withdrawal of credit. It is slow and steady growth in various factors, in various ways, that push forward prices over time, and inflate away any debt we are lucky enough to have, as long as it remains to be good debt.
I hope that was “interesting” (sorry) and the juice was worth the squeeze in terms of conclusions. But remember - “When the facts change, sir, I change my mind - what do you do?”
Before I go, SAVE THE DATE for the next Property Business Workshop - Thursday January 16th, with some great subject matter - planning, efficiencies, and also financial accounting and bookkeeping - not “how to use Xero” but how to ensure reporting is SET UP correctly and how to monitor it on an effective, ongoing, monthly basis.
There’s only one way to deal with all of this ongoing noise and excitement - Keep Calm, ALWAYS read or listen to the Supplement, and Carry On!
Turning organizational challenges into thriving work environments with sustainable HR solutions | HR Transformation Specialist | HR Consultant | Ex-GAP | Ex-Cipla | Ex-Schindler
1 个月Insightful. I was surprised to read that the war in Middle East is not hampering the markets too much. Adam Lawrence
4x Founder | Generalist | Goal - Inspire 1M everyday people to start their biz | Always building… having the most fun.
1 个月Keep calm and carry on, but don’t trust the guesswork.
Founder of Evergreen South a Property Investment and Development Business
1 个月Fascinating stuff and thanks as always for the steer on the near and long term on the rates etc.
a?g?e?n?c?e? (vrais) e-commer?ants aux services de ton e-commerce | Multi-expertise : fondations (webdesign, CRO), acquisition (ads, seo, emailing), rétention (newsletter, social media) + studio créa | COO @MIG
1 个月Sounds like a must-read for anyone navigating the property and economic landscape right now. Let’s dive into the details without the guesswork. Adam Lawrence
Director at Eddystone Properties Ltd | Director South West Landlords Association
1 个月We’re one of those monthly mortgage drawdown statistics for a residential purchase - ended up with 4.29% after starting at 4.72% in May. We managed to secure a lower rate 4 times through the process so yes, definitely pays to keep checking!