Banks, Rates, Risk and Survival

Oct 30, 2022

“Shock is when language and emotion get overwritten by trauma’s numbing code.” – Stewart Stafford, actor.

Welcome to the supplement. I make no apology that this week will be a long one – get the second pot of coffee on the go in preparation. There’s a quick roundup of one more incredible political and economic week, before getting into the meat of what I want to discuss and why.


Arise, Great Rishi?

So, the great Sunak has risen to the top of the governing party. Or so we hope. The danger is, of course, that at the moment Jeremy Hunt and Dominic Raab look like fantastic, stabilising, supremely competent politicians. Yes, I really did just say that. Benchmarking (which is exactly what I’m doing there) can be dangerous – the comparison to the outgoing administration is irresistible, but the outgoing administration almost caused economic and resultant political meltdown in the oldest and most stable of all political systems and economies in the entire world – in under a month and a half. Imagine that.

We will no doubt be going into great detail about some of the decisions that Rishi will have to make over the next 2+ years; suffice to say the current ones look good. Deferring the budget – because markets are now calm, because someone who looks extremely financially competent and more importantly fiscally responsible is at the helm, was a strong move and the right move. The markets can interpret whatever comes out of the Bank of England MPC meeting next week, which will once again put the base rate of interest up (0.75% is just about still getting my vote, although in my view there will be at least 3 votes for 0.5% only and it might be a close one) – and then have a couple of weeks to stabilise before the budget which will simply HAVE to be costed either via tax increases or via austerity.

Will we see a bunch of leaks about this? Rishi may well shore up the ship and do what his immediate predecessors didn’t – he may well move away from populism. I really hope so. That will be one gauge.


Misery reigns

He also made one more decision. His first speech contained the words “Britain faces a profound economic crisis”. Johnson and Truss just wouldn’t have said this – both fully paid up members of the “boosterism” school of thought – which is basically, never admit anything is bad and turn every positive into a negative even when we really should be thinking about downsides. It has its fans, but managing expectations to reality might be more sensible. We will see.

So – what IS this profound economic crisis? It really got me thinking – and I thought back to the last Bank of England MPC meeting, and the resultant business briefings that take place around the country. I attend quarterly at one of the local briefings, and always have questions to ask (surprise, I know). I have written about this briefly before, but something has been bothering me about it and I’ve given it a lot more thought over the past few days.


So remind me – what happened?

The timeline of events is helpful here:

6th September 2022 – “The lettuce” is made Prime Minister
22nd September 2022 – The Bank of England MPC meeting takes place
23rd September 2022 – There is a “fiscal event” – an aberration of a budget, unfunded, ideological, idiotic, disastrous, released by the temporary chancellor Kwasi Kwarteng.
23rd September 2022 – After the release, the international markets and bond markets react aggressively, selling off sterling, and selling off government gilts, pushing prices down and yields up. It’s a Friday.
24-25th September – KK’s budget gets destroyed across every wing of the press aside from the far-righters, who think it is “right” and ignore the evidence.
26th September 2022 – The sell off continues of sterling, and of government gilts, as the pensions market starts to come under pressure thanks to Leveraged Liability Driven Investments (that 99.99% of the world didn’t understand, before that date – and I’m sure 99% still don’t)
26th September 2022 – The Bank of England publishes their annual stress test report on what happens to the banks
27th September 2022 – The 30-year gilt yield closes at 4.99%
28th September 2022 – The Bank of England breakfast briefing that I attended (having read the stress test) – pre 9am.
28th September 2022 – The Bank of England intervenes in the longer duration gilt market, to stop this selloff and steady international markets


The Stress Test

The stress test consisted of the following assumptions – remember this is a STRESS TEST. The doo doo has hit the proverbial fan, in this scenario:

GDP down 5% (double the contraction in the financial crisis)
Housing market down 31%
Unemployment up to 8.5% (current figure 3.6%)

This is fine. I mean, it isn’t fine – but remember, this is NOT a prediction. This is “worst case scenario”. Olympus has fallen. Rishi has not delivered us from evil. Etc.

There is one key element missing. The assumption for this test was that base had made it to 6% in early 2023, and then fallen back to 3.5% by the end of the test (end 2023).

This was the basis of my question. I was concerned – the other assumptions looked like doomsday scenarios. Less than 1% chance of that happening. Not something to lose sleep about.


Excuse me Sir – is this a proper stress test?

The base rate – at that time – according to the bond yields market – was expected to hit 6% in 2023. This was ALREADY the stress rate. That, to me, looked problematic and nowhere near “stressy” enough. Hence the question.

What followed was a near bloodbath. I was a chalk outline on the floor. The answer was not really an answer. My framing of the question was simply “Do the monetary policy committee believe that the stress rate of 6% is enough, given that that’s the market’s current forecast?”

The answer was “The committee is VERY comfortable that this is a more than sufficient rate for the stress test”. That was it. No more than that. This is a very unusual response at these sorts of meetings – normally it is jovial, convivial, chatty and quite light-hearted even though the subject matter is heavy. The same humour that characterises doctors, surgeons, or undertakers, if you will. I felt like the proverbial naughty schoolchild.

I was desperately hoping someone else in the room was going to pick up the gauntlet – but, sadly, they let it go. The answer was enough. My immediate reaction was – “he knows something I don’t” (well, you’d hope so – he works for the Bank of England – I don’t!) – and then my second order reaction was “oh dear – it’s bad and so he can’t say what it is.”


Whatever it takes

That very same day (timing is everything, right) as per the timeline above, when the meeting finished (9am) I got back to the car. By the time I’d got to my desk, the news had broken – The Bank was going to intervene in the long-dated gilts market and do “whatever it takes” to get the price down.

Those words again. Whatever it takes. Rishi, and Boris, ringing through my brain, from 2020 and the pandemic response. The Bank was also going to do whatever it took in 1992 (before independence) to keep us in the ERM. Until they couldn’t, and George Soros and others spotted it, and “broke the Bank of England”. Strategy swiftly changed to being a cheap currency from defending sterling. It was abject stupidity and arrogance.

An independent central bank is much smarter than a government controlled one. (That all happened in 1997). Rhetoric and language is very important. “Whatever it takes”. I didn’t think TOO much about all this, after all – because what was clear to me is that the Bank were going to intervene, and also the long-dated bond markets (20 years+) are really quite small in terms of liquidity compared to the might of the 10-year, and the 5-year and shorter dated gilts. In context they are still many billions, but much, much smaller on a percentage basis – so much easier for the central bank to control.


All sorted. What was the fuss about?

The Bank indeed ended up deploying far less capital than even its initial pledge. It did the job. Markets calmed down. I suppose I wrote off the incident in my head because the Bank official’s attitude was, very quickly, explained by the announcement of supporting the long-dated yields just an hour or so after the briefing. But then – Rishi, and his “profound economic crisis” speech. Hell of an opener.

You could argue that gamesmanship would mean he would want to make it out to be worse than it is – because if he then sorts it out, he looks even better. Maybe – but what sort of sell is that to the electorate in 2024? Oh don’t worry folks, I know it was my own party, with me as a minister/in control of the Treasury that screwed a lot of it up in the first place, but now I’m in charge all is fine? I don’t like the political side of things – I prefer the brutality and lack of BS in economics, at least when discussed at the more guerilla level as I tend to do – but I don’t see the point unless he thinks it is happening.

So then I cast my mind back to that meeting. What if the Bank weren’t only talking about what the actions were that day? What if, instead, they were aware of another reason why base rates really couldn’t be hiked to 6% – because it would make so many mortgage borrowers insolvent? Because small businesses would be crushed to a halt – because because because. The problem with the absence of information is that your mind works hard to fill those gaps.

I’m a good reader of people, body language, and emotion. I’ve won a few decent enough sized poker tournaments (years ago, granted!) by being decent at maths and decent enough at reading people. There was, as Detective Columbo would say, “one more thing that bothered me”.

The body language was SO cocksure from the Bank’s official. So utterly convinced. That, when I reflected on it one more time, was the real problem. If someone is so convinced they are right, how much are they really trying to understand the “what ifs”? What if something even worse would happen (inflation is 20% and rates are 5% – what then? What’s the choice then? Etc. etc.)


Fragility and Binary Choices

When systems become fragile (we’re already there, even if Rishi has steadied the ship – he hasn’t yet fixed the leaks or thrown the fat overboard), if something else happens, there’s a problem. I wrote about this many times during Covid – the initial response was OK, in the context that there were no other shocks. We had a few smallish ones that battered supply chains, leading to some inflation that many wanted to write off as transitory. We must once again revisit that debate, so that I can provide some clarity – because from social media comments I am getting, I see people are still not getting it, nor are they sure on where I am at.

Liverpool or Everton, Protestant or Catholic, Brexit or Remain, Left or Right wing. Society wants us to choose – and I find the identification of oneself with either binary choice, in a strong way, fascinating. Many humans are pretty passionate by nature, but also most (by definition) in a normal distribution cluster in the centre. That’s why either of two parties has a shout at most elections. If one side or the other goes to the extreme (ahem, Comrade Corbyn?), it is no surprise because simple mathematics tells you they are going to the thinner part of the curve, and thus only get say 30% of the vote. The floating voters all run the other way.

I dislike the binary choices. Birmingham City or Aston Villa? These days, I prefer Solihull Moors. Boring? Maybe. I voted Remain in the referendum, but agonized far more than many others I know. I knew (and know) some sensible, balanced people who voted Brexit and I was keen to listen to their point of view. I was never comfortable with the political union point and believed the single currency to be doomed to failure relatively (relatively, I said) quickly (within my lifetime). On balance, I knew from my economics training that GDP would suffer and value would be destroyed in the shorter term/first decade (as a minimum), and was concerned that that in itself would kill people who didn’t need to die – because recessions kill people. Far more people than terrorists, or global warming. I also was uncomfortable because the “main men” were Farage of course, Johnson and Gove – and I didn’t believe any of the three should ever be our leader, and had a paranoid vision about a triumvirate of evil to rival Hitler, Mussolini and Hirohito (OK, that’s a bit much, I’m semi-joking there). A typical political decision – bad option, or worse option. Why are they asking me, anyway?

Why do I dislike the binary choices? Because life isn’t binary. Life, viewed on a binary basis, is lovely and simple. Blissful ignorance. I don’t want and never want to live at that level of cognition. Things are complex, and they are beautifully complex. Puzzles you can’t solve (that lead to you writing between 2000 and 7000 words on a Sunday morning, trying to work it all out). I genuinely love it.

Having digressed a little…….so is inflation transitory, or more secular? Will it be gone quickly, or is it here to stay? You know now what I am going to say. The truth is, there’s an element of both – and the immediate problem was transitory but then kicked off some secular effects. An energy crisis (we are there already) means that everything took a hike. So where does that take us? Well, companies are clever. So they realise they can raise the price of things, at least for a bit, and make some super-normal profits. When they get caught, and when competition catches up, the game is up. Workers are not stupid. They see an opportunity to earn more, and so wages have risen in the past 12 months more than they have done for many decades. That isn’t headline-grabbing – because the rate has still been below inflation, so the average worker has still been losing ground. However, I’ve been concerned that the inflation is more secular than transitory, and even as the transitory effects start to die away (already started), the secular effects have gained more and more pace over the past year. I feel it is more secular than transitory, and also fear that there are more shocks in the pipeline (see last week’s article for China and the zero covid policy being one of them). Shocks that we do not control on an individual or a governmental level.


What if the Bank is wrong?

So – back to the Bank. I’m worried that they are wrong. This isn’t a flight of fantasy where I am considering my knowledge to be superior to that of the MPC members. Maybe one or two of them……I jest of course. I don’t think this is LIKELY – I don’t think we are sure to go up to 5 or 6% base or beyond – but unlike them, I very much DO think it is possible.

Where does that leave us all, then? Concerned? Stressing about stress tests? Absolutely not. Don’t worry about what you can’t control. Seek to understand and be informed, and dodge the individual land mines that we all have in our portfolios, lives, businesses and all the rest of it. But it does lead me to really quite a strong conclusion.


Still consider fixing? Really?

If you missed the fixed rates – no matter. I wanted to break all of mine until June 2024 – some fell through the cracks as lenders pulled products. They messed around. They changed underwriting criteria (not above the line, but below the line). I’ve got a few I’d like to be fixing (happily, over 80% of the ones I wanted to do are done).

The rates available are the rates as at TODAY. They are going down, but not as fast as the market is calming. Here are the truly relevant events left this year that we know about:


What’s left of 2022, Economics-wise?

3rd November 2022: Bank of England monetary policy committee meeting. Likely outcome – 0.75% rise in the base rates. I wouldn’t be stunned to see 0.5%. I suspect we may even get a split vote again – 3 votes for 0.5%, 5 for 0.75%, 1 for 1%. 30 days ago the market expectation was 1.25% at this meeting with possibly some 1.5% votes.

17th November 2022: Budget. Sensibly pushed back from Hallowe’en. It’s almost like the Central Bank and the Treasury are on speaking terms again……..Expect cuts to services – but perhaps less than you might think. Expect help for the most vulnerable – for which Sunak will get zero political capital, but it’s the right thing to do. Expect the gap to be closed.

15th December 2022: Bank of England MPC meeting, rates up again most likely, probably 0.25% I’d say right now.

That’s it. Other things will happen. Most news won’t be good. But that’s it. 8 weeks left before Xmas.

What can you do? Keep an eye on the rates. Make your broker your best pal. Check the service levels. Check AT LEAST once a week, and ideally every time there is a new product. Product teams will start to be under pressure VERY soon, likely in November. Not a lot of people are applying at 6.79% etc (surprise) and these variable products are not all that tempting when base is still expected to go above 4% next year. People prefer to fix in non-risky times – in risky times, floating really should be the loan of last resort.


An insane prediction, by an idiot

I’m going to make a prediction – there will be some limited company 5 year fixed money available before the end of this year, at 75% LTV (if you have rent cover), at 5.75% or below. There might not be loads. You might need to act very quickly. But there will be, in my view – because the current swap rates and bond yields could support it. It might have a high fee attached – 3 or even 4%. A meaningful chunk of that capital growth you’ve enjoyed. For new purchases, the vendor ends up feeling that pain (the way we do our numbers, anyway) – our offers just become sharper – and that’s what you need to do.

DON’T overgear. Take out what you’ve already got borrowed on your variable, or your loan ending soon. DON’T ask me what “soon” means – that’s your job, it’s your portfolio, and every answer is bespoke – and I can’t give financial advice anyway, of course. Consider paying those ERCs. Consider spending some money on decisions in principle, and valuations, and booking fees, to have the option to fix. It will still take time, but it’s no secret in the industry that future business pipelines look utterly anaemic at the moment. Some of the lenders will have to accept lower margins, or seek suitors in the mergers and acquisitions space.

Things are, at least, looking calmer. The volatility is still there, but on the downside on yields at the moment. The next step is for that volatility – the amplitude of the waves in the curves and graphs – to shrink. That looks likely with the safe pair of hands on the tiller (although I’m still under-enamoured with the current Governor of the Bank of England)


Mate, you and Rishi need to get a room

Now I don’t want to get too carried away with waxing lyrical. As I said, benchmarking the new administration, who look vastly more competent than the previous one, is silly. We still have nearly zero heavyweight politicians in Government. Where’s Blair or Brown, Clarke or Heseltine? Where’s Ashdown or Cable? Who are their replacements? The markets have calmed down but have a long way to climb down. They haven’t overreacted YET to Rishi, but the credit rating is still in danger, the bond yields are still elevated, the spread between the bonds and the swaps is still large – and consumer confidence is still on the floor.

There is a danger when staying close to the “action” that you can lose tonality and understanding of what the public are thinking. The dreaded “Westminster bubble”. I vaccinate myself with a regular helping of LBC, to listen to what the average, but engaged, individual is thinking and saying – and to try and understand that mindset.

The average individual isn’t bloody happy. That much is for sure. We’ve had some luck with weather being a bit better than forecast. December to February is unlikely to see particularly forgiving conditions. The gas has to go on. The 15% saving across Europe in energy is far easier with higher temperatures – but in reality, can also only be saved once, I think – like austerity. When you’ve already cut to the bone, further cuts just cost more money elsewhere.

The reality is that the world population is still growing – nearly at 8 billion, now, if you took your eye off those counters during Covid, or never watched them in the first place. That means more mouths, more energy, more everything. More energy infrastructure worldwide.

Meanwhile, Western Europe has not done a fat lot (apart from go back to coal, look at fracking, make noise about nuclear) in 9 months nearly since the war started. Pathetic. Serious investment is needed NOW in our energy security.


Survive – then you can focus and thrive

Be calm. Prioritise staying in business. The point is to insulate against the next upside risk – there will be one (one? There will be a few). Fixing rates is insurance, to keep you in the game. Up your asset management – be more on top of rent increases. Sweat your assets – look at HMO or SA, you WILL need to work harder in the next 2.5 years for the same returns you’ve enjoyed in the past 2.5 years presuming you’ve had some exposure to the property market. Look at FAST cashflow in deals, existing assets with cashflow rather than complex development (although at the right price of course…….)

Great deals have been done since well before the housing act 1988. Every day, every week, every month in every market, with interest rates at 20%+. Be ready for the rainstorm, and have the hatches battened down. Work on your investor relationships. They will know that opportunity is coming – your job is to convince them that you are the one for them to work with.

Here’s your first taste of your 2023 strategy. It’s my strategy – for free. The secret sauce.

Do great deals. Don’t niche in too much (although ensure you have experience and/or the right people around you, supporting you). Discount, yield, capital growth. How much of what do you want or need for it to stack up? Marginal deals? No, not at this time. Repeat 10 times after me – I will NOT be a motivated buyer.

Good luck, and carry on – and if you enjoy the supplement (how have you got this far if you don’t? Ross, is this just you reading the last two paragraphs as usual?) – please comment, like and share and spread the word. Thank you!