Supplement 050223 – Mortgage Rates and Recessions – what to do!

Feb 5, 2023

“The good news is not good news. It is simply the absence of bad news.” – Adam Lawrence, wannabe polymath.


Welcome to the supplement and yes, I did just quote myself. I have reached a new high, or plumbed a new depth, depending on how you frame that situation. (In reality I couldn’t find an existing quote which fits the current situation, so I just got on with it!)


I’m quietly (well, not that quietly given that I am talking about it) pleased with the overall prescience of last week’s piece. The Bank of England have acceded to what seemed to be obvious and cheered up their forecasts quite a bit. I do need also to make something quite clear here – overall this really wasn’t that hard to see coming.


The nuance is that the Bank tends to use the market’s overall prediction of the base rate in their forecasting. “The Market” in this context means the Uk Government Gilts market, or the bond market as it is internationally known. The expectation during the “slough of despond” that was October 2022, in these markets, was that base rate would reach 6.5% in 2023. This was a brief overreaction to the Liz Truss premiership (although, had she stayed in post, without being neutered by the appointment of Jeremy Hunt as Chancellor, that might well have come true – so the market perhaps wasn’t overreacting, just underestimating the powers that be behind the curtain in the Conservative party who were unwilling to have a lunatic running the asylum). 


This fed through into their November forecasting and, of course, a terrible forecast came out for the biggest/longest recession ever, etc. etc. That was made clear by very, very few people – precisely zero that I saw, and I’m not sure I made much of a fist of it at the time, either. I don’t recall with clarity. Must do better next time, either way.


That market expectation as I write today is closer to 4.5% for the base rate in 2023 as the “peak” of this cycle. The Bank still has the same two dissenters – the doves – that thought 3% was enough at the December meeting. They’ve held their line in terms of rises – and both voted for 3.5% to remain the Bank rate this time around. Importantly, they didn’t vote for a cut – so they appreciate we do need to hold, and see what happens. On balance, policy wise, I can see why they are where they are. This cycle WILL lead to economic sludge, and WILL go far enough to keep the brakes on and get us into reverse. That much seems relatively obvious still. The past 3 quarters that we have the final data for (Q1 – Q3 2022) showed the following figures for growth: +0.6% Q1 (tailwind of stimulus growth/covid recovery over), +0.1% Q2 (brakes on faster than hoped or expected – blame the extra bank holiday), -0.3% Q3 (going backwards, some Truss-inspired, some inevitable due to the passing of the Queen and mourning period having genuinely suppressed economic activity. 


The expectation for Q4 2022 is around 0%. I would be on the upside of this, ever so slightly, and would throw a dart at 0.1%, avoiding the technicality of a recession but still leaving us worse off than 6 months before, as a nation. We will know that official number by next week’s supplement as the ONS will publish it. If I’m off the wrong side, the dreaded “R word” will legitimately enter the headlines as we will be “in one”. This quarter, Q1 2023, seems fairly likely to be a negative one as well – Q1 is always a struggle for weather reasons, and there have been some hiccups although no huge “big freezes” – and I can guarantee that the co-ordinated industrial action will also be blamed for the economic misery of the Q1 2023 figures when they do come out (May 2023). If we have avoided a negative number in Q4 2022, more by luck than judgement, we do “the dance” that I’ve spoken of before – down, up a bit, down a bit more, perhaps then level, we avoid the technical recession but we are still going in the wrong direction as an economy.

Whilst I, and the overall consensus opinion, could be a shade out here – we won’t be a long way out at all. The fact we have to have this discussion around the margin tells you what you need to know – the brakes are indeed very much already on, and going forward for the country is difficult right now. There are no reasons to grow, and as tax burdens increase (I’d expect more pain in March, sorry folks) the disincentives are indeed looming up on the horizon for the business owners. This was the Liz Truss point, of course – well made, but very badly executed in an unfunded income tax cut. Completely the wrong way to go about it, at completely the wrong time, AND getting inflation under control still needs to be the number 1 priority above all else. If there is a technical recession – if GDP contracts – so be it until inflation is back under 5% at the most.


However, Thursday was a very interesting day for other reasons. The Bank Rate rise was no surprise – the 7-2 vote was more comprehensive than I expected, and my pattern of predicting the “correct scores” on the votes has definitely been broken. I expected it to be closer than that – but the Bank is now on the same path the Fed was on, get to the top as quickly as possible and manage from there.


The market is betting that the rates come down faster than the Bank is likely to want to put them down. Yo-yoing does not imply great control or superb Central Bank forecasting. The same is playing out in the US, with the Fed going 0.25% this week to signal either the end, or the beginning of the end (more likely) of this hiking cycle. The market still believes that the rates will be down faster than the Chairman is saying – my fear is that the market is wrong, because it is basing it on the Federal Reserve actions of the past decade, and there’s a big unsaid marker here – a real unspoken piece of economic history that will dominate reflective pieces in years to come.


That unspoken piece is that the rates have, currently, been able to go up much faster than any single economist or commentator would have liked, or was calling for, at the end of 21 or beginning of 22. If you’d asked for predictions and revealed the base rates in Jan ‘23 to 100 economists, they would have been putting their heads in their hands. I would have been saying things like “If it isn’t armageddon, that is 6 months away”. In reality though, it really doesn’t look like that referring to last week’s supplement. This leaves a massive question that will need to be answered.


Did we really need the low base rate between 2009 and 2022? Or – let’s be fairer – because we would have gone there in 2020 anyway during the pandemic. Did we need it between (say) 2013 and 2019? It really doesn’t look like it. Mark Carney – a man I hold in high regard as a Central Banker, DID want to swallow the pill in the middle of the last decade and was using 6% unemployment as the benchmark – that ended up never happening, and perhaps because lobbying forces, the powers that be and political pressures really enjoyed very very cheap debt?

I need to be careful here. I built a business on the back of said very very cheap debt. It’s gone well. However, I never lobbied for it and was always prepared to change tactics, restructure, and do whatever else was necessary – as can be evidenced by what I did do, and write and speak about, in 2022, as regular readers will know. Still – this conversation is at the macro level – and I can tell you now the spoiler on this story – NO, it didn’t need to happen. 


Would it have been easy to give this a go? Well, in theory, yes. The problem was the absence of data from a basically zero (or in some territories negative) interest rate. The theft from the future from the savers to the borrowers (that’s effectively what’s happened) was so lucrative for the thieves, and the savers really couldn’t do too much about it. It turned into a racket – like so many other financial (and other) wheezes, and the victimless crime has been carried out.


Conspiracy theory stuff? I’m not so sure. Controversial – maybe, conspiracy I think not. No-one even tried – not even Carney – for no good reason I can remember ever been espoused by the Bank. His famous “forward guidance” was a great idea, and didn’t always pan out (and it was trying to manage and shape expectations, not give cast-iron guarantees – that much was always known) – in the case of unemployment though, the rate rises were just allowed to fizzle out.


There is some ideology behind this driver too, I’m sure. The traditional right-side of the Conservative party would typically see all unemployed as lazy, feckless, unwashed, etc. etc. – and wanted to move those people from the net claimant column to the net provider column, by ensuring higher minimum wages (so the state subsidises them less, even if still subsidising them) and preferred to push up the minimum wage from around the same sort of time as the forward guidance around unemployment wasn’t carried out, as minimum wage rises really started to gather some pace around 2015.

It makes sense why this wasn’t ever publicised if this was indeed an unwritten understanding between the Bank and the Government. A lot of traditional Conservatives would also not have been in favour of this level of tweaking within the market. As of 1st April 2023, the minimum wage will be up 55.5% in 8 years – a vast improvement on the public sector pay, for example, which has been so crushed that much of it has started to dance with the minimum wage. 


Assuming a 9% figure for April 2023’s inflation figure – inflation in the same time period is compounded to 30.9%, so there is a really significant real wage rise there. Two points of order – firstly, it is quite impossible for a Conservative government to score any political points for this, which is precisely why this is the first and last time you will read these statistics anywhere; secondly, it is also two fingers up to the traditional Conservative view that minimum wage will destroy jobs, since in that time unemployment has moved from 5.5% in the quarter ending April 2015 to a projected 3.8% or so in the quarter ending April 2023. 


The pressure it is putting on the public sector pay however is problematic. Things have reached the nut low and the squeeze has gone as far as it can. The problem is terribly badly misunderstood – a few callers on the LBC show I listened to this week did at least identify that the pension situation is part of the problem, but none of them could frame it correctly and instead spent their efforts blustering on about defined contributions versus (unfunded) defined benefits. A much better framing of that discussion is that if part of the massive pension advantage that public sector workers enjoy – and holidays ALSO need to come into that mixer – needs to be moved to pay, in the now, then from a national accounting perspective, this should not be a problematic conversation. Mark Serwotka didn’t seem to understand this (the General Secretary of the PCS union, who in 2000 pledged he would only ever take the salary of an average civil servant – if he has held to this for 23 years, then incredible credit to him, not typical of a union boss from what we’ve seen over the past 6 months) – or wasn’t willing to enter into a meaningful conversation about the 23% pension contribution for teachers (for example) versus the 3% contribution for those in the private sector.


Anyone with half a brain can see that if the pensions ARE a huge problem – which they are – and are based on final salaries, then the incentive to keep those salaries down becomes absolutely gigantic. Sidestepping the issue doesn’t sort it. Addressing it head on – transparently – facts on the table – WOULD sort it. Freeze it as it is today, and move some of the money from column A to column B. At least ENTERTAIN that solution! I honestly have my head in my hands at these moments. Frame the debate correctly – this is about compensation packages, which are made up of a number of components – hours worked/holiday, pensions, salary, benefits or lack of them, etc. etc. 


At the risk of getting overexcited, there was yet another interesting anomaly from the events of the week this week, rounding back to the Bank of England meeting. This was, as usual, hard to predict (if it wasn’t, we would all be bond traders and very wealthy). The front end of the yield curve – today’s image depicts the yield curve in the UK as it currently stands, because I know I use the terminology regularly and it still isn’t 100% understood by 100% of readers – sharpened up a little with yields rising. This means the price of short term debt for the UK Government is currently a little higher than it was before the announcement. The inversion in the curve (the traditional expectation is that you lock the money away for longer and you get higher returns, but in times of economic turbulence you often get a higher rate for the shorter term and a lower rate for the longer term, in the expectation of recession and depressed growth meaning lower interest rates rather than higher ones) is a traditional indicator of recessions. 


The 2-year/10-year is oft quoted – when the 2 year returns are higher than the 10-year, trouble is impending (there is currently a -0.18 spread, meaning a small inversion, in this relationship). The 3-month/10-year has been a far better predictor historically – and that has a spread of -0.85 at the moment, meaning that the 3 month gilt, returning 4.00% annualised (or 1% in 3 months), offers up a 0.85% annualised return higher than the annualised return on the 10 year gilt, which is currently 3.15% annualised. This is a fairly significant inversion – one month ago, this wasn’t inverted at all, and the spread was 0.04 to put this into context).


Better than this, the 5-year (which is relevant to us as typically people and organisations these days that are using 5-year fixed rate debt cycles, if we weren’t before last year we usually are now!) is the lowest point of that entire yield curve, currently 2.9% (touching 2.85% on Thursday). The 5-year SONIA Swap (best understood as the rate at which other banks will lend to each other, without going into a more complicated and technical explanation) is 3.285%, and this is the rate, with no operational costs and margin, that a packaged lender can get funds at as we speak, and – in reality – the yardstick by which 5-year fixed rate products are priced.


Deposit taking banks can work to a 1.5% margin or less on top of this rate if they have keen depositors/savers who are saving into longer-term deposit accounts – Many specialist lenders are borrowing ABOVE the SONIA rate (why, you might ask – well, there are certain volume requirements, and operational costs for them above SONIA – they might also have certain nuances in their savings books that put them at a premium above SONIA from the other lenders) at rates up to 4.5% at the moment (and obviously need to get money out of the door at a few percent above that to pay operational costs and also make a profit). Bigger, high street deposit takers can work to lower margins of course – they might be happy in some circumstances to lend 1% or less above the 5y SONIA. The high street are paying 2.75% or less on these sorts of accounts (less than they would borrow from each other, of course, but they have a lot of customers who trust them – would you want to put £5m of savings in the highest paying bank, with only an £85k government guarantee behind it……there’s counterparty risk here, after all).


The 4.5% will likely evaporate over the next couple of weeks since there is such a premium above the 5y SONIA and 5y Gilt, but we will see.


So – we’ve got the very best chance we’ve had for some time of seeing some low(er) priced mortgage products! A quick FAQ I thought would be handy here:


  1. Is it time to get off my old tracker mortgages? 
  • I can’t TELL you the answer to this, but what I can tell you is that the base rate is likely still going up, and might hold up for some time (1-2 years around the 4% mark or so?) and this is the best opportunity to do so given the differential in the products that will emerge over the next 2-3 weeks and the ones tracking base rate. Pay rates will be 5.75 – 6.25% and highly likely to rise to 6.25 – 6.75% within a few months, so make sure you can still cashflow at these levels and don’t get into any trouble!


  1. What about any applications I’ve got in? Should I pull out?
  • Rarely is this the best tactic here. What you SHOULD be doing is ensuring your broker is being proactive, asking the lenders to put the rates down to the CURRENT best price available for that product, rather than the rate that you applied at. Thus, you get the best of both worlds. If the application has been in since August (we still have a fair few that have been), then the rate likely will not return to where that was – if you applied after late September, you really need to get your broker to check for you. The best brokers will ALREADY be doing this and this is a good yardstick to gauge your level of service and your brokers’ skillset by.


  1. Should I be waiting before putting any new applications in?
  • Maybe for a couple of weeks – but there really isn’t much need if you see 2) above. Of course, the new lower rates might be with a different provider. You’ve got a few weeks in the pocket where the rates aren’t going to go the WRONG way, look at it that way perhaps. 


  1. Are all the problems fixed? Have you been too miserable or bearish in your predictions?
  • I say the same thing in all of these situations. The risks that remain are to the upside. We are going to see lower mortgage rates (compared to the last 4 months) faster than I expected. We are not seeing the 3.xx% rates with 1-1.5% fees coming back any time soon unless there is a negative economic event. The “insurance” that fixed rates offer still looks attractive to me.


  1. How are you stacking your deals at the moment?
  • With realistic refurb costs compared to recent pricing, even though that pricing might be coming down – with 0% capital growth this year and next, and 5.25% mortgage pay rates at a “normal” fee expected in 6 months time. There’s 0.25% or maybe even 0.5% in that to the downside, but I’d rather be conservative in these situations. The highest rate we have been using over the past 6 months is 7%, and the lowest since September has been this rate of 5.25%, so overall it is bringing some deals back into the viable territory that weren’t there already. We are looking at the next 5 years (and looking at expanding this horizon) and adding rent increases at 3.5% annually each year over that period.


That will hopefully be helpful in terms of implementation for regular readers of the supplement. 


Economic news woke up this week with the plethora of stats that were released in the USA, and resultant moves in the market in the UK. The FTSE at an all-time high doesn’t feel right, but it is very very difficult to make sense of the post-covid FTSE with a Brexit backdrop. Our only growth hopes at the moment are via immigration and via efficiency savings and productivity growth – I am still holding out for more comprehensive pandemic-inspired working-from-home productivity studies, but supply chain issues in areas like semiconductors have completely reversed, and in spite of hiring freezes in large tech companies and some shedding of jobs, innovation should keep rolling forwards. Large minimum wage rises should start to make people really quite expensive in some industries – McDonalds has already more than halved its workforce in the past 10 years in spite of continuing year on year expansion, and any regular visitors (I blame the kids, although let’s face it, I love the nuggets) will be able to tell you that a lot of the process has been automated, worldwide. 


This will be the future – TESCO employees are down 25% in the past 3 years, although there are still more job vacancies than ever before. You might argue many a beleaguered public sector worker will be off taking those jobs with minimum wage on the path that it is on…….although it will seem to be a more competitive marketplace year on year as minimum wage keeps pace with or exceeds inflation!


That’s (more than) enough for this week – as usual, the best advice I can ever give is to keep calm and carry on!