Supplement 12 Nov 23 – Quantitative Incongruency?

Nov 12, 2023

“They shall grow not old, as we that are left grow old: Age shall not weary them, nor the years condemn. At the going down of the sun and in the morning. We will remember them.” – Laurence Binyon, English Poet


Welcome to the Supplement everyone. I wanted to get stuck in this week with the macro update for the past couple of weeks, as last week I focused only on the interest rate, and the truth as I currently see it about the market at this time. First, though, the Bank of England minutes of last week’s meeting, in detail – in order to get some insight into the question that everyone wants answering – when will rates go down?


We must remember, as I say so regularly, that base rates don’t set the mortgage rate (unless you are on a floating rate linked to base – of course). The mortgage rates (the fixed rates) are set based on the 5-year SONIA swap rates, which are derived from the 5-year Uk gilt plus a premium (which varies depending on market sentiment, and also on supply and demand). The price of the swap on the 5-year is the ONLY one that was trading above its gilt price this week – which is upsetting – as we’d much rather it trades under that price, then mortgages would be cheaper.


Why? Well, there’s the simple supply and demand argument. There’s just much more demand for 5-year fixed rates than other fixed rates – as a rule – because 2-years are struggling with the stress tests that are being applied, and are needing whacking great fees as a result. Borrowers who are refinancing are feeling stuck between a rock and a hard place. However – the swap rate is BEFORE the banks put their premium on to make a profit and cover costs, so because they are buying the 5-year in greater demand (and the SONIA rates are defined by the massive banks, not the challengers and packagers that a lot of investors tend to get their mortgages from) – and the volumes are truly huge. On swap rates other than the 5-year, the smaller lenders have to pay whacking great premia above the swap rate to get a swap done – and so that doesn’t work unless there’s a sudden massive demand for different products. Or in plain English – they’ll get you one way or another.

Most people – the vast majority – don’t see the logic in a long fix at the moment. It is more like the lesser of evils – which makes sense. Swallow it, and stay in business – or sell up. A stark choice, really, and I’ve been very clear about where I am at on waiting around for better rates or rates to drop. There were many thinking that rates would drop this year or go back to normal, and I’ve been vocal about my position on that. Only if something goes badly, badly wrong. Base dropped to 0.5% in March 2009, remember, but credit was nearly impossible to come by at the time. I was laughed out of building societies and banks (self employed at the time), and told simply not to bother. So, price is NOT everything, although it is everything that most have concentrated on. On reflection, I really shouldn’t have taken that to heart – but if I knew then what I know now……..etc. etc.


I also have to raise a mistake that I think the Bank of England is making at this time, and also declare a conflict of interest on this point. We all know the acronym “QE” (Quantitative Easing) but the acronym “QT” has not yet gained particular popularity, nor do I really expect it to. It stands for Quantitative Tightening. If you think of QE as the Bank of England (with the Government’s money, on paper) buying Government debt (and achieving this by simply printing money) – then, avoiding the nuances, QT could be thought of as the Government paying the Bank back, and money being set on fire. 

This isn’t accurate – because what ACTUALLY happens is that in QE, the Bank “buys debt” and forces it out (almost exclusively through the commercial banking system) – with one side effect being inflated assets, of course, because if debt is cheaper and money is nearly free, then returns on equity will rise and rise – the opposite is happening at the moment, but very slowly because many large companies had the foresight to fix their debt for a long time on their existing obligations when rates were very low. In QT, the Bank instead sells that debt onto the open, secondary market. 


Let me just explain that a little more. Regularly (most weeks) the DMO (Debt Management Office) issues new Government bonds. Roll up, roll up, they are never going to go bust, after all! Much more interesting, as well, at 4%+ compared to the rates since 2009, and particularly since 2016. I couldn’t resist a dive into the data and since 2005, there have been 37 issues of treasury bonds at 1/8th of a percent yield. This was between April 2020 (no surprises, I am sure) and June 2021 (when the sale flopped a bit, and a 7-year bond with a 0.125% coupon – yes, really – sold at around a 2.5% discount to par). In plain English that means that if you bought £1million face value of those bonds, you would have paid £973,600 for them – and received a massive £1,250 per year for them, and received £1,000,000 back in June 2028. Mindblowing, I know. A return of £35,150 over the term – on £973,600 – and no inflation protection. Those buyers weren’t reading the supplement at the time, you’d think…..


Last week – as a comparator – a 4.5% yielding bond sold at £100.102 – so for £1,001,020 you could have had £1m in bonds back in 2028 and £45,000 per annum. By no means the largest on offer in recent times, but still – we are 2 years and 5 months further on, now, and the return over the 5-year term (rather than 7, above) will be a £1,020 loss on face value, but £45k x 5 over the term – so £223,980. An awfully big difference – 6.37 times larger in 2 years fewer than the 2021 investment.


So what? Well, the point is that the DMO sets the prices according to the market’s appetite, of course. They have to be set in advance, not the night before – institutions and other buyers need to know what they are buying and decide whether to enter the auction or not for the bonds. They will be considering price, duration, coupon, and their own obligations in the future, naturally.


So, in the past 12 months there have been around £45bn of active sales by the Bank of England into the secondary market. This compares to a little under £200bn of issues by the DMO in the past 12 months – precisely 22.7% of all new issues, that otherwise wouldn’t have been sold. What’s the alternative? That they are just left to mature, naturally.


Anyone with any sense will tell you that putting 22.7% more liquidity/alternative supply into a market will distort the price significantly. How significantly? The Bank doesn’t know (or if they do, they hide it very well on their website) – and indeed, they don’t seem to care. The question was asked this week at the Regional Breakfast Briefing and they consider it a background affair, in line with their overarching policies to tighten. It does have a direct effect – because with that extra supply – of course – the price goes down, which means the yields go up. The difficulty is in saying by how much they go up – but they are higher than they otherwise would have been. 


The other consequence here, of course, is that they are also sold at a loss. Who takes that loss? I know you are going to know the answer to this but……the taxpayer of course! If, instead, they were left to mature (and £35bn have matured in the past 12 months, on top of the £45bn in sales) then these losses would be avoided. The Bank actually made a massive profit on these trades before (£124bn in net transfers is the current position) – some because they had to buy long-dated bonds around the time of Liz the Lettuce to calm the markets down and stop pension funds having a complete meltdown and selling off bonds at a loss. These were bought at 5% yields and sold off at 3.5% and 4% – which is a significantly profitable trade on a long-duration bond. The current forecast is that this £124bn profit will all be lost in selling bonds into this market – a complete reversal of the position. One eighth of a trillion pounds. “Oh well”.


This is one more reason why buying bonds, of late, for the right investors, has been a good strategy. Yields are down quite a bit, now, but still artificially high thanks to QT. One more fork in the eye here, though. It’s going so “well” (hmmm) that the Bank is going to sell off £50bn extra next year, on top of the £50bn that will mature naturally. If EVERYTHING was left to mature naturally, as I strongly believe it should – then there would also be no losses to book (in fact, there would be profits – because of the coupon interest). The treasury REALLY doesn’t need these losses (the current forecast has been that the £124bn in net transfers provided will be wiped out altogether) because those need to be replaced by…..wait for it…..more debt of course. Nuts, outside of the BoE circle. In the past 12 months, £30bn has been “lost” following this strategy.


This seems to be the first time that I’ve pointed out, or indeed thought of, a downside to an independent central bank. Surely there is an upside, here, though – or at least a counterargument?

I can’t think of it. If this was actively reducing the money supply (i.e. the bonds were actually retired, rather than sold into the secondary market) – then that WOULD be a reasonable pushback. The money then would be quite literally be being set on fire. Could the Bank and the Treasury do this? Of course they could. It is by no means the biggest cooking of the books that’s been dreamt up over the past few years. You can take a look at this April 2020 article in the FT for example, which details just how the Bank was allowed to bypass the bond market during the pandemic and simply transfer funds to the Treasury, so that we could do “whatever it takes” during the pandemic. Not the worst idea, at the time, and they “only” dipped into this for around £150 billion-  although all records of this little exercise seem very difficult to find……


Why would actively reducing the money supply in this way be helpful? Because at least it would be combatting inflation, and that would justify some losses (if indeed they ended up being booked). Of course, without the cover of a crisis – remember, “Never waste a good crisis” – this would be politically very difficult – although if we lost £30bn to temper £30bn of higher payments on index-linked securities, that would not be bad business at all. The Bank seems to have lost sight of the big picture here, though, and also seems too keen to get rid of the asset purchase facility. The logic just escapes me – and if there are more seasoned economists reading or listening, I’d love you to tell me where I’m getting it wrong.


It’s hard to really understand the Bank’s position. The (albeit technical) question cooked up by me this week really got a relatively dismissive answer, although I don’t blame the BoE rep. It is just too hard a question to answer in detail in an open forum – it would need a 10 minute explanation. My fear is that the committee simply haven’t given it the relevant thought, and perhaps don’t really care about the bond yields – it isn’t their job, after all. I hope it isn’t just as simple as that.


To put some meat behind what I’m saying, here – let’s look at correspondence from the Bank to the Treasury from 3rd November. Regulars will know I’m cynical by default. From the Governor’s letter to Jeremy Hunt: “As set out in the Minutes of the Monetary Policy Committee meeting ending on 20 September 2023, the MPC has judged that quantitative tightening is going smoothly. There has been no evidence of a negative impact on market functioning across a range of financial market measures. APF reduction was likely to have had some tightening effect on yields, which, while difficult to measure precisely, was judged to have been modest.”


Allow me to translate. We are marking our own homework, and we think we’ve made a good decision and are not willing to challenge it. There’s no proof we’ve got it wrong, although it is difficult to tell, and we can’t really measure it (APF is the Asset Purchase Facility i.e. the amount of bonds that the Bank of England owns). It’s not much, probably, so there you go.


Not great, is it? Jeremy Hunt’s reply basically says “OK, well this is your job, and I’m not going to interfere, so get on with it”. This is balderdash at the very highest level.


Rant over – thanks for humouring it. Now the rest of the Bank meeting minutes – which I will abbreviate in the interests of time, after getting that all off my chest!

  • The vote was 6-3 to hold the rate – as we know – with the 3 votes all being to raise the rate by 0.25%. That is a sign of how far we still are away from considering a cut
  • The bond markets expected (on November 2nd) that rates would stay where they are until Q3 2024 (so would by then have been 5.25% for about a year) and then cut very slowly to 4.25% by August 2026. Let’s pause here though – because it is quite likely now that the time and pace of the cutting will be underestimated. I wouldn’t go crazy, but I think the lag effect here will kick in and they will be forced to cut before that – see the Supplement from a couple of weeks back regarding the refinancing wall apart from anything else
  • GDP expected to be +0.1% in Q4, compared to NIESR forecast shared last month expecting +0.2% – recession likely avoided, but remains a technicality
  • The Bank expects 4.75% inflation in Q4 this year. At the first glance this looks very brave, given a 6.7% print in September – however, there are forecasts for October’s print (out in a couple of weeks) to be 5%, because of the drop in the energy price cap – and from enough forecasters that I respect. It solely makes sense in reality because October 2022’s inflation print was 11.1%, thanks to the gas prices, and a bit of lettuce as well of course. My view is that realistic numbers are now finally being mentioned, but next 12 months I’d be surprised if inflation averaged below 4%
  • Core inflation will remain above CPI
  • The Bank predicts 2% inflation by the end of 2025 now. I’m expecting prolonged stubbornness around the 3.5-4.5% level
  • NIESR (National Institute for Economic and Social Research) sees rate cuts being possible in early 2024 if inflation is under 4.5%, which it expects it will be. I’d imagine the relatively hawkish committee will want to be sure before a cut, although some will no doubt want to point out the political pressure that will be behind a rate cut around the time of an election announcement (but remember we have an independent central bank, of course……)
  • There’s a rare mention of housing which has obviously suffered the most from the rate rises as a sector. Teeing up the Autumn statement in a couple of weeks time when the new (as new as “Daz” is new in the washing powder game) help to buy style scheme is rolled out, no doubt (there are also whispers of a stamp duty incentive, but theoretically, one is already in place for houses under 250k)
  • Labour demand has softened, which is in line with what is happening – but in the big corporate world, hiring freezes have become job cuts, which is likely a sign of things to come in early 2024
  • The risks remain to the upside (and in this world, it feels like that will be ever thus in terms of geopolitics and the impact on energy prices)
  • The last line in the report also caught my eye – Ben Bernanke (former Federal Reserve chairman, engaged by the Bank to review their appalling forecasting of recent years – looking forward to his report!)


This week we have gone in reverse order – such was my desire to get all that off my chest – but I will now revert to the macro scoreboards. Nationwide and Halifax have, first of all, upset all of the bears out there by printing 0.9% and 1.1% respectively in house price rises for October. This surprises almost no-one who has followed my commentary about the real-time nature of their information – rates were coming down in October, and some of those who were waiting have decided to wait no more. Each month concertinas demand, and with rising wages and houses in real terms looking cheap, regardless of what the rest of the media wants to say about them, the sludge of 2023 goes on with a fairly significant rise – which looks more like a September seasonal bounce than usual. Sales are being agreed, and whilst things are comparatively freezing compared to 2022, 2022 was white-hot early on as I’ve said many times before.


Nationwide are actually very sanguine about it. Mortgage approvals remain 30% below 2019 – which is congruent with the FCA data for 2023 so far – simply on pricing. Both indices have year-on-year pricing down 3.2 and 3.3% respectively – and Halifax thinks 2024 will be another fall. Both are on track with the narrative that rates are now stronger for longer and, as Zoopla have said, affordability won’t improve until rates come back down in a meaningful way.


My comment here would be that this could be a relatively steady decay, and it could be that they remain 1% or thereabouts below the base rate (the swap rates) – much more than 1% is unlikely, although the gilt yield has been nearly 1.25% below the base rate this week, and that’s stretching the bottom end of the range really (historically, anyway – although this move from nearly nothing to 5.25% has been unprecedented in that it started from such a low base). Nationwide’s commentary reflects a slow progression back to buoyancy also. The forecasts were that it would be -0.4% for Nationwide and +0.2% for Halifax, so the forecasters were miles off, really. 


The October PMI composite stayed below 50, although it beat forecasts. Services are very nearly holding their own, with manufacturing still shrinking according to the main players in the sector. The construction PMI for October printed 45.6, with 50 reflecting a stable sector – so shrinkage is still very much on the table, which surprised no-one.


The mortgage rate (the rate that banks were charging for variable mortgages) unsurprisingly rose even further to 8.01% (from 7.93%) as the big banks were slower to adjust downwards in spite of a 0.5%+ cut in floating yields in the past couple of months. Price gouging accusations are already out there, and expect more negative press for the banks in coming months.


The RICS house price balance was also better than expected but still a very bearish -63%, the best reading for 3 months but still the lowest prints since 2009. The market continues like a mini-2009 without the credit issues – where transactions continue to stay low and stock on the market still looks relatively low, as people know now is not a great time to sell – so only the motivated and those who have their fingers in their ears are on the market. Quality still sells quickly from what I’m seeing and hearing – and I mean quality at that price band. 


Friday this week was full of data with the major headline being the GDP growth rate. The expectation was a contraction of 0.1%, but in reality it was a big fat zero. So – it exceeded those low expectations, and – in reality – simply kept up with inflation. Not terrible – simply symptomatic of the sludge we are still working through. The only people to have been upset by this will be the journalists, as it means no recession headlines for at least another 6 months – not even the ones hinting at a recession.


The quarter’s growth annualised is 0.6%, with 0.2% of that having come about last month. Year-on-year the growth is 1.3%, although this flatters because September 2022 was subdued due to the passing of HM Queen Elizabeth. 0.6% is nothing to write home about, but the economy lumbers on like a wounded beast, coping with the inflation forced by the gigantic pandemic stimulus. If we went back in time 12 months – I think we’d find exactly where we are at today as an acceptable outcome. Electricity is down 85% on the ridiculous spot price highs of the 2022 autumn, and Putin, ultimately, was foiled (from a selfish UK perspective). I remain concerned that he can manipulate the oil price – but, in mid-November, you would think he would have fired that bullet by now. Once again, we are the beneficiaries of a milder-than-normal winter, according to recent forecasting – we will never know how lucky we were.


Business investment had a bad quarter, but is still up year-on-year. Investment was curtailed after the super deduction expiry, in April, of course – so to be up 2.8% year-on-year is helpful. Infrastructure investment has helped. Construction orders had their fourth negative quarter to slip back to 20% lower than 12 months ago – and no wonder some are feeling the pinch on that front. Hard to see a major resurgence but reserving judgement until the Autumn Statement would be a sensible move. Friday’s figures mostly exceeded expectations when it came to growth, and pushed yields up again, because the economy simply isn’t looking as trim as it was.

I wanted to close the macro roundup with one fairly significant point though. The money supply (this week’s chart, using M2 as the chosen measure as many analysts do) is flat or contracting (as it needs to on the back of the stimulus) – the velocity of money has continued to pick up but prices have also already responded significantly. Almost all of the indicators that showed inflation as highly likely in early 2021 are now showing inflation as much less likely – so the overarching news is that the pace is out of the entire piece. Wage rises are sucked up in getting back to where living standards were – largely – and so are not as inflationary as they have been in the past – and next year’s wage rises are simply not going to be as large as this year either. The problem really is that the people have taken the brunt of their part – now it is over to the corporates to simply accept lower margins in order to stop services inflation continuing to rage away. 


In reality this is only likely to stop when corporates don’t think they can get away with further price rises. Cuts are already in place in terms of headcount, and individual firms will have to improve productivity by having fewer heads who are better paid – and that’s the route the largest have already started going down, it seems. That way they can just about maintain margins in what is now going to look like a relatively disinflationary (not deflationary – just lower inflation!) environment. I’m sure to build on this point in coming weeks and months.


Next week we are treated to unemployment and inflation data. There will be lots to say – I’m sure – and I’ll be here saying it! Until then…..If you haven’t given me a subscribe on Youtube or the podcast platforms yet, I’d really appreciate it if you do – links are here to Youtube: and here to the Propenomix website: – thanks for supporting me spreading the word, more subscribers will lead to more and better content, and that’s the aim for everyone! Only one more sentence…………drum roll………..keep calm and carry on!