Supplement 250623 – What do we do?

Jun 24, 2023

“If the metrics you are looking at aren’t useful in optimizing your strategy – stop looking at them.” – Mark Twain

Welcome to the Supplement everyone. I’m absolutely full to the rafters with macro at the moment, and pickled with fury at the overall ignorance and befuddlement that has been being shared by the media and supposed experienced commentators this week, regarding interest rates. However, I know that last week was rammed with macro, and gave a good grounding – so I’m going to comment on what’s happened last week, try to keep that part a touch shorter, and talk more instead about exactly what YOU – yes YOU – are supposed to do about it all, rather than staying on my well-trodden high horse. Let’s go……..


  • The current mortgage crisis (yep, they went there – AGAIN) is vastly overblown
  • The government have been as politically skilful as they can be by extending clemency to the small number of residential mortgages in arrears
  • This does nothing for those renting and having their rents being forced up because their landlords are having their mortgage payments forced up, and far more of them (in percentage terms) are on variable rates
  • Base rate is up to 5% in case you have been living “sub petram” this week (under a rock)
  • We are being continually conditioned to care about and watch the wrong metrics. Why? Let’s not go full “flat earth” here
  • YOU can selectively control your leverage
  • You could also recapitalize
  • You can also sell
  • This looks like one of the very worst times to remortgage and has done for about 3 weeks
  • Margins can – and really should – need to fall on lending and increase on borrowing
  • Bank profits have been dramatically improved and margins will be rising and THIS is where pressure needs to be applied in order to ensure the market works effectively
  • Windfall tax would have every single piece of the market puzzle answered in the same way as it was for the energy companies – there are very few differences in the logic here – watch this space
  • The world has gone too far and although is finally realising what some of us have known for a couple of years or more – the markets have gone too bearish with this information
  • It hasn’t looked like the worst week to make the most of drops in various markets by purchasing and getting involved in discounted stocks and products
  • Uncle Warren went over the $50-bn lifetime giveaway milestone, the first person ever to have done so


The government “covid-style” announcement is a bit of a comedy one, to be honest, in the way it has been framed – but is also politically as “clever” as Hunt/Sunak could have been given that they both believe intervention in this market is wrong. I agree with them – it IS wrong, although their messaging, alongside the Bank of England’s messaging, is devoid of economic nouse, and is also devoid of backbone. I grow more unimpressed each week with Rishi’s political nouse, and that is where the next election will be lost in my view – even though he faces a very difficult task, he is politically not up to the job and never was. Technically he is, academically he is – but on a political experience (and a strength of character basis) – he is not. A great pity.


What has the government actually done? Their first major bullet is the privilege to talk to your bank or lender without it affecting your credit score. This sounds like balderdash to me – scores are based on what actually happens in terms of payments etc – not on conversations with your lender. So, point one gets “nil points”.


Point two is that you can change to interest only, or extend your term (it isn’t clear in their initial statement whether this has to be made an option, or is still solely at the behest of your lender – I suspect the latter, but with significant government pressure/them threatening to regulate if the major banks don’t play ball) – and then change back within 6 months if you want to to your original deal, and THIS won’t affect your credit score either. See point one – credit scores measure the frequency of payment of debt, and also your percentage of usage of unsecured debt (when it comes to credit cards) – so, again, this is a nothing piece of air. “nil points” again.


Point three – or perhaps the only real point – is a 12 month repossession moratorium. This worked well and was well received during covid during the only thing that they really did do (mostly) correctly – macroeconomic policy interventions. Repossessions can still take place with the asset owners consent, but not without it. It’s time to wheel that old phrase out again – and it is relevant at the moment as it often is – the can has been kicked down the road.


This is politically smart presuming that within 12 months that an election will at least have been called. September 2024 looks relatively likely to me, so perhaps it will be extended by a further 6 months to buy the last pieces of goodwill from the owner occupiers in trouble. Is it going to make a big difference? Well, the government in their own words says the following:


The latest market indicators (FCA; UK Finance) show that mortgage arrears and defaults remain below pre-pandemic levels, which were themselves extremely low. The FCA reported 0.86% of total residential mortgage balances in arrears in the first quarter of 2023 which is significantly lower than the 3.32% rate in 2009. (My own emphasis – but this is not the equivalent of the first quarter of 2009. Who says it is? We are not “post-crisis-event” here, but instead living through death by 1000 cuts thanks to inflation…….so what use is this comparison? 


The proportion of disposable income spent on mortgage payments is currently at 5.4%, compared to around 10% in the 1990s and prior to the financial crisis. Well worth knowing, helping to put things into context – but aggregating every single UK household really isn’t useful here.


The average homeowner re-mortgaging over the last twelve months had around a 50% loan-to-value ratio. This indicates homeowners have considerable equity in their homes, which makes it easier to manage repayments. Lenders have less than 10% ‘owner-occupier mortgages’ on their books with loan-to-value rates greater than 75%, compared to around 25% before the 2008 financial crisis. Taken together, this puts the market in a significantly stronger position than before. Once again aggregating isn’t particularly helpful, although it is always good to know those stats. Suddenly we’ve gone to a 2008 pre-crisis event comparison, which looks smarter and fairer – and things stack up much better than they did after years of utterly rampant credit expansion and a booming market – which is perhaps unsurprising.


Yes, there are a couple of million households in the crosshairs – more, in fact, if the elevated rates do go on for 2-3 more years then come down slowly. That’s the “prediction”, although that soft landing is unlikely to be what really plays out because real problems of the black swan or at the very least grey swan nature will come along. 12 months isn’t enough time to sort this, and I do have a whole raft of measures I’d be seeking to implement if I was working on policy at the PRA/FCA and wanted to proactively make a difference – something that was akin to the warnings on the side/front of a cigarette packet. Bullet points if you will – my style, right? – perhaps more on that next week depending on the events of the next 7 days.


Who is really at risk? Those who overpaid in 2021 and took 2-year mortgage deals. Our dependency on low-timing cheap credit is what will really be at the root cause of these problems, and if we are not learning lessons about mortgage terms and pushing to 7 and 10 year fixes, with portability or lower commitment periods inbuilt – we have, as so often, learned very little from our mistakes in any sort of good time. Sigh.


Then you have to turn to the renters. It’s fairly easy to say that the prevailing government doesn’t care – tenants don’t vote Tory (a blanket statement, I’m sure some do of course). This is the typical characterisation of the Conservative Party. I think Rishi DOES care, actually, as it goes, but doesn’t spend as much time as he should and have the right people around him to really understand, and isn’t going to get that from those around him who are traditional Conservatives. 

However, landlord mortgages (if assessed in the same way as the residential owner-occupier section above), are MUCH more likely to be affected by what’s currently going on with rates. Mark Carney – a far, far more skilful central banker than the current incumbent at the Governor’s office at the bank – knew this and was always worried about the volatility. Ultimately, it is easier for these borrowers/housing providers to exit the market and put their money elsewhere, than it is for someone to sell the family home and go into rental (one option, of course, however unpalatable it might be to anyone). 


The reality of what single property, amateur landlords are facing at the moment is that they look at the prices they can still achieve, even if the market is 5 or even 10% off the top of the mid-2022 market, and if the rent cannot cover the mortgage payment, and 7.75% 2-year rates (total cost including arrangement) or 6.75% 5-year rates do not leave any cashflow and “feel” very uncomfortable (as they should do if you are entering a negative gearing situation, as I’ve written and spoken about before) – and selling looks like a good option. 


This of course potentially reduces rental supply – depending on what you are selling, but selling a lot of 2 or 3 bedroom places in areas that are remotely up-and-coming will almost certainly hit the owner occupier market. Studio flats may well go to another investor who is simply a cash buyer – perhaps an overseas investor, so would stay in the rental market – but this is not how net positive rental units are created. This tapestry is one that sees lower rental stocks in a time of already very low rental stock. The Zoopla report from this month deserves more airtime as it raises a number of very important points – but again, in the interests of getting to the end without breaching the 4000-word epic word limit I often set myself, that will have to wait until next week as well, at the least. Warning – I bust that limit this week, but there’s just so much to say at the moment. I’m just going to borrow one whole line from Zoopla’s report: “We do not see a situation where rental supply is likely to expand enough to moderate rental inflation over the rest of 2023.” – I’d have to wholeheartedly agree with that.


Base went up to 5% on Thursday – I spoke last week of just how important that was, and the committee showed solidarity (other than the non-member doves who once again wanted to maintain the rate) by voting 7-2 in favour. This was really made most likely and much easier by the release of the May inflation figures, which as I suggested, showed stronger CPI than was predicted (8.7 vs 8.4) and (much more relevant and much more worrying) saw core at 7.1%, when the consensus forecast was 6.8%. Both numbers missed by 0.3% on the upside, which is nearly unforgivable. I am going to take a tiny detour into the weeds of the detail here though.


We need to get into MoM here because that’s where we will find the good news when it does finally appear. Month on Month. Happily – really, because metric “blindness” is definitely a thing – we can only look at four measures because we don’t have any more data than that:


  • Month on Month CPI
  • Month on Month Core
  • Month on Month Core Producer Prices
  • Month on Month Producer Price inflation 


Annualised CPI based on the past 4 months is 12%. This is frightening – of course – but we have month-on-month drops coming thanks to energy prices going down 17% in July (for example). Let’s see the positives though – last year April was 2.5% on its own versus this April’s 1.2%. October was 2% on its own and that inflation is falling out thanks to falling energy/fuel prices, and anecdotally food seems to be coming under control (or at least rising a lot less quickly).

We are seeking real-time info here, rather than lagging annual numbers, 11/12th of which have already happened by the time we start a month (one more reason why the misses on the predictions are quite so unforgivable, but there we go).


Annualised Core based on the past 4 months is 13.35%. That is horrific. It is worrying because these are new month-on-month highs. This, at this time, is the most worrying piece of data that there is. That’s an economy that’s overheating. Core will lag CPI, and whilst CPI is now definitely past its peak, core might have a couple of months to go before it does reach peak. Dropping off for the past 12 months, when it comes to June’s number, is 0.4% – there’s faint hope in the forecasts of only 0.3% for June 2023, but anything at forecast or above keeps core at 7%+. If they miss the forecast to the upside again, there’s a chance of 7.5% core, but a fighting chance of 7.3%-7.4% going on previous predictions. This will justify the gilt markets trading where they are or going another 10-25bps even higher, I’m afraid.


I know what you might be thinking – and you are right. This SHOULD be known information, largely. I am always very keen to point out that I’m not a bond trader. However, it strikes me that these markets move based on the wrong metrics all the time, and we need to get to the right metrics so we can understand what’s going on.


The other two metrics contain better news. These metrics peaked in July/August last year and are on the way down. This is continued good news for CPI. However, the frustration continues because what we could do with is MoM Services inflation data – services inflation (the monster driver of the UK employment market, of course – 75%+ of our economy and 47% of CPI) was up to 7.4% annualised for June. This is driving forwards, and holding up CPI further. If you do the maths, CPI is up 3.7% simply based on this one metric, and this is what a recession, or considerable number of liquidations, would impact (in the sector). The sector isn’t growing in output – it is simply prices going up and chasing wage demands to an extent, since this number is still below private sector wage demands (more like 7.8% than the 7.4% that this hit). The most worrying thing is the upwards trend here. 


One more piece of relevance here is the liquidation data – May ‘23 continued the trend of new highs in corporate insolvencies, which all else being equal puts pressure on employment data. However, employment vacancies continue month-on-month drops and this will accelerate with more liquidations – the number of extra jobs has come down around 50% if you use pre-pandemic as the gauge – of the 500,000 extra job vacancies that appeared, 250,000 of them have now disappeared leaving 250,000 more compared to 4 years ago. There was a 14.5% increase in vacancies in the same period 2015 – 2019 (you could cite a number of reasons not to look at this time period, but the financial crisis had worked its way through, Brexit would be a significant factor though of course) – now 2019 – 2023 we are still facing a 29.9% rise, so a little more than double a more stable time. This is how tight the labour market still is, but is trending in the right direction, ultimately. Will those insolvencies be enough to really make an impact on the labour market – not yet, but rising insolvencies is a typical pre-recessionary sign. We are of course best looking at comparisons to 2019 rather than 2022.


I wanted to add a little more to this without putting the tin-foil hat on. Questions pop up such as “why is the submarine story taking the headlines, what is it distracting us from?”. I understand the question. The reality is the compelling nature of this story, a real life horror movie event, and unfortunately there are a lot who have taken pleasure in the demise of an extremely wealthy human being. This – to me – says more about their personality types and issues than it does about inequality; but there you go. Let’s be real – the media are heavily influenced by their billionaire owners, and by the government – and the government would always prefer a distraction in a week of base rates hitting their highest level for 15 years. 


In reality, though, we should in my view be more concerned about the fact that we are trapped in a culture that measures the wrong things. The liberal side of the argument relies on arbitrary measures of “poverty” when in reality many who are in the definition of more than 20% of the median income really can’t be described as living in poverty – many have safe, watertight and weathertight places to live, with mobile phones and flat screen TVs. This just doesn’t resonate with what the word means, and (in my view) completely loses its impact. The same is true on the more conservative side of the argument, of course, and I worry more about the third reason to be concerned – lack of skill of people in positions of power and authority to make massive decisions. Andrew Bailey, current (under pressure) Governor of the Bank of England is one of the greatest examples of this in current times.


Everyone reports on “inflation” – they usually mean CPI, but CPI is not the most important measure. CPIH is more relevant to us (including housing/shelter costs). Core is much more relevant to everyone, at the moment. 


The same goes for GDP – a poor metric for growth. Where that money goes (just consider, AI can potentially increase GDP quite healthily, but make 0.1% of people much richer, and a good slug of the rest relatively poorer). The very same goes for base rate – of course those of us with any base rate tracker products do care (50% of landlords, according to some statistics – but I suspect this is only measuring BTL products in personal names, frankly) – but the very most relevant statistic is the 5-year SONIA swap rate, because this is how an awful lot of mortgage pricing is done. The list of such metrics, I could go on about for quite literally hours on end, it is an entire presentation in itself.


This is at the heart of analytics and business analysis. Watch the right things. Don’t care about the wrong things. Don’t worry about what you can’t control. This is also exactly how you need to treat the media. I vastly prefer having a very light view of what’s going on and searching out the data and the true facts that I seek, and draw conclusions from them on a Sunday – and I have no plans to change that in the foreseeable future!


So – let us get on to what you should be doing. I’ve heard so much nonsensical BS this week, mostly on talk radio (I’ve been in the car a lot, and can’t stay away from it, even though I’ve mostly been listening to podcasts), about this situation, I just have to blow away a few myths


  1. The Bank of England only has one lever. They are “one-trick ponies”. Technically wrong, for a start (remember QE and the near-trillion quid injection into the Treasury coffers?). But much more than that – not relevant. Great stewardship here looks like regular communication with the media – calming markets and evidencing that you understand the bloody job, first of all. The TOTAL OPPOSITE is the Governor’s current position – as weak a leader as Boris, in my view.
  2. Rates are going up so mortgage rates will keep going up – NO. Good governance here sees the 5-year SONIA swap going downwards, and thus mortgage rates getting cheaper (same for the 2-year)
  3. The government should bail out homeowners. Come off it! Get off the bus that expects the government to save your backsides, people, and sort yourselves out. It is the only way forwards.
  4. Inflation is all from the supply side. Please, please, please. I was debunking this argument in 2021! You just aren’t looking at the facts, the data, and you don’t understand inflationary times if you think like this. I didn’t live through them (personally) as an active economic agent – but I’ve done the work, read through the data, and accurate historical accounts. Not “I remember when the interest rate was 17%” or whatever, yawn yawn yawn.
  5. Handouts are the best solution. No – they are also extremely blunt, and highly inflationary. I’m not ideologically opposed to them, as it goes. £900 to approx 6 million households is £5.4 billion. This is quite redistributive. I am in favour of that, overall. However, it is also highly inflationary, and that’s why it is stupid at this time – even though it is needed at this time. It is working in direct opposition with the supposed “big goal”. I hate a problem without a solution – perhaps this is the right balance, but 100% of that money (basically) will be consumed very quickly. I also feel the government gets no political capital for these, and that’s not really very fair – but defending this administration is difficult, and I try to avoid the political side as much as possible anyway.


Again – I could go on. But I won’t – I want to go on to your actions at this difficult time:


  1. People are facing stark choices. Put rents up to market at a terrible time, especially if you have been clement on this front for many years. Otherwise, sell. Today – if properties are not yielding 6.75%+ net (after operational costs) they are not viable holds. That’s TODAY. That is likely 1-1.25% above the range that we could easily be at within 12 months (remember, I’m talking swap rate, not base). If it doesn’t work at 5.5% net after op costs – the asset needs to be moved on. Sell it.
  2. Hold hard for a few more weeks. The markets SHOULD calm a little. The inflation news as above isn’t great although July CPI will come down again as a guarantee (because of the energy price news) and that will be somewhat helpful, even if it is the wrong metric to gauge. Lenders though have big balances to deploy, and it will be lenders NOT getting their money from the swap market. It will be deposit takers, and building societies really should be at the table in a big way here. Their cash balances are swelling, and costing them money. They don’t need “2% on SONIA” to deploy their funds and can work to lower margins, they take less risk and have much less sophisticated business models in terms of financial engineering. They need to be faster to market, but watch out for products particularly from Paragon and Skipton Building Society in the next few weeks – keep an eye on the Leeds too. Your broker should be all over these – if not, change broker. Paragon is at about 6.5% for the moment with the fee amortised over 5 years – not a terrible rate as at today. They have a pay rate of 5.4% with a 5% fee, which is currently only for porting customers I believe, but may well be rolled out to the new business for limited companies. We need a couple more weeks for the market to form again, properly, assuming rates will be less volatile in the swaps market in the next month.
  3. Pay off and refinance in a “while”. Not the worst idea in the world – if you are comparing a basic income position apples-to-apples, instead of paying 6.5% you can get a 6.5% return on your money by paying down. I operate a corporate leverage model and this is nearly unthinkable to me, but on a personal level might well make sense. Nothing wrong with it. Costs time, and cash might be very useful in a full meltdown, but a full meltdown currently looks unlikely. The underlying economy is too strong and indeed that’s part of the problem.
  4. Don’t buy negative cashflowing assets at this time. This forces you right into high-yield; unless you are looking at a huge pile of cash you need to deploy and can buy lower-yielding assets at decent discounts, it isn’t the time to put financial pressure on your cashflow. This doesn’t mean “don’t do BRR” for example – I don’t mean negative cashflow for an initial refurb period, say – but I do mean low yielding properties that make you suffer from negative gearing (cost of debt above net yield after operational costs) – it’s not the time for those. The knife is wobbling and falling a little – the old “it will all make money over time” is still true, but you MUST be selectively aggressive at times like this. 
  5. Stay positive and tune out the noise. This is still absolutely the very best asset class out there, in volume, for the medium and long term. Don’t worry about the short term. Keep up the positive mindset and the affirmations!


That’s enough for now on what you need to do. I wanted to give a little airtime to the margin rebalancing that needs to happen. We need to move away from this 2% margin on SONIA to the lenders that are funded by their own deposits or by brokering loans for building societies. People are seeing the incentive to keep funds on deposit and are still keen to deploy monies where they are protected by the FSCS – Chase might be offering 5%, but they will be losing money on that 5% and it is a marketing scheme/acquisition strategy that can’t last. People will be quite comfortable at 3.5% in the good old building society and that can be lent out profitably at 5.5-6% total cost of debt including amortised fees, even as and when base hits 5.25-5.5%. This is more like a functional old lending market – people take a 5-year building society bond, at likely 1-1.5% below the swap rate (2-year looks more attractive at the moment for reasons inverse to the lending market – 2-year bonds are providing much better returns in the gilts market). Once the yield curve DOES rebalance and become functional again (which might well take 2-3 years but could be accelerated by a recession of significance), that market can come back. 

Reframed, those in 2008 may remember 5.5% base rates, but 5% mortgage rates and 3% savings rates. 5-year fixes 1% below base were not uncommon at all and some had very favourable terms (OK, banks learned their lessons on most of those but not necessarily all). This margin rebalance needs to come back in order to make the lending market more functional. This takes time, but needs to be accelerated – again, proper leadership and understanding from anyone at governmental or central bank level who cared about the BTL sector/PRS (and I expect no help from them, but I do expect them to try and help the tenants) could accelerate this quite easily. But no, continuation of the same old reactive crap, avoiding problems and minimising workloads – disgraceful when earning the sort of money that the MPC do, particularly the “guv’nor”.


Bank windfall tax personally also looks on the cards, as the deck hits them in the face – they are all reporting improved margins in Q1 2023 rather than trying to actually improve the market – this is profiteering at the worst possible time, and should be punished by the government via a windfall tax. They should be told why – this is not skill, whereas the energy companies could claim some skill from the strong trading positions they got themselves into. This is a bond market that has largely hit them in the face, positively (unlike a lot of the regional American banks – this is almost diametrically opposed). Pay up and reinvest in something more useful – this will also be politically expedient with the election coming up and is a no-brainer policy. Labour should get ahead of this so that they can at least claim the Conservatives have stolen another one of their policies.


Hunt addressed this indirectly, and poorly, in November 2022’s budget which unpicked Kwasi’s poor work in September. The Kwar Krash (I actually like that more than the Kami-Kwasi chat, to be honest). Corp tax went from 19 to 25, as had been planned, but the bank surcharge went down from 8% to 3%, meaning a net tax increase to the big banks of a mere 1%. This is the wrong time to stop charging the banks for 2008. The damage has not been completely repaired, and this needs to be addressed. Get on with it, Jeremy.


My little ray of sunshine as we finally approach the last couple of paragraphs. I do feel in my gut that we are near the end of this inflationary cycle on the upside. There’s years to go yet before getting to target – and I was pleased to hear people talking this week of an increase in target to 3% or similar, something I called for a couple of years back. Let’s hope that gains momentum. Core is close to the top – as per the above, it still goes up next month it seems, but liquidations with teeth will soon have hiring on pause, unemployment going up, and thus swap markets at least stabilising. Let’s hope unemployment can stay under about 4.5%, there won’t be too much blood on the streets and we can indeed have a soft-ish landing here – the markets are only realising what regular readers of the supplement will have known for the past 2.5 years, and they are at peak bearishness whereas I see we are 90-95% into the most problematic part of this cycle. Be happy about that.


I’ve deployed my ISA allowance this week, and that also follows on to me thinking I’ve seen peak bearishness. Thursday afternoon looked a good time to get stuck in, to me, and whilst I’m an amateur (so please don’t follow me) I got stuck into some REIT products because I think SONIA is near its high watermark. They are at a discount to asset values despite numerous writedowns, and whilst I’m avoiding office like the plague because I think it has a decade-long structural problem post-covid that isn’t yet priced it, I’ve got stuck in on some other commercial and also farmland REITs. I also bought a bit of Tesco after a 3.75% drop – there’s enough arguments for their yield being acceptable and their longer-term prospects being strong, for me. Markets tend to drop before or at times of recessionary announcements and recover fairly quickly – of course all bets are off if we do have a black swan, but if we only ever try to predict the black swans we won’t be correct most of the time, and will constantly find excuses not to invest. Some never approve of this particular Uncle Warren-ism, but be greedy when others are fearful. Perhaps better characterised as “be selectively active when others are paralysed by fear”.


Talking of the great man, that’s where we end this week. Uncle Warren went over the $50bn lifetime donation milestone. His Berkshire stock is worth about $112bn as at today, and whilst it will drop a few % when he passes, that’s pretty much all going to charity too. $150+bn, and instead most of the world spends time hating on billionaires in submarines – go figure. Keep calm and carry on – but get on with getting towards being able to achieve merely 0.1% of what he has, and you will still leave an incredibly positive legacy that benefits humanity. Arise, Sir Warren. Until next week – and extra points for lasting until the end on this one, folks.