The last few years have not been good ones for the economy, but there have been winners. Those who bought into US and UK government bonds in 2008 have done rather well of course, and although the last half decade has been a bad period for most of the developed world, the global economy has done well. But it may be that things are set to change. QE, at least US QE, may be coming to an end and the markets are panicking. Yesterday I looked at the big winner from all this: the US economy. Markets are focusing on emerging market bonds, and I assume that in the rout that may follow, some emerging markets that are fundamentally very strong will be punished. The markets are like that. In times of panic, they are not so good at discriminating within regions and sectors. But today I am focusing on the developed world. Which countries may be vulnerable to rising interest rates? I think I should warn you that the UK is on the list.
In the US, households have paid off debt, so much so that the ratio of household gross debt to gross disposable income has fallen from 130.7 per cent in 2007 to 107.9 per cent in 2012. Over the last couple of years US equities have soared, and now US house prices are rising. This is a good combination of data. There is a good chance that the US consumer is set to become the lynchpin of the global economy again, and that may mean the crisis that began in 2007/08 could be drawing to a close. It is also good for the dollar.
Plenty of regions, including the UK and the euro area, have serious challenges ahead, but the crisis that started with the sub-prime debacle, and moved on to the collapse of Lehman Brothers appears to be in its final stages. This is to be celebrated.
But as conditions in the US return to normal, QE will inevitably come to an end too, and interest rates will rise. That’s the flip side of normality. Inevitably there will be losers.
No one knows for sure how equities will be affected by the end of QE. How much of their recent rises has been down to the Fed? But if the Fed reverses QE because the US economy is doing better, does that not provide a reason for equities to rise? The counter argument is that we are set to see the ratio of profits to GDP fall, thus earnings will fall even as GDP rises. This may be right, but I have never been that struck by the argument that rising equities are justified by profits rising at the expense of wages. The reason is simply this – to grow in a sustainable way, the economy needs wages to rise.
But let’s look beyond the US. Between 2007 and 2012 across the OECD average household gross debt to gross disposable income has fallen slightly. It has fallen by more than 20 percentage points in both the US and the UK, by just over 10 percentage points in Germany, and by five percentage points or so in Spain and Portugal. In the case of Germany, the ratio is now much lower than at any point seen in a very long time – much lower even than in the year 2000. The OECD data to which I have access does not go back before 2000, but I am guessing the ratio is now the lowest it has been since the early days of reunification. In fact, the ratio for Germany is now just 87.2.
In the case of Spain and Portugal, I would say that household deleverage still has long way to go. For the UK, things are not so clear. In fact UK households have seen the highest level of deleverage across the OECD, yet the ratio of household gross debt to gross disposable income is still 146, compared to just 112.4 in 2000. The fact that UK households have managed to pay back as much debt as they have over the last few years, given that wage growth was so modest, is quite impressive. But the process has further to go – or so I reckon.
Countries that have seen this key ratio rise sharply since 2007 include France, Canada, Greece, Ireland, South Korea, the Netherlands and Sweden.
It has risen sharply in Italy too, but even so the ratio is just 74.5, which is the second lowest in the OECD. In this respect at least I don’t think Italy has a major problem.
The rise in French debt is worrying, but even so the ratio is still only 110.4. For the time being, at least household debt levels in France seem affordable.
I am more concerned about Sweden, Canada, and the Netherlands. At end of 2012, the ratios were 188.1, 151.2 and 285.3, respectively. I am also worried about Australia, where the ratio has not risen much since 2007, but at 170.7 seems to me to be too high.
Now consider house prices. The ratio of UK house prices to rent and income, according to the OECD, is 31 and 22 per cent above the historical average respectively. So that’s not good. But the extent of this apparent over-valuation is similar in France, Australia and Sweden. In Canada the ratio of house prices to rent is 64 per cent over average. In the Netherlands, house prices appear to be overvalued too, but not by quite as much as in the UK.
It seems to me that all these countries are vulnerable to rising interest rates. At least in the UK household debt to income has been falling, but George Osborne’s idea to push house prices upwards will surely not help. For France, the dynamics of household debt and house prices valuations is yet another woe to add to a long list. But for me the countries to watch out for are Canada, Australia, the Netherlands, and Sweden. Don’t say you weren’t warned.
These views and comments are those of the author alone and do not necessarily reflect the view of The Share Centre, its officers and employees