Strong UK Employment Data, But a Word of Caution

Yesterday the Office for National Statistics released strong data on the UK labour market, which was music to the ears of UK RMBS investors. The headline unemployment rate stands at 4.0%, roughly unchanged for the last six months and at the lowest level seen in the last 45 years. There are an estimated 32.6 million people employed, 444k more than a year earlier, and more importantly average weekly earnings grew by 3.4% (the highest for over 10 years and 1.2% in real terms).

Financially this has left the UK consumer in a good position, with rates low and employment high. On top of that, homeowners in almost all regions have witnessed substantial house price growth since the financial crisis, though this has halted or even reversed a little in London and the South East in the last couple of years, while the pace of growth overall has been grinding lower over the last few months.

Despite these very healthy numbers, we remain cautious when it comes to the UK consumer as there are many challenges ahead, Brexit foremost among them.

This week Honda announced plans to close its factory in Swindon, where 3500 people work, in 2021. This follows the news that Nissan has ditched plans to build the its new X-Trail SUV in Sunderland.

How big a part Brexit played in these decisions is unclear. Both firms pointed to other factors – chiefly a wider global auto sales slowdown – but the recently signed EU-Japan trade agreement may have had an influence, and we should also remember it is possible for global businesses to make strategic long term decisions regardless of political timing.

Whatever the reasons, the potential for job losses is far greater than just for the workers at these plants, as many companies in the supply chain will also share the pain, which may then cause a further knock-on effect for other local businesses.

The good news is Honda made its announcement very early, leaving workers and supply chain businesses two to three years to deal with it. But it is likely to put something of a brake on construction and new home purchases in the area, and consumers might also delay larger purchases such as a new car (especially if it is a Honda).

With the economy at essentially full employment, it’s inevitable that unemployment will increase in the coming years, either because of negative Brexit consequences or a more naturally ending economic cycle.

Contrary to popular belief, house prices don’t influence mortgage foreclosures; a rise in unemployment and divorces are the main drivers for borrowers to stop paying their mortgage. We are a very long way from the unemployment rates seen during the financial crisis (8.4% in 2011) and the housing crisis of the early 1990s (10.6% in 1993). Mortgages are still very affordable and even if we stress test RMBS bonds to the worst employment and housing stresses seen in the last 50 years, we can see that investment grade RMBS remain extremely robust.

An economic slowdown will not be limited to the UK, and we expect to see this in other European countries and the US too as the cycle matures. RMBS and even CLO investors should be well protected, but with the potential for uncertainty in the near term, our view remains to keep liquidity high and credit duration short to insulate ourselves from any volatility to come.