Q2 2018 Z.1 Flow of Funds

By Doug Noland

Credit Bubble Bulletin

Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized rate (SAAR) of $2.283 TN during the second quarter. While this was down from Q1’s booming SAAR $3.681 TN, it nonetheless puts first-half Credit growth at an almost $3.0 TN pace. Annual NFD growth has exceeded $2.0 TN only one year in the past decade (2016’s $2.739 TN). NFD expanded $2.509 TN in 2007, second lonely to 2004’s record $2.910 TN.

NFD ended Q2 at a record $50.710 TN, up $2.674 TN over the past four quarters and $4.868 TN over two years. NFD has increased $15.65 TN, or 45%, since the end of 2008. NFD ended the quarter at 248% of GDP. This compares to 231% at the end of 2007 and 189% to end 1999. It’s worth noting that Q2 y-o-y GDP growth of 5.4% was the strongest since Q2 2006.

The historic federal government borrowing binge runs unabated. Federal debt rose SAAR $1.186 TN during Q2, huge borrowings yet down from Q1’s blistering SAAR $2.828 TN. For the quarter, Federal Expenditures were up 6.0% y-o-y, while Federal Receipts were down 2.0%. Over the past year, outstanding Treasury Securities increased $1.292 TN to a record $17.091 TN. Since the end of 2007, Treasuries have ballooned $11.040 TN, or 182%.

But let’s not forget the government-sponsored enterprises (GSEs). Agency Securities expanded SAAR $236bn during Q2 to a record $8.962 TN. Over the past year, Agency Securities jumped $295 billion, with a two-year jump of $638 billion. This has been the strongest GSE growth in more than a decade. Combined Treasury and GSE Securities expanded to 128% of GDP (vs. 92% at the end of ’07 and 80% in 2000).

Total Debt Securities expanded SAAR $1.579 TN during the quarter. Washington continues to completely dominate securities issuance. Federal government accounted for SAAR $1.186 TN, the GSEs SAAR $80 billion, and Agency/GSE-MBS SAAR $161 billion. With net corporate debt issuance grinding to a halt during the quarter, little wonder corporate Credit spreads remain compressed.

And while overall Bank Assets posted a marginal decline during the quarter, this was fully explained by the contraction of “Reserves at the Federal Reserve.” Bank “Loans” expanded SAAR $504 billion, the strongest growth in a year. Security Broker/Dealer Assets expanded SAAR $199 billion, also the biggest gain since Q2 ’17. The largest Broker/Dealer asset gains were in “Security Repurchase Agreements” (SAAR $88bn) and Treasury Securities (SAAR $133bn).

Total (home, commercial and farm) Mortgages expanded SAAR $557 billion during the quarter. First-half growth in Total Mortgages is running just below 2017’s $576 billion pace, the strongest expansion since 2007. Commercial Mortgages expanded SAAR $201 billion, one of the strongest quarters since the crisis. The Fed’s Z.1 report recently created a category “Loans,” which combines mortgages, other bank loans and consumer credit. “Loans” expanded SAAR $1.028 TN during Q2. This was just below 2017’s $1.041 billion increase, the strongest annual gain since 2007.

And while lending has recovered strongly since the crisis, the greatest inflation has been in the securities markets. Total Debt Securities (TDS) were up $2.111 TN over the past year to a record $43.982 TN. TDS ended the quarter at 215% of GDP, after beginning the nineties near 130%, ending 1999 at 157%, and closing out 2007 at 200%. Total Equities jumped $5.141 TN over the past four quarters to a record $48.414 TN. Total Equites ended the period at 237% of GDP, after ending the eighties at about 70%, the nineties at 193% and 2007 at 172%. Total (Debt and Equities) Securities jumped $7.251 TN over the past four quarters to a record $92.396 TN, or 453% of GDP. This compares to about 200% to begin the ’90s, 350% to end 1999 and 373% to conclude 2007.

The rapidly inflating Household Balance Sheet remains fundamental to Bubble Analysis. Household Assets jumped another $2.323 TN during the quarter to a record $122.657 TN. Household Assets jumped $8.628 TN over the past four quarters (7.6%) and $17.076 TN over two years (16.2%). The one-year gain in Assets lags only 2013’s $10.669 TN, while the two-year gain is unmatched. By asset category, Financial Assets jumped $1.697 TN during Q2, and Real Estate assets rose $559 billion. Financial Assets were up $6.468 TN over four quarters and $12.978 TN over two years. For comparison, Household Financial Assets rose $3.923 TN in Bubble year 1999. The pre-crisis record annual gain was 2004’s $5.000 TN.

With Household Liabilities increasing $132 billion, Household Net Worth (assets less liabilities) surged another $2.191 TN during Q2 to a record $106.929 TN. Household Net Worth inflated $8.106 TN over the past four quarters and $16.035 TN in two years. It’s extraordinary to see $2.0 TN quarterly growth in Net Worth over eight quarters. Comparing previous peak two-year periods, the 1998-99 period saw Net Worth jump $8.208 TN and the 2004-05 period $13.232 TN. “Uncharted waters,” as they say.

Household Assets ended Q2 at a record 601% of GDP. Household Net Worth ended the quarter at a record 522% of GDP. For comparison, Net Worth-to-GDP ended the seventies at 342%, the (“decade of greed”) eighties at 378%, Bubble Year 1999 at 447%, and Bubble Year 2007 at 473%. The ratio of Household Financial Assets-to-GDP ended Q2 at a record 430%. This compares to 363% in 1999 and 379% in 2007. It’s worth adding that total Household Equities holdings (Equities and Mutual Funds) ended the quarter at 132% of GDP, up from cyclical peaks 117% during Q1 2000 and 103% in Q3 2007. Total Equities-to-GDP was at 33% to end 1985 and 47% to end the eighties. Equities-to-GDP dropped to a cyclical low 59% in 2002 and 53% in 2009. Equities to GDP averaged about 77% over the past 44 years.

International flows to U.S. asset markets continue to play an integral role in fueling the U.S. Bubble. Rest of World (ROW) holdings of U.S. Financial Assets rose SAAR $467 billion during Q2 to a record $27.480 TN. ROW holdings have surged $13.325 TN since the crisis, almost doubling the 2008 level. ROW holdings jumped $3.214 TN in just the past six quarters, extraordinary growth with parallels to the surge in ROW holdings in the manic 2006/07 period. ROW holdings began the 2000s at $5.640 TN, or 57% of GDP. ROW holdings ended Q2 2018 at 135% of GDP.

ROW holdings expanded $2.782 TN in 2017. Holdings increased only (nominal) $433 billion during 2018’s first half. ROW U.S. Corporate Bond holdings declined during Q2, while Treasuries were little changed. I don’t believe it is mere coincidence that ROW flows to U.S. securities markets ebbed as global financial conditions tightened. Recall that U.S. 10-year yields jumped to 3.13% mid-quarter, before reversing sharply on EM market tumult.

Ten-year Treasury yields closed Friday trading at 3.06%, the high since May 17th. Safe haven bids for Treasuries and the dollar have waned of late. For the most part, EM has somewhat stabilized. But the Fed will likely raise rates again next Wednesday, returning the markets’ focus to U.S. rate prospects.

It’s still early innings for EM travails. Liquidity tends to ebb and flow with greed and fear, as crisis conditions unfold over time. It’s been quite a short squeeze backdrop in U.S. equities the past several months. This week saw some decent squeezes in global markets. The Argentine peso jumped almost 7% this week, with the South African rand up 4.3% and the Brazilian real gaining 3.1%. Brazil’s Bovespa equities index surged 5.3% and Turkish stocks rallied 3.4%. The Shanghai Composite jumped 4.3%. Hong Kong’s Hang Seng Financial index recovered 5.6%. Japan’s TOPIX Bank Index surged 6.6%. European bank stocks rallied 4.1%. Italian stocks were up 3.1%, while Italian 10-year yields dropped 15 bps. Copper jumped 8.0%, and crude surged 2.6%.

Booming U.S. securities markets bolster the case for the Fed sticking with “normalization.” This week’s squeeze notwithstanding, higher U.S. rates boost the odds of another round of EM de-risking/de-leveraging – and a further tightening of global financial conditions. Such a backdrop would be conducive to tighter conditions at the “periphery” coming closer to penetrating the “core.” The Q2 Z.1 report indicated waning international liquidity flows into U.S. securities markets.

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