Page 1 of 3 CREDIT BUBBLE BULLETIN Q4 2012 Flow Of Funds
Commentary and weekly watch by Doug Noland
For years, I would anxiously await the opportunity to sift through each new voluminous quarterly Z.1 ''flow of funds'' report from the Federal Reserve. On a quarterly basis, the Federal Reserve's credit data illuminated the evolving US bubble - with each report reliably offering additional clues and credit insight.
The past few years analyses have been somewhat boring to write and, surely, painful to read. More recently, however, the data have again turned more interesting. As you read through this analysis, please keep in mind the Fed's decision to increase quantitative
easing to US$85 billion monthly beginning this past January.
For Q4 2012, total non-financial credit expanded at a 6.4% rate, the strongest expansion since Q3 2008 (7.0%). Total household borrowings expanded 2.4% annualized, the briskest pace going back to Q1 2008 (3.6%). Household mortgage credit contracted 0.8% annualized, the smallest pace of decline since Q1 2009 (positive 0.2%). Corporate borrowings grew at a blistering 10.7% pace, the quickest since Q4 2007 (11.5%). Federal debt expanded at an 11.2% rate during the quarter. In nominal dollar terms - seasonally-adjusted and annualized (SAAR) - Q4 total non-financial credit expanded $2.536 trillion. Looking at the main categories, Total household debt increased SAAR $312 billion, total business SAAR $1.076 trillion, and Federal Government SAAR $1.259 trillion. Credit expansion has become increasingly broad-based.
For full-year 2012, total non-financial Debt (NFD) expanded $1.848 trillion, up from 2011's $1.351 trillion to the strongest pace since 2008. For comparison, NFD increased $1.457 trillion in 2010, $1.078 trillion in '09, $1.907 trillion in '08, $2.552 trillion in '07, $2.387 trillion in '06, and $2.343 trillion in '05 (nineties avg. $715 billion). For the year, household debt growth turned positive for the first time since 2007, with the strongest (non-mortgage) Consumer credit growth ($154 billion) since 2000 just offsetting the continued contraction in Mortgage borrowings. Total Business credit expanded $687 billion, up from 2011's $546 billion for the strongest expansion since 2007's booming $1.316 trillion (business credit expanded $163 billion in 2010, after contracting $245 billion in '09). The growth in Federal government market debt increased to $1.140 trillion, up from 2011's $1.068 trillion - for the fifth straight year of trillion-plus deficits.
I'll briefly interrupt Q4 2012 ''flow of funds'' analysis in order to update data for the deleveraging vs. leveraging ''debate''. The fourth quarter's $655 billion expansion pushed total non-financial debt (NFD) above $40 trillion ($40.099 trillion) for the first time. In the past four years, NFD has increased $5.620 trillion, or 16.3%. As a percentage of GDP, NFD ended 2012 at a record 253%, up from 232% to end 2007 and 240% to conclude 2008. It is worth noting that household liabilities contracted $663 billion over the past four years, while Federal debt expanded $5.580 trillion.
Total (non-financial and financial) system credit ended 2012 at a record $56.281 trillion (355% of GDP). Total system debt growth has been somewhat restrained by the four-year $3.261 trillion drop in Financial Sector debt obligations to $13.852 trillion (low since 2006).
As I have tried to explain in previous CBBs, the contraction in US financial sector credit market borrowings has been chiefly due to the shift of assets onto the Fed's balance sheet coupled with the significantly reduced intermediation requirements for government debt when compared to mortgage credit (no need for the financial sector to securitize/intermediate Treasury bills, notes and bonds!). Especially after 2012's strong credit expansion, the deleveraging thesis has become even more flimsy.
Much of ''deleveraging'' analyses focuses on the decline in household debt. In aggregate, total household liabilities contracted $663 billion, or 4.7% during the past four years to $13.453 trillion (worth noting liabilities ended 2000 at $7.353 trillion). Meanwhile, fueled by a remarkable accumulation and price inflation in financial asset holdings, total household assets surged $11.764 trillion, or 17.4%, in four years to a record $79.525 trillion (up 57% since 2000).
Over four years, household net worth (assets minus liabilities) jumped $12.428 trillion, or 23.2%. Notably, household net worth surged $5.464 trillion, or 9.0%, during 2012, surely helping to explain the ongoing vigor in household consumption. As a percentage of GDP, household net worth jumped to 421%, down from the 2006's real estate bubble spike to 490% but still significantly above the 385% average for the period 1985-2003.
Along with quite strong inflation in net worth, the aggregate household sector continues to enjoy respectable income gains. Fourth quarter compensation was up 3.9% y-o-y (strongest gain in six quarters) to a record $8.662 trillion. Total national income was up 3.3% y-o-y for the quarter to a record $13.995 trillion. Compensation increased 3.3% in 2012, somewhat less than 2011's 4.1% increase. Total national income increased 3.6% in 2012, down from 2011's 4.3%. National income has risen 14.0% over the past three years, with compensation gaining 9.8%.
Most of the ongoing inflation in asset prices and incomes is either directly or indirectly related to Washington's extraordinary policymaking. Since mid-2008 (18 quarters), publicly held Treasury market debt has increased 120% to $11.569 trillion. Federal debt (includes some other obligations) doubled to $13.469 trillion, increasing over this period from 46% of GDP to 85%. State and local debt increased 33% in 18 quarters to a record $3.732 trillion.
Federal expenditures were flat during 2012 at $3.758 trillion, or 24% of GDP. Recall that federal spending jumped almost 28% in the three years ended 2010. In the process, federal spending as a percentage of GDP jumped from about 20% of GDP in 2007 (1995-2007 avg. 20.3%) to 25.5% in 2010. Federal receipts were up 5.9% in 2012 to $2.669 trillion, fueled by accelerating non-federal credit growth. Since 2007 (five years), annual receipts have increased $14 billion, or 0.5%, while federal expenditures have surged $858 billion, or a whopping 29.6%.
The Fed's balance sheet expanded $117 billion during Q4, the strongest expansion since Q2 2011. Federal Reserve assets were little changed for the year, while being up $502 billion, or 20.5% over two years. Fed holdings are up $2.1 trillion, or 210%, since Q2 2008. In 10 years, Federal Reserves have inflated an historic 292%.
Huge federal expenditures and deficits coupled with the Fed-induced collapse in borrowing cost have lavished inflated earnings and cash-flows upon corporate America. Despite these inflated earnings, ultra-loose financial conditions have nonetheless incited a mini-boom in corporate borrowings. Corporate bonds increased SAAR $719 billion during Q4 to a record $12.511 trillion. For the year, corporate bonds jumped $527 billion, or 4.4%.
Bank credit has quietly been showing a pulse. Bank assets jumped $226 billion during Q4, or 6.1% annualized, to $14.992 trillion. Bank assets were up 2.4% y-o-y and 10.7% over two years. During Q4, commercial loans increased $75 billion, with a 2012 gain of $195 billion, or 9.5%, to $2.252 trillion. Mortgage loans increased $55 billion during the quarter, although they were down $47 billion for the year.
The banking system continues to accumulate government securities, with this asset class jumping $140 billion, or 6.7%, during 2012 to $2.245 trillion. It is worth noting that total bank deposits rose $714 billion, or 7.0%, in 2012 to a record $10.948 trillion.
For the first time since Q2 2008, total (home and commercial) mortgage debt (TMD) actually posted a quarterly increase ($17 billion). Overall, TMD declined $259 billion (1.9%) in 2012, down from contractions of $328 billion in '11, $621 billion in '10 and $292 billion in '09. Total mortgage credit declined $1.567 trillion, or 10.7%, from its Q2 '08 high, having now dropped back to 2006 levels. For perspective, TMD is today double the level where it ended the 90s. If the current backdrop holds, I would expect positive mortgage credit growth in 2013.
While we're on the subject of mortgage credit, GSE assets declined $35 billion during Q4 and $211 billion for all of 2012, to $6.269 trillion. But we have to temper our enthusiasm for the so-called ''winding down'' of Fannie Mae and Freddie Mac. Agency-backed MBS increased $32 billion in Q4 and $135 billion (10.4%) in 2012, to $1.440 trillion. Overall, outstanding agency securities (debt and MBS) declined only $33 billion (0.4%) during 2012 to $7.544 trillion.
In the miscellaneous financial sector categories, credit union assets expanded 6.0% in 2012 to $904 billion. Securities broker/dealer assets increased 6.1% to $2.068 trillion, the first annual growth since 2007. REIT Liabilities were up a notable 22.9% to $778 billion, with a two-year gain of 55%. For the year, total securities credit jumped a notable $200 billion, or 15.2%, to the highest level since 2007. Securities credit has increased 40% in three years.
Rest of World (ROW) holdings of US assets increased $583 billion in 2012 to a record $19.384 trillion. ROW Treasury holdings jumped $474 billion last year to $5.546 trillion, with official Treasury holdings up $339 billion to $3.992 trillion. Over three years, total ROW holdings jumped $3.578 trillion, or 22.6%. During this period, Treasury holdings jumped 50%, or $1.848 trillion, with official holdings up $1.121 trillion, or 39%.
Granted, the fourth quarter was an odd one. There were clearly impacts from fiscal cliff uncertainties and looming tax increases. Still, the quarter was noteworthy for the big jump in credit growth and the even wider divergence between strong credit/financial markets and weak economic performance. A jump in (non-financial) credit expansion to a 6.2% pace equated with a barely positive (0.1%) real GDP reading.
It would be easier to dismiss this as an anomaly if it wasn't such a prominent global dynamic (China, India, Brazil, etc). As for the maladjusted US economy, we've reached the phase were it requires exceptionally strong credit expansion (and overheated markets!) to attain what most economists would view as ''normal'' growth.
A few years back, I opined that it would take roughly $2 trillion of annual system credit growth to more fully reflate the deeply maladjusted economy. After four years of outrageous fiscal and monetary stimulus, our credit system is poised to possibly reach this milestone in 2013. The good news is that jobs are growing at a decent clip (as one would expect with ultra-loose financial conditions and strong corporate borrowings). The bad news is that this reflation has required a doubling of federal debt coupled with incredible bubble-inducing monetary measures.
The government finance bubble has significantly inflated household incomes and corporate earnings, a bubble dynamic that has worked to incite speculation and inflation throughout equities and corporate debt markets. The reflation in securities and, increasingly, real estate markets has again inflated household net worth. Perceived gains in wealth and ongoing (government policy induced) income growth have spurred boom-time spending levels, in the process sustaining the consumption and services-based US economy. Ignore the underlying credit dynamics and things almost look OK.
Importantly, the government finance bubble has succeeded in sustaining the US ''bubble economy'' structure that evolved over the prolonged credit bubble period. This has ensured unending current account deficits and endless dollar liquidity; historic global financial and economic imbalances; and attendant myriad bubbles around the world. Desperate global central bankers, meanwhile, are content to disregard precarious bubble excess throughout global risk markets - fixated instead on acute economic and financial fragilities.
Flawed economic doctrine, analytical frameworks and policies over years fostered deep economic maladjustment and market bubbles. Resulting fragilities these days ensure even more aggressively ''activist'' policy measures viewed as necessary to bolster an acutely vulnerable global ''system.''
Two of the savviest ''macro'' analysts of this era - Stan Druckenmiller and Marc Faber - last week separately warned that this central banker-induced boom will end badly. Faber went so far as to predict unpleasant happenings for 2013.
I don't know if this historic bubble will burst this year. But I am convinced the longer the current backdrop continues the greater the eventual economic and financial turmoil. The Q4 2012 ''flow of funds'' provides added confirmation that policymakers have painted themselves into a corner. It's hard to believe the Fed will stick with $85 billion monthly QE in the face of mounting credit and market excess. On the other hand, the liquidity backdrop has created such unsettled global markets that central bankers will look for any excuse to avoid watering down the punch.
The S&P500 jumped 2.2% (up 8.8% y-t-d), and the Dow rose 2.2% (up 9.9% y-t-d). The broader market was strong. The S&P 400 MidCaps jumped 3.0% (up 10.9%), and the small cap Russell 2000 advanced 3.0% (up 11.0%). The Banks surged 4.5% (up 10.4%), and the Broker/Dealers jumped 3.9% (up 16.6%). The Morgan Stanley Cyclicals gained 3.6% (up 11.1%), and the Transports increased 2.7% (up 15.8%). The Morgan Stanley Consumer index rose 1.6% (up 12.7%), and the Utilities added 1.3% (up 7.7%). The Nasdaq100 gained 2.1% (up 5.4%), and the Morgan Stanley High Tech index rose 1.9% (up 7.8%). The Semiconductors jumped 2.4% (up 13.3%). The InteractiveWeek Internet index surged 2.9% (up 12.8%). The Biotechs rose 3.5% (up 15.6%). Although bullion was up $3, the HUI gold index slipped 0.4% (down 21.2%).
One-month Treasury bill rates ended the week at 8 bps and 3-month rates closed at 9 bps. Two-year government yields were up 2 bps to 0.26%. Five-year T-note yields ended the week15.5 bps higher to 0.895%. Ten-year yields rose 21 bps to 2.06%. Long bond yields surged 21 bps to 3.26%. Benchmark Fannie MBS yields were up 23 bps to 2.75%. The spread between benchmark MBS and 10-year Treasury yields widened 2 bps to a six-month high 69 bps. The implied yield on December 2014 eurodollar futures increased 6 bps to 0.59%. The two-year dollar swap spread was little changed at 14 bps, while the 10-year swap spread was down slightly to 8.5 bps. Corporate bond spreads narrowed significantly. An index of investment grade bond risk fell 5 to a two-year low 81 bps. An index of junk bond risk sank 28 to a two-year low 404 bps.
Debt issuance was decent. Investment grade issuers included American Tower $1.8 billion, Bank of New York Mellon $1.5 billion, Avon Products $1.5 billion, Burlington Northern $1.5 billion, International Lease Finance $1.25 billion, QVC $1.05 billion, John Deere $1.0 billion, Ace Ina $950 million, Manufacturers & Traders Trust $800 million, Allergan $600 million, McKesson $900 million, Mattel $500 million, Verizon $500 million, Markel $500 million, Southern Cal Edison $400 million, and Carefusion $300 million.
Junk bond funds saw inflows of $820 million (from Lipper). Junk issuers included Range Resources $750 million, Sealed Air $425 million, Mastec $400 million, Coinstar $350 million, Tital International $325 million, Prospect Capital $250 million, Cornerstone Chemical $230 million, Claire's Stores $210 million, and Acadia Healthcare $150 million.
Convertible debt issuers included MGIC $450 million.
International issuers included Royal Bank of Canada $2.0 billion, Bank of Nova Scotia $1.0bn, Swedbank $1.0bn, Bharti Airtel $1.0bn, Cosan Luxembourg $500 million, Tanner Financieros $250 million, Stats Chippac $255 million, and Aon $250 million.
Italian 10-yr yields this week fell 19 bps to 4.59% (up 9bps y-t-d). Spain's 10-year yields sank 34 bps to 4.74% (down 53bps). German bund yields jumped 11 bps to 1.52% (up 20bps), and French yields gained one basis point to 2.12% (up 12bps). The French to German 10-year bond spread narrowed 10 to 60 bps. Ten-year Portuguese yields sank 41 bps to 5.81% (down 94bps). The Greek 10-year note yield fell 43 bps to 10.37% (up 10bps). U.K. 10-year gilt yields were up 19 bps to 2.06% (up 24bps).