Q4 2015 Flow of Funds

Doug Nolan

I’d been waiting patiently for the Fed’s Q4 2015 Z.1 “flow of funds” report. The fourth quarter was a period of financial instability and tightened financial conditions. What tracks would be left in the data? Moreover, would the report confirm a continuation of the broadening Credit slowdown that had turned more pronounced during Q3, a slowing that would portend weak GDP and corporate earnings. Would the data support the thesis of mounting financial fragility? This Z.1 did not disappoint.

Importantly, Credit did slow almost across the board. For starters, weak Corporate borrowings were evidence of a meaningful tightening of Credit conditions. Q4’s growth rate of 2.7% was the weakest Corporate Credit growth since Q4 2010 and was down significantly from Q3’s 4.6%, Q2’s 8.6% and Q1’s 8.5%. Household Mortgage Debt slowed to 1.5%, verses Q3’s 1.7% and Q2’s 2.5%. The fourth quarter’s 5.9% pace of Consumer (non-mortgage) Credit expansion compared to Q3’s 7.2%, Q2’s 8.5% and Q1’s 5.6%. There was even a marked stalling in State & Local borrowings, with Q4’s flat growth down from Q3’s 1.7%, Q2’s 1.0% and Q1’s 4.3%.

Federal debt was the big outlier in the “almost across the board” Credit slowdown. Federal borrowings expanded at an 18.5% rate, the strongest Washington Credit boom since Q2 2010. 

This more than offset the private-sector slowdown, ensuring that overall Non-Financial Debt (NFD) growth accelerated to an 8.6% pace in Q4. This reversed the trend that had seen Q3’s 2.1% at less than half of Q2’s 4.6% pace (Q1 2.6%).

Q4’s surge in Federal borrowing pushed 2015 Total Non-Financial Debt growth to 4.5%, matching 2014. NFD expanded 4.0% in 2013, 5.0% in 2012, 3.5% in 2011 and 4.4% in 2010. 

Total Business (corporate plus business financial) borrowings expanded a robust 6.6% (up from 2014’s 6.3%). Annual Federal borrowings slowed somewhat to 5.0% (from 2014’s 5.4%). 

State & Local borrowings expanded 1.8% after contracting 0.5% in 2014. Consumer Credit expanded 7.0%, the same rate as 2014 (strongest since 2001). Home Mortgage debt expanded 1.5% (strongest since 2007), up from 2014’ 0.5%.

In nominal dollars, NFD expanded $1.961 TN in 2015, up from 2014’s $1.848 TN to the strongest expansion since 2007 ($2.480 TN). Last year’s debt growth was led by $794 billion of total business borrowings, the strongest expansion since 2007. Federal borrowings increased $725 billion, down only slightly from 2014’s $736 billion. Household Mortgage borrowings expanded $137 billion last year, the strongest growth since 2007’s $734 billion. Consumer Credit grew a record $231 billion (up from 2014’s $218bn).

The Domestic Financial Sector saw borrowings slow to a 1.3% pace, down from Q3’s 1.9% and Q2’s 2.4%. Bank (“Private Depository Institutions”) lending ended 2015 on a strong note, expanding SAAR (seasonally-adjusted and annualized rate) $722 billion during Q4. This put 2015 annual loan growth at $674 billion, up from 2014’s $579 billion and the strongest expansion since 2007.

Certainly related the quarter’s financial market instability, there was a significant contraction in Foreign Banking Offices in U.S.  Here, Assets contracted SAAR $562 billion (after Q3’s SAAR $59bn contraction). On the Foreign Bank asset side, Reserves at Federal Reserve dropped SAAR $732 billion. Liabilities saw a SAAR $445 billion contraction in Net Interbank Liabilities to Foreign Banks. “Money” on the move…

Especially during Q4, strong domestic bank lending was more than offset by a notable decline in market-based Credit. Q4 market instability clearly had a major impact on Wall Street. 

Securities Broker/Dealers saw assets contract SAAR $839 billion during the quarter, versus Q3’s $24 billion expansion, Q2’s $124 billion contraction and Q1’s $97 billion expansion. 

Broker/Dealer Debt Securities holdings contracted SAAR $168 billion, and Security Repurchase Agreement assets dropped SAAR $442 billion. Miscellaneous Assets contracted SAAR $266 billion. On the Liability side, Security Repurchase Agreements declined SAAR $502 billion and Other Miscellaneous Liabilities contracted SAAR $406 billion. Wild financial flows…

It’s been my view that policy and speculative market backdrops have unleashed intransigent Monetary Disorder.  Z.1 data offer support for this thesis. The category Federal Funds and Security Repurchase Agreements saw a Q4 contraction of SAAR $333 billion, which followed Q3’s SAAR $575 billion expansion, Q2’s SAAR $214 billion contraction and Q1’s SAAR $181 billion expansion.

Waning marketplace liquidity was apparent in a marked drop in corporate debt issuance. 

Corporate Bonds expanded only SAAR $53 billion during Q4, down from Q3’s SAAR $107 billion, Q2’s SAAR $654 billion and Q1’s SAAR $645 billion. It’s also worth noting that outstanding Asset-Backed Securities (ABS) contracted SAAR $96 billion during Q4, this following Q3’s SAAR $150 billion decline.

In the category “the more things change, the more they stay the same,” waning marketplace liquidity spurred a surge in GSE activity. The GSEs increased assets SAAR $224 billion during Q4, up from Q3’s SAAR $144 billion to the strongest expansion since Q4 2014 ($283bn). On an annualized basis, 2015’s $85 billion GSE expansion was the strongest since 2008 ($234bn).

Agency- and GSE-Backed Mortgage Pools expanded SAAR $196 billion during the period, versus Q3’s SAAR $185 billion, Q2’s SAAR $122 billion and Q1’s SAAR $5.1 billion. For 2015, GSE MBS expanded $127 billion, up from 2014’s $75 billion.

Treasury Securities ended 2007 at $6.051 TN. By 2015’s conclusion, Treasuries had inflated to $15.141 TN, an increase of $9.090 TN, or 150%, in eight years. It’s worth noting that Agency Securities ended 2015 at $8.153 TN, having now almost recovered back to 2008’s record high.

Total Debt Securities (Treasuries, Agencies, Corporates & muni’s) ended 2015 at a record $38.741 TN. Total Debt Securities have increased $11.3 TN, or 41%, from what had been 2007’s record level. Total Debt Securities as a percent of GDP ended 2015 at a near record 217% of GDP. For perspective, this ratio began the eighties at 66%, the nineties at 110%, and the 2000’s at 140%.

Equities ended 2015 at $35.687 TN (down from 2014’s $37.612 TN), or 199% of GDP. This compares to Equities/GDP of 44% to begin the eighties, 67% to start the nineties and 200% to end Bubble Year 1999. Combining Debt and Equity Securities, Total Securities ended 2015 at a record $74.428 TN. This was up 40% from 2007 (a then record 366% of GDP) to 415% of GDP. 

This compares to 109% to begin the eighties, 178% to start the nineties and 341% to end the nineties.

Household (& non-profits) Assets ended 2015 at a record $101.306 TN, up $2.953 TN (3.0%) during the year. Household Assets have increased almost 50% since the end of 2008. And with Household Liabilities rising $345 billion, Household Net Worth jumped another $2.607 TN last year. For the year, Household holdings of Real Estate increased $1.562 TN (to a record $25.267 TN), with Financial Assets up $1.171 TN (to a near-record $70.327 TN). Household Net Worth as a percentage of GDP ended 2015 at 484% (little changed from 2014’s record). For comparison, Household Net Worth to GDP began the nineties at 379%, ended 1999 at 446% and closed Bubble Year 2007 at 461% of GDP.

Total Non-Financial Debt increased $1.912 TN in 2015 to a record $45.149 TN. NFD has increased $10.218 TN, or 29%, over the past seven years. NFD to GDP ended 2015 at a record 252%. For perspective, this ratio began the eighties at 138%, the nineties at 179% and the 2000’s at 179%.

March 18 – Bloomberg (Rich Miller): “Policy makers across the world are acting in ways that suggest there may have been more to last month’s Group of 20 meeting in Shanghai than mere platitudes about promoting global economic growth. In the past few weeks, officials from China, the euro area, Japan, the U.S. and the U.K. have taken a barrage of actions to keep the world economy afloat and currency markets calm. That’s led some analysts to conclude that there is indeed a secret Shanghai Accord, akin to those reached in an earlier era at the Plaza Hotel in New York and at the Louvre Museum in Paris. The Federal Reserve on Wednesday capped off the series of moves by global policy makers by forecasting a shallower-than-anticipated rise in interest rates this year, with Chair Janet Yellen stressing the risks from a weaker global outlook and market turbulence.”
March 18 – Bloomberg (Luke Kawa): “According to economists at Goldman Sachs…, the Federal Reserve just delivered one of its most dovish decisions of the new millennium. The surprise, per Economists Zach Pandl and Daan Struyven, stemmed from the large reduction in where monetary policymakers expect interest rates to be at year-end if all things go according to plan. The median Federal Open Market Committee member thought that it would be appropriate for the midpoint of the federal funds rate range to be at 0.875% at the end of 2016, down from a median assessment of 1.375% back in December. Excluding two meetings during the depths of the financial crisis in late 2008 and early 2009, the shock of Wednesday's slash to the so-called ‘dot plot’ was only exceeded by introduction of calendar-based forward guidance in 2011, the decision to forego ‘Septaper’ in 2013, and last March's markdown…”
It’s unclear whether a “secret Shanghai Accord” emerged from last month’s G20 meeting. 

There’s no doubt, however, that leading global monetary officials have orchestrated concerted policy measures going back (at least) to the 2012 “European” crisis. It’s also clear that they became trapped in Bubble Dynamics of their own making. When de-risking/de-leveraging (“risk off”) dynamics materialize, market conditions now tend to turn sour rather abruptly. Yet when policy responses then incite short-squeezes and a reversal of market hedges, ensuing powerful rallies take on lives of their own. Under tremendous performance pressure, market participants have little alternative than to jump aboard. Rallies cannot be missed. The upshot is a backdrop of extreme market volatility and extraordinarily challenging market dynamics. To be sure, the fragile domestic and global Credit backdrops are not constructive for economic growth, corporate profits or equities prices.

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