Historic Crazy

Doug Nolan

Friday was one of those market days that left an uncomfortable feeling in the pit of my stomach. U.S. markets have been resilient thus far, with the S&P500 teasing near record highs. 
 
But something is amiss globally. The STOXX Europe 600 Bank Index sank 3.67% Friday (4.8% for the week), to near two-month lows. Deutsche Bank ended the week down 7.7%, trading back close to multi-year lows (down 35% y-t-d). Italian bank stocks were hammered 5.0% Friday (5.9% for the week) to lows goings back to 2013. UniCredit was hit 6.4% Friday. 
 
Spanish equities (IBEX) sank 3.5% this week to two-month lows (down 11% y-t-d), while Italian stocks (MIB) dropped 2.1% (down 20% y-t-d). The German DAX was down 2.7%, boosting 2016 losses to 8.5%. French stock lost 2.6% (down 7.1%).

German 10-year bund yields are at the brink of turning negative, ending the week at a record low 0.02%. Italian 10-year spreads (to bunds) widened 10 bps this week to a four-month high 136 bps. UK 10-year yields closed Friday at a record low 1.23%. Japanese yields ended the week at a record low negative 0.17%. Treasury yields closed Friday at a three-year low 1.64%.

June 10 - CNBC: "A new poll showing a majority of British people in favor of leaving the European Union hit foreign Exchange and stock markets on Friday. The data in London newspaper The Independent showed that 55 percent believe Britain should leave the EU, versus 45 percent who favored staying. The publication said it marked the largest portion of respondents who favored exiting since research firm ORB began polling the issue for it last year."


 The British pound dropped 1.39% Friday on polls showing Brexit with a widening lead. 
 
Currency markets remain unsettled. The pound dropped 1.8% this week, with the Swedish krona down 2.1%, the Norwegian krone 1.2% and the euro 1.0%. Meanwhile, the Brazilian real surged 3.1%.

Japan’s Topix Bank Index dropped 2.7% to almost one-month lows. Here at home, the Banks (BKX) fell 2.2% and the Broker/Dealers sank 3.6%. Notable financial sector declines included Bank of America/Merrill Lynch 4.1%, Citigroup 3.3% and Goldman Sachs 3.7%.

I can imagine the sense of excitement readers have to dive into the details of the latest Z.1 report. Watching paint dry and grass grow… Even for me, the Fed’s Q1 “flow of funds” data was for the most part uninspiring. At this point, Credit is growing adequately. “Money” is expanding briskly. The vulnerable corporate debt sector came to life during Q1. The banks are “dancing,” with bank Credit now in the strongest expansion since before the crisis. 
 
Importantly, securities market values are new all-time highs, with Household Net Worth inflating to record levels. Yet there’s a strong case to be made of latent fragilities – system vulnerability to a reversal in bond, stock and real estate prices.

Non-Financial Debt (NFD) expanded at a 4.8% rate during Q1, down from Q4’s (distorted) 8.8% but up from Q3’s 2.2%. Total Household debt growth slowed to 2.7% annualized, down from Q4’s 3.7%. Household mortgage debt was unchanged from Q4 at a 1.6% pace, while growth in Consumer Credit was unchanged at 6.1%. Corporate debt growth bounced back strongly. Corporate Credit growth had slowed meaningfully, from 2015’s Q1’s 9.1% to Q2’s 8.7% to Q3’s 4.8% and then to 2.9% in Q4. The first quarter saw Corporate Credit growth surge to an 8.9% pace. State & Local borrowings accelerated marginally to 2.2%. After the federal government’s blistering 18.5% fourth quarter borrowing pace, debt growth slowed to 4.6% in Q1.

It’s often helpful to view the data in seasonally-adjusted and annualized rate (SAAR) terms. 
 
For Q1, Total Borrowings expanded SAAR $2.159 TN (surpassing my $2.0 TN bogey for Credit growth sufficient to sustain the U.S. “Bubble Economy”). For perspective, Total Borrowings expanded $1.990 TN in 2015, $1.836 TN in 2014, $1.566 TN in 2013, $1.910 TN in 2012, $1.297 TN in 2011, $1.569 TN in 2010, $1.226 TN in 2009, $1.908 TN in 2008, and $2.479 TN in 2007.

Breaking down SAAR debt growth for the quarter, Total Household Borrowings increased SAAR $379bn (mortgage $156bn and consumer $214bn), Total Business SAAR $1.014 TN, State & Local SAAR $66bn and Federal SAAR $700bn. It’s worth noting that Business borrowings over the past year have been at the strongest pace since record 2007 borrowings.

Led by ongoing strong Treasury issuance, total Debt Securities (the Fed’s accumulation) expanded $526 billion during the quarter to a record $40.218 TN. As a percentage of GDP, Debt Securities increased to 221%. Debt Securities began the eighties at 74% of GDP, the nineties at 126% and the new Millennium at 162%. Total Equities declined marginally during the first quarter to $35.496 TN, or 195% of GDP. Equity Securities began the eighties at 44% of GDP, the nineties at 67% and ended 1999 at 201%. Total Securities (Debt and Equities) ended Q1 at $76.618 TN, or 420% of GDP. Total Securities began the eighties at 117% of GDP, the nineties at 193% and the new Millennium at 362%.

Buoyed by near-record securities market values, the bloated Household Balance Sheet remains a primary Bubble Economy variable. Household Assets increased another $855bn during Q1 to a record $102.6 TN. And with Liabilities up only $18 billion during the quarter, Household Net Worth (HNW) jumped $83.7 billion to a record $88.1 TN. HNW ended 2007 at $66.7 TN, and then fell below $49.0 TN in early 2009. HNW-to-GDP ended the first quarter at 483%, compared to 446% and 461% to end Bubble Years 1999 and 2007. Household holdings of Financial Assets increased $300 billion to a record $71.1 TN (390% of GDP). Inflating home prices saw Real Estate holdings jump almost $500 billion during the quarter to a record $25.8 TN. Household Net Worth has now inflated 81% from Q1 2009 lows.

It’s worth pondering the divergence between deflating stock prices and inflating bank assets. 
 
Q1 growth in “Private Depository Institutions” was off the charts. Net Acquisition of Financial Assets surged SAAR $1.766 TN, up from Q4’s $312 billion, Q3’s $179 billion, Q2’s $156 billion and Q1 2015’s $1.427 TN. Loan Assets jumped SAAR $903bn, with commercial business loans surging to SAAR $446 billion. For comparison, Loans increased $676 billion in 2015, $579 billion in 2014, $261 billion in 2013, $272 billion in 2012 and $143 billion in 2011. Loans expanded a record $696 billion in 2007. Bank Assets have expanded $4.015 TN, or 29%, since the end of 2010 to $17.712 TN.

On the bank (“Private Depository Institutions”) Liability side, Deposits are expanding rapidly. 


Total Deposits expanded nominal $252 billion during the quarter, or 7.8% annualized. Deposits have inflated $3.589 TN, or 37%, in just over five years to $13.215 TN.

During the quarter, bank lending picked of the slack as other sectors slowed markedly. The GSE’s contracted SAAR $88 billion, reversing some of Q4’s strong expansion (SAAR $298bn). 
 
Agency MBS growth slowed to SAAR $125 billion, down from Q4’s SAAR $195 billion. The Asset-Backed Securities (ABS) market contracted SAAR $228 billion during the quarter, after contracting SAAR $86 billion during Q4. Finance Companies contracted SAAR $65 billion during Q1, after expanding SAAR $18bn in Q4.

Security Broker/Dealer balance sheets remain in a curious flux. After contracting a notable SAAR $839 billion during Q4, Net Acquisition of Financial Assets expanded SAAR $191 billion during the quarter. Holdings of Treasury Securities increased SAAR $105 billion during Q1, and Miscellaneous Assets surged SAAR $443 billion. Corporate & Foreign Bonds declined SAAR $102 billion, Corporate Equities contracted SAAR $124 billion and Security Repurchase Agreements declined SAAR $72 billion. On the Liability side, Loans increased SAAR $157 billion.

Funding Corps Funding (“subsidiaries, custodial accounts for reinvested collateral of securities lending operations…) posted the strongest growth in many quarters. Net Acquisition of Financial Assets surged SAAR $478 billion, up from Q4’s $182 billion. On the Liability side, Securities Loans Net jumped SAAR $315 billion, following Q4’s SAAR $163 billion contraction, Q3’s SAAR $178 billion advance, Q2’s SAAR $209 billion contraction and Q1’s SAAR $139 billion increase. The data point to ongoing instability in securities lending and speculative finance more generally.

It’s my view that significant amounts of speculative finance continue to gravitate from the faltering global “periphery” to the perceived stable “core” U.S. securities and asset markets.


Z.1 data have not necessarily supported this analysis in recent quarters. After two consecutive quarters of net liquidation, Rest of World (ROW) “Net Acquisition of Financial Assets” increased $667 billion during Q1. Holdings of U.S. Corporate Bonds increased SAAR $178 billion, after Q4’s SAAR $364 billion gain. ROW now holds $3.075 TN of U.S. corporate bonds, $6.285 TN of Treasuries, $5.564 TN of U.S. equities, $2.064 TN of short-term deposits/money funds/repos, and $3.659 TN of direct investment. After beginning the new Millennium at $5.621 TN, ROW holdings of U.S. assets has inflated to a staggering $23.104 TN.

June 10 – Financial Times (Mehreen Khan): “A small change in central bank interest rates risks triggering an abrupt reversal in global markets, in echoes of the last financial crisis, the head of the German Bundesbank has warned. In his latest warning on the unwanted side effects of persistently low interest rates, Jens Weidmann said investors and asset managers could become ‘increasingly nervous’ in a world stuck with near negative rates as it raised the possibility ‘of a sudden hike in risk premiums’. He said monetary policymakers’ attempts to issue forward guidance hinting that rates will stay lower for longer, and lengthy aggressive bond-buying, had ignored consequences for financial stability…”


Credit Bubbles survive only so long as ample new Credit is forthcoming. Asset Bubbles persevere only so long as new “money” flows readily into the asset class and prices continue to inflate. I have argued that the current Bubble is deeply systemic, impacting virtually all asset classes. Undoubtedly, however, the most spectacular Bubble excesses continue to unfold throughout global bonds and fixed-income. I can appreciate Bill Gross discussing a $10 TN “supernova” that’s going to explode catastrophically “one day”. I can also respect legendary speculator George Soros’ decision to return to active trading with a host of bearish views and bets he expects to pay off one day soon. Gross and Soros are examining the same world as we are and must be in similar utter disbelief at what has transpired. Things turn notoriously Crazy near the end. We have witnessed Historic Crazy.     

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