Two Developments and the Q3 2021 Z.1
Doug Nolan
In such an extraordinary environment, I’ll take note of two of this week’s developments.
China – in an about-face - implemented policy easing measures, cutting reserve requirements and announcing a loosening of property finance.
This was to get ahead of an unfolding Evergrande default and rapidly deteriorating developer financing conditions.
Developer bonds rallied modestly, with an index of Chinese high-yield dollar bonds ending the week down 170 bps to 20.1% (back to where they began the month).
There were additional reports of generally mild Omicron symptoms, both from South Africa and the CDC (after studying the initial 43 documented U.S. cases).
Both developments were consequential, though I would caution against over-optimism.
Recall the Federal Reserve slashed rates from 5.25% in September 2007 to 2.0% by April 2008.
Yet aggressive easing measures likely only worsened the subsequent financial and economic crashes.
As for Omicron, there was confirmation this week of the variant’s extraordinary transmissibility – multiples of even the fast-spreading Delta variant.
December 8 – Bloomberg (Kanoko Matsuyama):
“The omicron variant of Covid-19 is 4.2 times more transmissible in its early stage than Delta, according to a study by a Japanese scientist who advises the country’s health ministry, a finding likely to confirm fears about the new strain’s contagiousness.
Hiroshi Nishiura, a professor of health and environmental sciences at Kyoto University who specializes in mathematical modeling of infectious diseases, analyzed genome data available through November 26 in South Africans in Gauteng province.
‘The omicron variant transmits more, and escapes immunity built naturally and through vaccines more,’ Nishiura said in his findings…”
Reports have Omicron cases doubling every 2.2 days in the UK, with an estimate of 64,000 daily cases by Christmas.
And Friday from Bloomberg: “Denmark is seeing the number of people infected with the Omicron variant of Covid-19 double every second day, offering a glimpse of a development that is probably unfolding throughout Europe…
Denmark has now recorded more than 1,000 cases of the Omicron variant after a 60% jump in one day.”
Meanwhile in the U.S., average daily Covid cases are back up to 121,000, having surged 38% over two weeks.
Cases and hospitalizations are surging in many states, especially in the colder Midwest and Northeast regions.
Unfortunately, all indications point to another challenging Covid winter.
While one can debate the longer-term ramifications of this week’s two key developments, they were undoubtedly decisive for speculative Bubble markets.
With next Friday the quarterly “quadruple witch” expiration of options and other derivatives, negative developments this week (i.e. severe Omicron symptoms or an Evergrande default spurring market dislocation) could have unleashed a self-feeding downside dislocation exacerbated by derivatives hedging-related sell programs (selling by those on the wrong side of derivatives protection written).
Instead, mild Omicron symptoms and Beijing intervention spurred a short squeeze, a reversal of hedges, and yet another round of derivatives-related market melt-up dynamics.
Even if the Omicron variant spreads crazy fast, the number of cases won’t be much of an issue by next Friday.
After almost reaching 35 the previous Friday, the VIX Index collapsed to end this week at 18.7.
The S&P500 surged 3.8% to a new record high.
And it’s not only equities markets that are highly unstable.
Crude prices surged 8.2% this week, with Gasoline jumping 9.4%.
Bitcoin sank another 9%.
Italian bank stocks surged 6.6%, recovering after the drubbing from two weeks back.
Italian 10-year yields rose five bps this week to 0.96%.
Italian bonds traded at 0.85% on November 22, 1.12% on November 24th, 0.92% on November 30th, 1.05% on December 1st, 0.87% on December 6th, and 1.03% on December 8th. Greek yields surged 16 bps this week to the high since June 2020.
After sinking 13 bps the previous week, 10-year Treasury yields jumped 14 bps this week to 1.49%.
U.S. long-bond yields surged a notable 21 bps this week.
While they rose somewhat this week, U.S. market yields remain absurdly low in the context of highly elevated inflation (November CPI up 6.8% y-o-y!).
In a world of fragile Bubbles, I understand the safe haven aspect of Treasury market pricing.
But, mainly, the introduction of QE – and inevitably entrapped central bankers – fundamentally distorted U.S. and global bond markets.
Liquidity over-abundance, ultra-low yields and central bank backstops unleashed the greatest period of Credit and speculative excess the world has ever experienced.
New Fed Z.1 data this week provide our quarterly snapshot of The Great U.S. Credit Bubble.
System Debt (Non-Financial and Financial) ended the quarter at a record $86.218 TN, having expanded $11.3 TN, or 15.1%, over the past seven quarters.
At $63.681 TN, Non-Financial Debt (NFD) has surged $9.183 TN, or 16.8%, over the 21 pandemic months.
NFD is now up 81% in the less than 13 years since the mortgage finance Bubble collapse.
NFD expanded during Q3 at a seasonally-adjusted and annualized (SAAR) rate of $1.491 TN, the weakest expansion since 2016.
The slowdown, however, is explained by an anomalous SAAR $327 billion contraction in Federal borrowing (after expanding at a blistering $2.2 TN pace during the first-half), explained by a $637 billion drawdown of the Treasury’s account at the Fed.
Meanwhile, Household borrowing remained exceptionally strong, and Corporate debt growth bounced back from a weak Q2.
Treasury Securities contracted nominal $52 billion during the quarter to $24.250 TN, reducing y-o-y growth to $1.350 TN.
Over two years, Treasury Securities surged $5.678 TN, or 30.6%.
Since 2007, Treasuries have inflated $18.199 TN, or 301%.
Treasury Securities ended September at 105% of GDP, up from 41% to conclude 2007.
Agency Securities expanded another $128 billion during the quarter to a record $10.536 TN.
This pushed one-year growth to $670 billion (2-yr $1.193 TN), the strongest GSE expansion since 2008.
At a record $34.786 TN, combined Treasury and Agency Securities ended the quarter at 150% of GDP (up from 2007’s 92%).
Total Household Borrowings surpassed SAAR $1.0 TN for the fourth straight quarter ($1.068 TN).
For perspective, Household Borrowings averaged $290 billion annually for the decade 2010 to 2019, with the annual record $1.290 TN posted at the height of mortgage finance Bubble excess in 2006.
For Q3, Total Mortgage Debt expanded nominal $328 billion, or 7.6% annualized, the strongest growth since Q3 2006.
This boosted one-year growth to $1.047 TN (6.3%), the largest gain since 2007.
Home Mortgages expanded $246 billion, or 8.2% annualized – also the strongest since 2006.
One-year growth increased to $767 billion (6.7%), the strongest since 2007.
Commercial Mortgages gained $53 billion (6.8% annualized), the biggest increase since Q4 2007.
Corporate Bonds expanded $223 billion during Q3, the largest expansion since December’s $217 billion.
One-year growth increased to $700 billion.
For perspective, annual growth in Corporate Bonds averaged $341 billion during the decade 2010-2019.
The expansion of Federal Reserve Assets slowed from Q2’s nominal $489 billion to $343 billion – ending the quarter at a record $8.600 TN.
The Fed’s balance sheet inflated $1.198 TN (16.2%) over one year and $4.591 TN over nine quarters (115%).
Since mid-2008, Fed Assets have inflated $7.650 TN, or 804%.
It’s worth noting that the Fed’s “repo” Liability jumped another $644 billion ($1.553 TN in 2 quarters) to a record $1.905 TN.
Meanwhile, the Fed’s “Due to federal government” Liability fell another $637 billion during the quarter to $215 billion, with a nine-month drop of $1.513 TN.
The Treasury’s drawdown of balances at the Fed explains the recent transitory decline in Treasury borrowings.
Treasury issuance will be ramping back up.
The great Financial Sector ballooning runs unabated.
The Domestic Financial Sector expanded $1.409 TN during the quarter to a record $130.6 TN.
The Financial Sector inflated $13.464 TN over the past year (11.5%) and $25.342 TN over eight quarters (24.1%).
For comparison, annual Financial Sector expansion averaged $3.715 TN during the decade 2010 to 2019.
The Financial Sector ended Q3 at 563% of GDP.
This compares to previous cycle peaks 494% (Q3 ’07) and 397% (Q1 2000).
The Financial Sector ended the eighties at 265% of GDP.
Bank (“Private Depository Institutions”) Assets expanded another $728 billion (11.9% annualized) during Q3 to a record $25.115 TN.
This pushed one-year growth to $2.213 TN, or 9.7%.
This is down from 2020’s unprecedented $3.392 TN - but compares to an annual average $653 billion expansion during the decade 2010-2019.
The Asset “Reserves at Federal Reserve” expanded another $348 billion to a record $3.859 TN.
This pushed seven quarter growth to $2.310 TN, or 149%.
Bank Loans expanded $114 billion (3.8% annualized) during Q3 to $12.184 TN, the strongest expansion in 18 months.
Loans increased $24 billion, or 0.2%, y-o-y. Within Loans, Mortgages jumped $90 billion during Q3 (to a record $5.842 TN), the strongest expansion since Q2 2016.
Consumer Credit rose $54 billion (9.7% annualized) to $2.267 TN.
While Banks struggle in such a highly competitive (thoroughly saturated) lending marketplace, the securities business is booming.
Bank holdings of Debt Securities jumped $253 billion (15.7% annualized) during the quarter to a record $6.700 TN.
This pushed one-year growth to $1.183 TN, or 21.5%.
Treasury holdings rose $110 billon for the quarter to a record $1.456 TN, with a one-year expansion of $269 billion (22.6%).
Bank Agency/MBS Securities holdings gained $109 billion (11.7% annualized) to a record $3.836 TN, with stunning one-year growth of $740 billion, or 23.9%.
Over the past seven quarters, Total Debt Securities holdings surged $2.052 TN, or 44.2%.
Treasury holdings have jumped $576 billion (65.6%); Agency/MBS holdings $1.202 TN (45.6%); and Corporate Bonds $205 billion (31.3%) during 21 pandemic months.
For perspective, Bank Debt Securities holdings on average increased $167 billion annually during the decade 2010-2019.
When the Fed creates “money” to settle its QE securities purchases, these Federal Reserve electronic funds flow through the banking system (more recently some bypass the banking system and flow directly to the Fed’s “reverse repo” program).
These flows into the banking system create new Deposit Liabilities – and for the most part are used to purchase securities.
Total (Checking and Savings) Deposits jumped another $474 billion during the quarter to a record $20.412 TN.
As a key manifestation of one of history’s great monetary inflations, Bank Total Deposits surged $2.187 TN over the past year and $4.878 TN, or 31.4%, over the past seven quarters.
Securities Broker/Dealer Assets expanded $103 billion (9.6% annualized) during the quarter to a record $4.392 TN.
This pushed one-year growth to $368 billion, or 9.1%.
While the Asset “Loans (other loans and advances)” declined $23 billion during Q3, it nonetheless jumped $189 billion, or 42.8%, over the past year.
Loans were up an unprecedented $256 billion, or 69%, during the past seven quarters.
Miscellaneous Assets jumped another $88 billion (23.4% annualized) during the quarter to a record $1.592 TN – most from the category “Receivables due from other brokers and dealers.”
Over seven quarters, Miscellaneous Assets surged $462 billion, or 40.9%.
Lack of Treasury issuance held growth in Total Debt Securities to a seven-quarter low $294 billion.
Over the past year, Total Debt Securities rose $2.913 TN, or 5.6%, to a record $54.816 TN.
Total Debt Securities-to-GDP slipped to 236%.
This compares to 201% to end 2007, 158% to end the nineties, and 124% to conclude the eighties.
Total Equities were down somewhat ($300bn) during the quarter, though they were up $18.381 TN, or 32.5%, over the past year.
At 323%, Total Equities-to-GDP compares to previous cycle peaks 188% (Q3 ‘07) and 210% (Q1 2000).
Total (Debt and Equities) Securities were little changed during the quarter at $129.8 TN, or 560% of GDP.
This compares to previous cycle peaks 387% (Q3 ’07) and 368% (Q1 2000).
As a centerpiece of the Great Bubble, the Household balance sheet has inflated right along with government Credit (Fed and Treasury) and the securities markets.
Household Assets inflated $2.667 TN during Q3 to a record $162.678 TN.
Household Assets expanded $22.926 TN, or 16.4%, over the past year, and an incredible $35.592 TN, or 27.9%, over 18 months.
Household Real Estate gained $1.440 TN (14.6% annualized) during Q3, with record one-year growth of $5.254 TN (14.7%).
For perspective, Real Estate on average increased $1.246 TN annually over the decade 2010 to 2019.
Household Real Estate as a percentage of GDP rose to 176%, the high since Q3 2007.
Household holdings of Financial Assets increased $928 billion during the quarter to a record $114.1 TN.
Financial Asset holdings jumped $16.637 TN, or 17.1%, over the past year, with 18-month growth of $27.537 TN, or 30.4%.
Financial Assets-to-GDP ended September at 492%.
This compares to a Q1 2009 trough 325%, as well as previous cycle peaks 374% (Q3 ’07) and 354% (Q1 2000).
Little changed for the quarter, Household Total (Equities and Mutual Funds) Equities holdings were up $10.412 TN over the past year (32.3%).
Total Equities-to-GDP slipped from Q2’s record to 184% - but compares to previous peaks 104% (Q1 ’07) and 115% (Q1 2000).
Household Liabilities increased $305 billion during the quarter to a record $17.969 TN.
One-year growth of $1.127 TN was the strongest since peak mortgage finance Bubble year 2006.
Household Net Worth (Assets less Liabilities) – a key Bubble manifestation – jumped another $2.362 TN during the quarter to a record $144.709 TN.
Net Worth inflated a staggering $21.799 TN (17.7%) over one year and $34.124 TN (30.9%) over 18 months.
Net Worth ended September at 624% of GDP (slightly below Q2’s record 626%).
This compares to previous cycle peaks 491% (Q1 ‘07) and 445% (Q1 2000).
Review the incredible growth in the Federal Reserve’s balance sheet, Treasury and Agency Debt, the Financial Sector, Bank Assets/Liabilities, Total Debt Securities, Total Securities and Household Net Worth - and surging spending and inflation are not difficult to explain.
We have an interesting Fed meeting coming next week.
If the market rally holds through Wednesday, it will be difficult for the Fed not to upsize taper and talk “hawkish pivot.”
Meanwhile, the type of volatility experienced throughout global markets is stealthily at work impairing liquidity.
Especially as the Fed and others begin winding down QE programs, the liquidity backdrop ensures acute vulnerability to “risk off” de-risking/deleveraging episodes.
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