Repo Madness: Q3 2023 Z.1
Doug Nolan
Setting the stage for analysis of the Fed’s new Z.1, Q3 was not your typical quarter.
For starters, GDP posted a 5.2% growth rate, more than doubling Q2’s 2.1%.
Personal Consumption rose from 0.8% to 3.6%, with Gross Private Investment doubling to 10.5%.
It was a notably unsteady period for the markets.
Strong July gains had the S&P500 trading to 15-month highs, with the Nasdaq100 late in the month reaching the highest level since January 2022.
The loosening of market financial conditions accelerated, with spreads and many CDS prices back to pre-Fed “tightening” levels.
Markets were volatile in August, with a meaningful tightening of financial conditions.
Equities sold off sharply into quarter-end.
Bloomberg:
“US Household Net Worth Falls on Drop in Value of Stock Holdings.”
Z.1 report headlines focused on the decline in Net Worth, though much of the dip came near the end of the quarter.
The Q4 rally has pushed perceived household wealth right back to record levels.
Financial conditions loosened sharply in November.
Despite tighter bank lending and the potential for market de-risking/deleveraging, “risk on” markets have been notable for the degree of speculative fervor and liquidity abundance.
To the Z.1. Non-Financial Debt (NFD) expanded at a 5.24% annual rate, down from Q2’s 6.27%, but higher than Q3 2022’s 4.53%.
It's worth noting that annual NFD growth never reached 5.0% during the period 2009 through 2019.
Total Household debt growth slowed from 2.71% to 2.52% during the quarter, with mortgage borrowings expanding 2.51% (down from 2.88%) and Consumer Credit slowing to 1.05% (from 2.08%).
For the second straight quarter, federal borrowings completely dominated NFD growth.
At 10.60%, the growth in federal debt slowed from Q2’s 12.67%, but was more than double Q3 ‘22’s 4.19%.
In seasonally adjusted and annualized dollars (SAAR), NFD expanded $3.775 TN, down from Q2’s SAAR $4.445 TN, but ahead of Q3 ‘22’s $3.123 TN.
Prior to pandemic 2020’s colossal $6.804 TN, 2007 held the annual record for NFD growth at $2.529 TN.
For Q3, Household Debt expanded SAAR $495 billion and Business Debt SAAR $322 billion.
Meanwhile, federal borrowing expanded SAAR $2.968 TN.
NFD ended the quarter at a record $72.950 TN, having expanded $3.297 TN over the past year, $7.964 TN over two years, and an incredible $17.802 TN, or 32.3%, during the past 15 quarters.
There are complex dynamics to ponder.
Federal borrowing now dominates system Credit expansion.
This perceived money-like debt enjoys insatiable demand, while providing the perfect instrument for levered speculation.
Traditional sources of finance have tightened, with a notable pullback in bank lending, along with diminished corporate and household debt growth.
Meanwhile, evidence of an ongoing historic expansion of speculative finance mounts, as suggested by the extraordinary expansion of “repo” lending.
NFD expanded nominal $942 billion during Q3, with Treasury Securities gaining $901 billion, or 13% annualized, to a record $28.649 TN.
Treasuries inflated $2.180 TN over the past year, with two-year growth of a staggering $4.399 TN, or 18.1%.
Over 17 quarters, Treasuries ballooned $10.835 TN, or 60.8%.
Since 2007, historic excess has seen Treasury growth of $22.598 TN, or 373%.
We cannot ignore the government-sponsored enterprises (GSEs).
For the quarter, GSE Securities declined $70 billion (FHLB Assets contracted $50bn) to $11.902 TN.
Still, GSE Securities expanded $460 billion, or 4.0%, over the past year, and $1.366 TN, or 13.0%, over the past seven quarters.
GSE Securities ballooned an unprecedented $2.638 TN, or 28.5%, over 17 quarters.
In conspicuous government finance Bubble “blow-off” excess, combined Treasury and GSE
Securities ballooned $2.640 TN over the past year, $5.766 TN over two years, and $13.473 TN (49.8%) over 17 quarters.
At $40.551 TN, combined Treasury and GSE Securities ended September at 147% of GDP – up from 55% to end 2007.
Bank Assets contracted $132 billion during Q3 to $25.738 TN, led by a $260 billion drop in Debt Securities holdings (Agency/MBS down $193bn, Corporate Bonds $38bn, Munis $28bn).
Bank Loans increased $95 billion, slightly lower than Q2’s $101 billion, and down big from Q3 ‘22’s $347 billion.
Bank Loans expanded a respectable $640 billion y-o-y – which compares to the annual average of $363 billion for the two-decade period 2000 to 2019.
On the Liability side of the banking system’s balance sheet, Total (Checking and Time/Savings) Deposits contracted only $49 billion, down from Q3 ‘22’s $179 billion fall and the smallest decline since Q1 2022.
Total Deposits dropped $696 billion y-o-y, or 3.3%, to $20.145 TN.
Yet Total Deposits were still $4.611 TN, or 29.7%, higher over 15 quarters.
Net Interbank Liabilities dropped $97 billion during Q3 to $632 billion.
Broker/Dealer Assets declined $52 billion from Q2’s record level to $4.757 TN.
Debt Securities Holdings gained $30 billion to a 14-quarter high $435 billion, with Agency Securities jumping $34 billion to a 13-quarter high $121 billion (up $52.4bn y-o-y).
“Repo Assets” fell $23 billion to $1.604 TN.
Over the past year, Broker/Dealer Assets inflated $333 billion (7.5%), with “Repo Assets” surging $274 billion, or 20.6%.
Treasury holdings jumped $121 billion, with Agency/MBS Securities rising $52 billion.
Loan Assets fell $171 billion to $635 billion.
On the Liability side, “Repo” borrowings increased $13 billion during Q3 to a 13-year high $2.067 TN.
Over the past year, “Repo” borrowings surged $454 billion, or 28.1%.
It’s worth noting that Broker/Dealer “repo” borrowings surged $326 billion, or 22%, (to $1.781 TN) in the five-quarter Q1 2018 through Q2 2019 period, leading up to summer 2019 repo market instability - and the Fed’s resumption of QE.
After beginning 2020 at $1.073 TN, Broker/Dealer Miscellaneous Assets ended September at $1.701 TN.
December 6 – Bloomberg (Greg Ritchie and William Shaw):
“The Bank of England stepped up warnings about hedge funds shorting US Treasury futures, saying its measure of the net position is now larger than before the ‘dash for cash’ crisis in March 2020.
The net short position has grown to $800 billion from about $650 billion in July, the central bank said, citing calculations based on Commodity Futures Trading Commission data.
That suggests a jump in the so-called basis trade, which is where investors seek to exploit price differences between futures and bonds.
The trade is particularly risky because returns are bolstered by borrowing money in the repo market.”
December 8 – Reuters (Jamie McGeever):
“Hedge funds look to be scaling down their record short position in U.S. Treasury futures, marking the beginning of the end of the so-called 'basis trade' - an unwind that regulators have warned could pose severe financial stability risks…
They ‘short’, or sell the bond future, and go ‘long’, or buy the cash bond.
The trade is funded in overnight repo markets and highly leveraged.
If the unwind is now underway, the question for authorities - and financial markets at large - is whether the $1 trillion position can be unwound in an orderly manner.”
Shorting Treasury futures is associated with only a slice of global speculative leverage.
Yet the recent surge from $650 billion to $800 billion – or even $1 TN - is indicative of a general surge in leveraged speculation.
I’ve always assumed much of Treasury and Agency speculation transpires in offshore “tax havens” (i.e., Cayman Islands, Luxembourg, Singapore).
It’s unclear how offshore financial flows and leverage impact Fed Z.1 data.
Total System “Repo” Assets declined $222 billion during the quarter to $7.468 TN.
Behind the decline, the Fed’s “Repo” Liability dropped $506 during Q3 to a nine-quarter low $1.863 TN - with a one-year contraction of $857 billion.
But over 15 quarters, system “Repo” Assets ballooned $2.395 TN, or 47.2%.
Interestingly, Rest of World (ROW) “Repo” borrowings jumped another $158 billion (second only to Q1 ’19) during the quarter to a record $1.576 TN, with unprecedented one-year growth of $455 billion, or 40.6%.
For perspective, ROW “Repo” borrowings expanded an annual record $232 billion during 2019.
ROW “Repo” borrowings jumped a then record $186 billion in 2006, only to collapse $368 billion during 2008’s chaotic second-half (to $402bn).
Over the past five years, ROW “Repo” has ballooned $736 billion, or 88%.
ROW holdings of U.S. Assets declined $839 billion during Q3 to $44.531 TN, of which $468 billion resulted from the drop in Equities holdings.
Debt Securities holdings fell $214 billion to $12.823 TN, reducing one-year growth to $530 billion.
Over the past year, ROW holdings of Treasuries jumped $265 billion (to $7.516 TN), Agency Securities $78 billion ($1.256 TN), U.S. Corporate Debt $198 billion ($3.780 TN), and Equities $1.615 TN ($11.927 TN).
ROW Assets ballooned $8.568 TN, or 26.2%, over 13 quarters, and $30.523 TN, or 218%, since 2008.
The largest holders of “Repos,” the money market fund complex, saw assets expand another $226 billion during Q3 to a record $6.143 TN.
Money Fund Assets ballooned $1.059 TN, or 20.8%, over the past four quarters, and $2.141 TN, or 44.9%, during the past 15 quarters.
At $729 billion, 2007’s annual record for growth in Money Fund Assets is about to be broken.
Money Fund “Repo” holdings contracted $284 billion during Q3 to $2.949 TN.
“Repo” holdings were up $205 billion y-o-y and $1.706 TN, or 160%, over 15 quarters.
Holdings of Treasuries surged $523 billion during the quarter to $1.767 TN.
Holdings of Agency Securities declined $64 billion during Q3 to $690 billion, but were up $198 billion, or 40.2%, y-o-y.
The quarter ended with 48% of Money Fund Assets invested in “Repo”, 5% in Open Market Paper (commercial paper), 29% in Treasuries, and 11% in Agency Securities.
For comparison, these ratios were 17%, 26%, 4%, and 6% at the end of 2006.
I’ll assume regulators recognize that the Money Fund complex is now at the heart of operations financing government financial Bubble speculative excess.
Total Debt Securities increased $770 billion during the quarter to a record $61.105 TN, with one-year growth of $3.062 TN.
Debt Securities ballooned $15.360 TN, or 33.6%, over the past 17 quarters.
Equities dropped $2.792 TN to $70.100 TN, with a one-year gain of $9.083 TN (14.9%) and a 17-quarter surge of $19.333 TN (38.1%).
Total (Debt and Equities) Securities ended Q3 at $131.206 TN, or 475% of GDP.
This compares to previous cycle peaks 387% (Q3 ’07) and 368% (Q1 2000).
With equities poised to gain upwards of $7 TN of market capitalization this quarter, ratios will only become more stretched.
The Household balance sheet is always central to Bubble Analysis.
While declining $1.162 TN for the quarter to $171.266 TN, Household Assets were up $8.739 TN over four quarters.
And with Liabilities gaining $574 billion y-o-y, Household Net Worth inflated $8.165 TN over the past year to $150.989 TN.
Integral to the ongoing economic expansion, Net Worth inflated $37.722 TN, or 33.3%, over the past four years.
At 546% (and going higher), Household Net Worth-to-GDP compares to previous cycle peaks 488% (Q1 ’07) and 444% (Q1 2000).
Household Financial Asset holdings jumped $6.433 TN over the past year to $112.424 TN, with Total Equities rising $4.576 TN to $39.088 TN.
At 407%, Household Financial Asset holdings-to-GDP compares to previous cycle peaks 373% (Q3 ’07) and 354% (Q1 2000).
Real Estate holdings gained $469 billion for the quarter to surpass $50 TN for the first time.
Real Estate holdings jumped $1.971 TN y-o-y and $17.003 TN, or 51.4% over the past four years.
Household combined holdings of Deposits, Money Market Funds, and Treasury & Agency Securities increased $157 billion during Q3 to a record $21.304 TN.
These holdings were up $1.123 TN y-o-y and $6.025 TN, or 39.4%, over the past four years.
Federal Reserve Assets dropped $589 billion during Q3 to $6.731 TN, with a one-year decline of $932 billion.
Treasury holdings were down $819 billion y-o-y to $4.367 TN, with Agency Securities dropping $295 billion to $2.026 TN. Federal Reserve Liabilities declined $301 billion during Q3 and $756 billion y-o-y to $7.995 TN.
After closing 2021 with positive “equity” of $164 billion (Assets of $8.911 TN less Liabilities of $8.747 TN), the Fed ended September with an unprecedented $1.264 TN deficit ($6.731 TN less $7.995 TN).
While the Fed has helped shield the markets from losses on Treasury and Agency securities, I wonder if the trillion-dollar hole in the Federal Reserve balance sheet will inhibit the next major QE program.
December 8 – Bloomberg (Christopher Anstey):
“Former Treasury Secretary Lawrence Summers said the Federal Reserve should hold off on a shift toward lowering interest rates until there’s decisive evidence showing that inflation is back under control or that the economy is entering a slump.
‘The moment they turn, or announce they’re going to turn, is going to be a seismic moment…
And for that reason, they probably need to be very deliberative and careful about getting to that point…’
‘These [payrolls data] were good numbers — they showed an economy that, at least as of November, was still looking pretty robust,’ Summers said.
The acceleration in wages ‘reinforces my sense that people need to be careful about declaring the war against inflation as having been won.’”
FOMC officials will next week update their Summaries of Economic Projections (“dot plot”).
They would be wise to avoid feeding the rate cut frenzy.
It’s interesting.
The marketplace is fixated on “soft landings” and the next easing cycle.
Meanwhile, history’s greatest speculative Bubble just continues to inflate seemingly without a care in the world.
The recent dramatic loosening of financial conditions is problematic on multiple levels.
The almost 10-point pop in the preliminary December reading of University of Michigan Consumer Expectations is evidence of the impact of loosening.
And markets snickered at Powell’s perfunctory push back.
It’s time for the Fed Chair to sideline abiding “Balanced Powell” – to show some gumption and regain control of the narrative.
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