Potential Catalyst and the Q1 2024 Z.1
Doug Nolan
Ominous.
Global risk off is gathering momentum, and there’s now a clear and present potential de-risking/deleveraging catalyst.
The NASDAQ100 gained 3.5% to close the week at an all-time high.
Nvidia surged another 9% this week, increasing y-t-d gains to 166%.
Nvidia’s market capitalization added about $270 billion this week to $3.244 TN.
Broadcom rose 23%, with Micron and Apple jumping 8%.
At this point, the U.S. equities Bubble has dodged so many bullets that there’s no longer a fear of guns.
June 10 – Financial Times (Leila Abboud):
“Emmanuel Macron has an oft-repeated catchphrase he uses behind closed doors with ministers and advisers: Il faut prendre son risque, you must be willing to take risks.
The president of France has done that in spades by calling for snap elections after his centrist alliance took a drubbing on Sunday from Marine Le Pen’s far-right Rassemblement National...
In doing so, he has again shown the daring that has marked his political career since he was elected as a little-experienced outsider in 2017.
‘I have confidence in the French people to make the right choice now to enable the country to face the great challenges ahead of it,’ he said…
The bet could also backfire spectacularly if the two-round vote on June 30 and July 7 forces him into a power-sharing government… with the RN.
It would be the first time under the fifth republic founded in 1958 for the president and prime minister to hold such diametrically opposite views on how the country should be run.”
No need to listen to me when I contend that these elections have potentially momentous ramifications.
But I wouldn’t dismiss market alarm.
Things are going haywire in the European bond market.
The spread between French (3.17%) and German (2.36%) 10-year government yields surged 29 this week to 77 bps, the largest widening in data back to the year 2000.
This was the first double-digit spread gain since the 11 bps widening in Covid crisis June 2020.
Spreads widened significantly throughout peripheral European bonds.
Italian spreads to bunds widened 23 to 157 bps, the largest weekly gain since December 2022.
Greek spreads widened 24 bps, Spain 21 bps, and Portugal 19 bps.
Amazingly, France’s yields ended the week within three bps of Portugal.
France’s CAC40 equities index was hammered 6.2%, with bank stocks under heavy selling pressure.
BNP Paribas sank 12% this week, with Credit Agricole down 11.0%.
Worry was not limited to France.
The Italian All-Share Banks Index was slammed 9.0%, while the European STOXX 600 Banks Index slumped 5.5%.
European (subordinated) bank CDS surged 31.5 to a six-month high 135 bps.
This was the largest increase since the U.S. bank crisis week of March 17, 2023.
European high yield/“crossover” CDS surged 42 to 332 bps, also the largest jump since the banking mayhem.
No reason to let a bout of European political turmoil get in the way of a historic stock mania.
But I’ll nonetheless note that U.S. bank CDS suffered their largest weekly price gains in two months (4-5 bps).
High yield CDS jumped nine Friday to a six-week high 347 bps, the largest daily increase since April.
Investment-grade CDS gained 2.6 Friday to a six-week high 53.8 bps, the biggest daily rise since April 15th.
U.S. bank stocks (BKX) dropped 2.6% this week (2-wk loss 4.2%), the largest weekly decline since the week of April 12th.
June 12 – Financial Times (Sarah White, Adrienne Klasa and Leila Abboud):
“Marine Le Pen’s big-spending, populist plans to help poorer and working class voters with tax cuts and promises to lower the retirement age may have been easy to tout when her French far-right party was in opposition.
Now the Rassemblement National is waking up to the reality that those economic pledges may be difficult to enact if it takes power following snap elections — and could turn into a ‘Liz Truss-style’ liability on the campaign trail.
Rivals from president Emmanuel Macron’s centrist party have already pounced, warning that a debt crisis like the UK gilt market turmoil in 2022 could ensue if they end up in a power-sharing situation with the RN…
Analysts have even said it could be worse: the impact from the RN’s spending would be twice as painful as what might have happened under Truss, blowing out France’s deficit to economic output ratio by an extra 3.9 percentage points a year, according to consultancy Asterès.”
June 14 – Reuters (John Irish and Elizabeth Pineau):
“France is facing a ‘very serious’ moment as parliamentary elections loom, said President Emmanuel Macron on Friday, with financial markets rattled by the country’s far-right and far-left political blocs currently leading polls…
‘We are at a very serious moment in the history of our country.
There are major issues at stake, with wars, and with unprecedented economic challenges,’ said Macron…
A first series of opinion polls have projected that the RN, which has promised to cut electricity prices and VAT on gas and increase public spending, could win the election and be in a position to run the government.
A poll conducted for Le Point magazine, published on Friday evening, forecast National Rally as in the lead in the first round of the parliamentary election, narrowly ahead of a coalition of left-wing parties called the ‘Popular Front’.”
“Le Pen Victory Threatens ‘Liz Truss-Style’ Debt Crisis in France.”
French election stakes are arguably much greater than the Truss fiasco.
The fledgling UK Prime Minister backtracked and resigned, and the gilts market soon recovered.
There will be no quick market fix if the extremists assume effective control of French policymaking.
Also, unlike the fleeting UK debt crisis, French election results have the potential to reverberate throughout the European debt markets and beyond.
According to reports, hedge funds have been huge buyers of at European debt auctions, often taking 20 to even as much as 50%.
Moreover, the great U.S. “basis trade” has purportedly taken hold in Europe.
So, it’s safe to assume that the European debt market, especially the periphery, is highly levered.
And this speculative leverage is on top of the typical vulnerability associated with European banks’ huge holdings of the region’s bonds.
The traditional “doom loop” of simultaneous gloom enveloping bonds and the banking system is today even doomier with the highly levered hedge funds so actively involved.
Let’s take the France vs. Liz Truss debt crisis comparison one stop further.
A UK debt crisis would never pose an existential threat to the British pound.
I’ve repeated over the years that I doubt the Germans and Italians will share a common currency indefinitely.
As far as I’m concerned, the jury is still out on the euro monetary experiment.
Indeed, I’ve expected a big global de-risking/deleveraging financial crisis would risk another euro crisis of confidence.
And don’t count on a Draghi “whatever it takes” massive monetary inflation to work such wonders the second go around.
The entire highly levered global speculative Bubble is at risk when euro sustainability fears materialize.
That the shock European Parliamentary Elections followed by a week the shock Mexico election boost the odds of problematic de-risking/deleveraging.
Levered EM “carry trades” were already under pressure.
This week, the Colombian peso dropped 5.0%, the Hungarian forint 2.6%, the Policy zloty 2.4%, the Chilean peso 1.5% and the Czech koruna 1.3%.
Ten-year Treasury yields sank 20 bps this week, despite a more hawkish leaning “dot plot” and Powell press conference.
The market ended the week pricing a 4.83% policy rate at the Fed’s December 18th meeting – or two full rate cuts – despite the median Fed forecast of only one.
“Treasury Yields Slide After Encouraging Inflation Data.”
It was more a case of German and U.S. yields sinking on urgent safe haven buying.
The “Periphery and Core” dynamic can be fascinating.
Heightened instability at the “Periphery” and attendant sinking “Core” Treasury yields bolstered the big tech speculative melt-up – even in the face of rising odds of a problematic global de-risking/deleveraging episode.
Such market dysfunction seems to ensure a particularly destabilizing adjustment if risk aversion takes hold.
And it’s a good time to remind yourself that contemporary global liquidity is “fungible.”
A deleveraging in EM “carry trades” coupled with European bond “carry” and “basis” trades would pressure liquidity globally, increasing the likelihood of contagion and broad instability.
There is now a near-term potential catalyst for the type of deleveraging that could trigger major instability and dislocation throughout the levered trades and derivatives universe, including the beloved “basis trade.”
June 14 – Bloomberg (William Horobin):
“A coalition of France’s left-wing parties presented a manifesto to pick apart most of President Emmanuel Macron’s seven years of economic reforms and set the country on a collision course with the European Union over fiscal policy.
The group — which unveiled its program days after Macron called a snap legislative election — wants to reverse the government’s pension reform, reinstate the right to retire at 60, raise the minimum wage, and impose an extra tax on the profits of certain industrial firms, their leaders told reporters Friday.
‘We will finance all of this very ambitious project by taking from the pockets of those who have the means to give,’ Socialist Party head Olivier Faure said.”
There was a lot going on this week, including Thursday’s release of the Q1 Z.1 report.
Over the years, I’ve often pondered how much time Fed officials spend with their own Credit data.
During the mortgage finance Bubble period, I could only assume they avoided the Z.1. Sifting through Thursday’s data deluge, I imagined FOMC officials around a table discussing the report.
It’s my imagination, and I took liberties.
Chicago Fed President Austan Goolsbee:
“Policy is working just as we expected.
A little slower perhaps, but we’re pretty much there.
I see proof of sufficiently restrictive policy everywhere.
Bank loans actually contracted during the quarter.
The pace of non-financial debt slowed for the third straight quarter.
The inflationary fuel has dissipated.”
Fed Governor Michelle Bowman:
“Don’t get too carried away Austan.
We all know that bank lending is a diminished force in the U.S. economy.
Overall Credit growth remains excessive.
Treasury deficit spending reduces the relevance of bank Credit.
Besides, the Wall Street securitization machine continues to operate in overdrive.”
Dallas Fed President Lorie Logan:
“The broker/dealers posted yet another strong quarter.
And the repo market continues to expand.
And why would corporations borrow from the banking system when conditions remain so easy throughout the debt markets?
I wish we had a better understanding of how hedge fund leveraging is impacting these markets.”
Philadelphia Fed President Patrick Harker:
“M2 barely expanded for the quarter.
Bank time and savings deposits flatlined during Q1.
Conditions are definitely tight.”
Richmond Fed Tom President Barkin:
“Come on Pat, this is 2024.
Money market fund assets continue to expand at a double-digit pace.
Market risk premiums and liquidity indicators suggest financial conditions remain loose.”
Fed Governor Lisa Cook:
“Tight conditions are biting households.
Consumer Credit expanded at a less than 2% pace.”
Kansas City Fed President Jeffrey Schmid:
“I don’t think our consumer data captures this “buy now pay later” phenomenon and these other new consumer financial intermediaries.
Finance companies continue their brisk growth.
Besides, the overall household sector is benefiting tremendously from higher rates on their cash holdings and from stock dividends.
Households are sitting on a record amount of liquid assets, and household net worth experienced another quarter of extraordinary gains.”
Atlanta Fed President Raphael Bostic:
“I don’t know about you all, but my annoyance is turning into frustration with these Wall Street talking heads saying we’re confused.”
Cleveland Fed President Loretta Mester:
“If you’re not confused, you don’t understand the problem.
Doesn’t Wall Street recognize they’re a big part of the problem?
They keep front running our shift to a less restrictive policy stance.
They loosen prematurely - and that stimulative effect works to delay our rate cuts.
If there is any inconsistency or indecision on our part, it’s because of the unpredictability of these markets.”
Minneapolis Fed President Neel Kashkari:
“I’m in agreement with Raphael and Loretta.
I’ve worked with some of these guys.
They make an art out of pressuring us to loosen policy to juice the markets, while framing the discussion as if they’re out to protect the interests of the working class.”
Fed Chair Powell:
“John, does your team see much potential impact from the outcome of the French elections?”
New York Fed President John Williams:
“Well, only exorbitant European market and economic repercussions would potentially effectuate R star (the neutral rate).”
Powell:
“The markets, John, the markets.”
Williams:
“I’ll get back to you on that.
We’ve had some turnover, and much of the staff is already off to the Hamptons.
But it is an interesting issue you raise.”
Non-Financial Debt (NFD) expanded at a seasonally adjusted and annualized rate (SAAR) of $3.339 TN during Q1 to a record $74.587 TN.
Q1 growth was down somewhat from Q4’s $3.429 TN - but up significantly from Q1 ‘23’s $2.639 TN.
For perspective, prior to Covid year 2020, 2007 held the record for NFD growth at $2.530 TN.
Total Household debt growth jumped to SAAR $578 billion from Q4’s $450 billion, with Mortgages increasing to SAAR $280 billion.
Total Business borrowings rose sharply to SAAR $834 billion (from Q4’s SAAR $136bn), with Corporate borrowings surging to SAAR $658 billion after Q4’s SAAR $16 billion contraction.
It was the strongest quarter of Corporate Credit growth since Q2 2022.
At SAAR $99 billion, Q1 posted the strongest State & Local Government borrowings back to Q2 2021.
And at SAAR $312 billion, Rest of World boosted borrowings in the U.S. at the briskest pace since Q3 2022.
And while all sectors increased borrowings during the quarter, it was the Federal Government that continues to power system Credit excess.
Federal borrowings expanded SAAR $1.828 TN (to a record $26.809 TN), down from Q4’s SAAR $2.878 TN - but up significantly from Q1 2023’s SAAR $1.195 TN.
Treasury Securities increased nominal $582 billion.
One-year Treasury growth of $2.527 TN (10.4%) matched record pre-Covid total system NFD growth.
Over 16 quarters, Treasury Securities inflated a staggering $7.208 TN, or 37.9%.
Since 2007, Treasuries have ballooned $20.757 TN, or 343%.
At $32.438 TN, Total Treasury Liabilities ended the quarter at a record 115% of GDP, up from 99% to end 2019 and 55% to conclude 2007.
GSE growth has slowed markedly.
After expanding $1.115 TN in the four quarters ended Q1 2023, Agency Securities basically flatlined during Q1 at $11.974 TN.
Combined Treasury and Agency Securities ended Q1 at a record $38.782 TN, or 137% of GDP.
With FHLB contracting $42 billion, GSE Assets declined $26 billion during Q1 to $9.315 TN.
Corporate Bonds expanded nominal $230 billion to a record $15.827 TN, with the strongest two-quarter growth ($543bn) since Q2/Q3 2021.
Non-Financial Bonds expanded $112 billion, the largest increase since Q1 2023.
Domestic Financial (i.e., bank and broker) Bonds gained $76 billion to a record $4.787 TN. ABS expanded another $22.2 billion, with growth at a 9.5% pace over three quarters (to a record $1.391 TN).
Broker/Dealers issued bonds at the strongest rate ($22bn) in two years.
Finance Company bonds expanded $35 billion to a record $1.114 TN, with one-year growth of $106 billion, or 10.6%.
Total Debt Securities expanded nominal $885 billion (6% annualized) to a record $59.986 TN, with one-year growth of $3.093 TN.
Debt Securities inflated $16.288 TN, or 37.3%, over 18 quarters.
Total Debt Securities ended the quarter at 212% of GDP, versus previous cycle peaks 194% at Q1 2008 and 147% to end 1999.
Equities inflated $6.470 TN during the quarter to a record $84.040 TN, with two-quarter growth of $13.477 TN (matching the gain from the 2020 Covid recovery).
Equities ballooned $15.255 TN, or 22.2%, over the past year, and $33.270 TN, or 65.5%, over 18 quarters.
Equities ended March at 297% of GDP.
This compares to previous cycle peaks 188% during Q3 2007 and 210% to conclude 1999.
Total (Debt and Equities) Securities surged $7.355 TN to a record $144.026 TN, with one-year growth of $18.349 TN (14.6%).
Total Securities ended the quarter at 510% of GDP, up from pre-Covid Q4 2019’s 454%, compared to previous cycle peaks 376% (Q3 2007) and 357% (Q1 2000).
Total Securities ballooned $59.558 TN, or 52.5%, over the past 18 quarters.
Broker/Dealer Assets expanded $282 billion, or 23% annualized, during Q1 to a record $5.158 TN.
Debt Securities holding surged $93.8 billion to a 14-year high $542 billion, with one-year growth of $121 billion, or 28.8%.
The Broker/Dealer Loans asset expanded $36.2 billion (to a six-quarter high of $688 billion), the strongest growth in 11 quarters.
The repo market continues to be the chief source of funding for Broker/Dealer securities holdings.
Repo Liabilities surged nominal $171 billion to a record $2.281 TN, with one-year growth of $262 billion, or 13.0%.
It’s worth noting that five-quarter growth of $655 billion is the strongest since the 2006/07 Bubble period.
Money Market Fund (MMF) Assets expanded $81 billion to a record $6.441 TN, with one-year growth of $748 billion, or 13.1%.
Treasury holdings surged $294 billion during the quarter, as MMF liquidated $284 billion of repo positions (winding down Fed reverse repo).
Money Fund Assets inflated an unprecedented $2.438 TN, or 51.2%, over 17 quarters, in one of history’s great monetary inflations.
Federal Reserve Assets declined nominal $320 billion to $6.473 TN, with a one-year contraction of $1.274 TN.
Treasury holding declined $227 billion to $4.176 TN, while Agencies shrank $92 billion to $2.029 TN.
Total Liabilities fell $291 billion to $7.482 TN.
The Fed’s Securities Repo Liability dropped $414 billion to $977 billion (down $1.766 TN y-o-y).
The Liability “Bank Reserves” jumped $211 billion to $3.346 TN
With the Fed winding down its Repo operation, the Total Federal Funds and Security Repurchase Agreements Assets declined $198 billion during Q1 to $6.709 TN.
Money Market Fund repo holdings contracted $284 billion to $2.382 TN (down $854bn y-o-y).
Meanwhile, Broker/Dealer repo borrowings jumped $171 billion for the quarter and $262 billion y-o-y.
ROW repo Liabilities were little changed for the quarter, but up a notable $461 billion over five quarters to $1.622 TN.
Excluding the Fed’s position, the repo market expanded $198 billion during the quarter to a record $4.981 TN, with five-quarter growth of $1.306 TN, or 36%.
The banking system balance sheet also exemplifies the dominance of securities finance.
Bank (Private Depository Institutions) Assets expanded $232 billion, or 3.5% annualized, during Q1 to a record $26.387 TN, with one-year growth of $262 billion, or 1.0%.
Loans actually contracted $35 billion for the quarter to $14.447 TN (up $308bn, or 2.2%, y-o-y).
Mortgages increased $30 billion, or 1.8% annualized, to a record $6.772 TN, while Consumer Credit contracted $58 billion, or 8.4% annualized, to $2.706 TN.
Meanwhile, Debt Securities holdings rose $113 billion, or 7.5% annualized, led by a $100 billion increase in Treasurys (to $1.615 TN) and a $46 billion jump in Corporate bonds (to $954bn).
Total Debt Securities holdings ballooned $1.490 TN, or 31.8%, over 17 quarters.
The Household Balance Sheet remains fundamental to Bubble Analysis.
Household Assets inflated $5.182 TN during the quarter to a record $181.429 TN.
And with Liabilities up $65 billion, Household Net Worth surged $5.117 TN to a record $160.844 TN.
Net Worth inflated $12.946 TN, or 8.8%, y-o-y; $24.457 TN, or 17.9%, over three years; and $50 TN, or 45.1%, over four years.
For the quarter, Real Estate holdings rose $907 billion to a record $49.997 TN, with three-year growth of $12.027 TN, or 31.7%.
Financial Asset holdings inflated $4.178 TN during Q1 to a record $122.516 TN, with Total Equities (Equities and Mutual Funds) surging $3.261 TN.
Total Equities ended March at 162% of GDP, up from pre-Covid (Q4 ’19) 143%, and the previous cycle peaks 104% (Q3 2007) and 116% (Q1 2000).
Household Net Worth ended Q1 at 569% of GDP, up from pre-Covid 537%, and the previous cycle peaks 488% (Q1 2007) and 444% (Q1 2000).
Household holdings of liquid assets (Treasuries, Agencies, Deposits and Money Funds) rose another $123 billion during Q1 to a record $21.859 TN.
These liquid assets inflated $897 billion (4.3%) over the past year; $3.441 TN (18.7%) over three years; and $5.398 TN (32.8%) over four years.
Rest of World (ROW) holdings of U.S. financial assets inflated $2.777 TN during Q1 to a record $50.897 TN.
Debt Securities increased $129 billion to a record $14.006 TN, with Treasuries rising $80 billion (to $8.136 TN) and Corporate Bonds gaining $60 billion (to $4.209 TN).
Debt Securities were up $1.054 TN over the four quarters (Treasuries $578bn, Agencies $122bn, Corporate $398bn).
Holdings of Total U.S. Equities jumped $1.240 TN to a record $15.744 TN.
Repo Liabilities added $3bn to a record $1.622 TN, with one-year growth of $350 billion, or 27.5%.
ROW holdings jumped $7.647 TN, or 17.7%, over the past year, and $14.934 TN, or 41.5%, over 15 quarters.
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