VALIDATING THE BUBBLE THESIS: Q2 2024 Z.1 / CREDIT BUBBLE BULLETIN

Validating the Bubble Thesis: Q2 2024 Z.1

Doug Nolan 

Up 10.0%, down 12.2%, down 1.3%, up 1.1%, up 9.8%, up 2.2%, down 9.7%, down 3.1% and down 8.8%. 

The past nine weeks of SOX performance. 

Nvidia: Up 15.8%, down 13.9%, down 7.7%, up 3.8%, up 19.8%, down 2.3%, down 5.1%, down 4.1%, and down 8.8%. 

Nasdaq100: Up 5.9%, down 5.9%, down 0.7%, up 1.1%, up 5.4%, up 0.4%, down 3.1%, down 2.6%, and down 4.0%. 

Small Cap Russell 2000: Up 4.4%, down 5.7%, unchanged, up 3.6%, up 2.9%, down 1.3%, down 6.7%, up 3.5%, and up 1.7%.

Benchmark MBS yields are down 38 bps so far in September (9 sessions) – and 120 bps since July 1st (to a 19-month low). 

Two-year Treasury yields have dropped 34 bps in nine sessions – and 117 bps so far in Q3. 

The implied rate for the December 2025 policy rate has dropped 30 bps in nine sessions to 2.84%.

Quarter-to-date, the yen has gained 14.2% versus the dollar, with the Swiss franc up 5.9%, the Singapore dollar 4.5%, the British pound 3.8%, the Swedish krona 3.6%, and the euro 3.4%.

Before our deep dive into data from the Fed’s Q2 Z.1 “flow of funds” report, I wanted to provide some color on the extraordinarily unstable market environment. 

The Fed will cut rates at next week’s meeting. 

Market pricing has even odds on 25 or 50 bps. 

Wall Street is cheerleading for a big cut.

Ahead of forecasts yet again, $38 billion of investment-grade corporate bonds were issued this week - following last week’s blockbuster $80 billion. 

The corporate debt market is overheated. 

August daily Treasury trading volume surged 19% month-over-month to a record $1.01 TN (from Bloomberg Intelligence’s Brian Meehan).

September 13 – Bloomberg (Catherine Bosley and Katia Dmitrieva): 

“Former Federal Reserve Bank of New York President William Dudley said there’s scope for a half-point rate cut at the central bank’s meeting next week. 

‘I think there’s a strong case for 50,’ Dudley said… ‘I know what I’d be pushing for…' 

The former Fed member cited a slowing US labor market, with risks to jobs greater than lingering challenges to inflation in supporting his call for a half-point reduction.”

Let the record show that Gold surged $80, or 3.2%, this week to a record high $2,578 – boosting 2024 gains to 25%. 

Silver surged 10% this week to $30.719, with y-t-d gains of 29.1%. 

Platinum rose 8.0% this week, with Copper rallying 4.0%, Palladium 16.9%, Zinc 6.9%, and Aluminum 5.5%. 

The S&P500 has returned 19% y-t-d.

The case for 50 is weak. 

I’d be pushing for no cut. 

Financial conditions are dangerously loose for an extraordinarily speculative market environment. 

The risk of stoking Bubble excess outweighs immediate economic risks, especially with lower market yields and loose conditions likely in the near-term to support economic activity. 

The unemployment rate is only 4.2%, while weekly unemployment claims remain depressed historically. 

Ongoing strikes (i.e., Boeing) and labor settlements (i.e., AMR and Amazon) point to labor bargaining power and persistent wage pressures. 

Services PMI (55.7) and ISM (51.5) data indicate ongoing expansion. 

The Atlanta Fed GDPNow forecast has ticked up to 2.47%. 

With 30-year mortgage rates down 120 bps in four months – to a 19-month low – we should expect a boost to housing activity (Homebuilding ETF up 25% y-t-d).

There are two discordant perspectives for viewing the Q2 Z.1 report. 

Non-Financial Debt (NFD) expanded at a 4.73% rate during Q2, up from Q1’s 4.49%, but below 2023’s 5.12%. 

Household debt expanded at a 3.15% pace (up from Q1’s 2.76%), Corporate 4.56% (vs. 5.09%), and the Federal Government 6.31% (vs. 6.20%). 

Business as usual. 

Nothing to see here.

From the Bubble perspective, there’s a lot to see – if you’re looking in the right places. 

Unrelenting growth in government debt, intermediated through “repos,” the money market fund complex, the Securities Broker/Dealers, and the Rest of World (ROW). 

Unprecedented speculative leverage that creates both demand for securities and liquidity for asset inflation and history’s greatest Bubble. 

A historic Bubble in government debt issuance that has fueled asset Bubbles and massive inflation in perceived household wealth, along with ongoing elevated incomes and spending.

On a seasonally-adjusted and annual basis (SAAR), Non-Financial Debt (NFD) expanded $3.522 TN, up from Q1’s $3.311 TN – and compared to 2023’s $3.590 TN. 

For perspective, prior to 2000’s record $6.796 TN, 2007’s $2.534 TN had held the record for annual growth in NFD for years.

Treasury Securities expanded SAAR $1.640 TN during Q2. 

Also SAAR for the quarter, the Household sector purchased Treasuries to the tune of $1.041 TN, Rest of World $408 billion, Money Market Funds $248 billion, and Insurance Companies $306 billion. 

Buying power everywhere. 

Meanwhile, the Fed liquidated its Treasury holdings SAAR $664 billion.

Treasury Securities inflated $2.131 TN over the past year to a record $26.903 TN. 

Treasury Securities inflated $3.650 TN (15.7%) over two years and $10.274 TN, or 61.8%, over 18 quarters - in one of history’s great debt inflations. 

Over 18 months, Treasury Securities-to-GDP rose from 76% to 94%. 

For comparison, this ratio ended the nineties at 33% and 2007 at 31%.

Agency Securities gained $84 billion during Q2 to a record $12.058 TN. 

Agency Securities inflated $1.047 TN (9.6%) over two years and $2.628 TN, or 27.9%, over 18 quarters. 

Combined Treasury and Agency Securities expanded $12.902 TN, or 49.5%, over 18 quarters in a historic inflation of government finance (rising to 136% of GDP).

Q2 Federal Receipts inflated 10.7% y-o-y to $5.084 TN, with Federal Expenditures up 6.9% y-o-y to $6.684 TN. 

Compared to Q2 2019, receipts were up 37.2% and expenditures 41.1%. 

State & Local Receipts were 4.1% higher y-o-y to $3.702 TN, with expenditures 5.3% higher to $3.928 TN. 

S&L Receipts were 33.5% higher than Q2 2019, with expenditures 33.3% greater.

Money Market Fund Assets (MMFA) gained another $107 billion during the quarter, to a record $6.547 TN. 

MMFA inflated $630 billion, or 10.6%, over the past year, and a blistering $2.545 TN, or 53.4%, over 18 quarters.

MMF “repo” (repurchase agreements) holdings surged $232 billion during the quarter to $2.614 TN. 

Holdings of Treasuries declined $114 billion to $2.450 TN. 

Fed data categorize money funds as “government” ($5.226 TN), “prime” ($1.188 TN), or “tax exempt” ($133bn). 

“Government” MMFA rose $312 billion during the quarter and $629, or 13.7%, over the past year. 

This growth has corresponded with even stronger growth in “repo” holdings. 

Over 18 quarters, “government” MMFA inflated $2.443 TN, or 65%. 

It’s worth noting that growth has accelerated so far in Q3, with MMFA expanding over $200 billion during the past 10 weeks.

Broker/Dealer Assets expanded $26.4 billion during Q2 to $5.185 TN, the highest level since fateful Q3 2008. 

The composition of growth is notable. Debt Securities declined $10.8 billion (Agencies down $17.1bn) to $531 billion, and Misc. 

Assets contracted $33.6 billion to $1.790 TN. Meanwhile, “Repo” Assets jumped $48.4 billion (11.7% annualized) to $1.709 TN (high since Q3 2008). On the Liability side, “Repo” borrowings surged $98.8 billion (17.3% annualized), with notable one-year growth of $325 billion, or 15.8%. 

Repo borrowings ended the quarter at $2.380 TN, also the high back to Q3 2008.

Total system “Repo” (“Federal Funds and Security Repurchase Agreements”) Assets surged $272.5 billion during the quarter to $6.982 TN. 

Repo Assets inflated $2.164 TN, or 44.9%, over the past 18 quarters. 

The Fed established a “repo” program to accept financial flows from non-bank entities (chiefly money market funds). 

After ending 2022 at a record $2.890 TN, the Fed’s “Repo” Asset was down to $1.053 TN by the end of June (up $76bn for the quarter).

To get a cleaner look at the growth dynamics of conventional system “Repo,” I subtract the Fed’s position from Total “Repo”. 

“Repo – Ex-Fed” jumped $194 billion (15.6% annualized) during Q2 to a record $5.157 TN. 

“Repo Ex-Fed” expanded $606 billion, or 13.3%, over the past year – and $1.170 TN, or 29.3%, since the Fed announced the restart of QE in the summer of 2019.

Rest of World (ROW) is an important piece of the puzzle. 

ROW holdings of US Financial Assets inflated $1.401 TN during Q2 to a record $53.663 TN – with one-year growth of $7.231 TN, or 15.6%. 

ROW holdings ballooned $14.947 TN, or 38.6%, over the past 15 quarters. 

It’s worth noting that ROW holdings inflated from Q4 2003’s $10.088 TN to a mortgage financial Bubble peak $17.466 TN to end March 2008. 

Over this period, “Repo” Assets surged from $494 billion to Q2 2007’s Bubble peak $1.237 TN – as global banks became key players in financing U.S. leveraged speculation.

And while ROW “Repo” Assets have inflated to a record $1.373 TN, “Repo” Liabilities have ballooned to an unprecedented $1.644 TN. 

Repo Liabilities increased $37 billion (9.1% annualized) during Q2, with one-year expansion of $223 billion (15.7%) and 15-quarter growth of $438 billion, or 36.3%. 

It’s worth noting that ROW “Repo” Assets inflated $513 billion, or 59.6%, over 15 quarters.

Total Debt Securities increased $850 billion during Q2 and $3.065 TN over the past year – to a record $60.261 TN. 

Debt Securities inflated $16.231 TN, or 37.1%, over 18 quarters. 

Equities Securities inflated $6.437 TN during the quarter, with one-year growth of $15.172 TN, or 22.1%. 

Equities ballooned $33.181 TN, or 65.4%, over 18 quarters. 

Total (Debt and Equities) Securities inflated $7.287 TN during the quarter and $18.237 TN over the past year – to a record $145.992 TN. 

Total Securities rose to 510% of GDP. 

This compares to previous cycle peaks 375% (Q3 2007) and 357% (Q1 2000). 

In a key Bubble dynamic, Total Securities inflated $49.411 TN, or 52.3%, over 18 quarters. 

Total Securities were at 439% of GDP before the Fed restarted QE in Q3 2019.

Household Total Assets jumped $2.938 TN for the quarter to a record $184.526 TN, with one-year growth of $11.403 TN. 

Household Assets ended 2019 at $133.309 TN. 

Household Liabilities increased $177 billion during Q2 to a record $20.729 TN, with one-year growth of $591 billion. 

For the quarter, Household Net Worth (assets minus liabilities) surged $2.760 TN to a record $163.797 TN, with four-quarter growth of $10.812 TN. 

Household Net Worth has inflated $46.586 TN, or 40%, since the end of 2019 (18 quarters). 

Net Worth ended June at 572% of GDP, up from 2019’s 535%, and the previous cycle peaks 488% (Q1 2007) and 444% (Q1 2000).

Household Real Estate holdings inflated $1.752 TN during the quarter to a record $52.319 TN (one-year growth $3.007 TN). 

Real Estate ended June at 183% of GDP, up from the end of 2019’s 153% - and now only moderately below the mortgage finance Bubble peak 190% (Q3 2006).

Household Financial Asset holdings inflated another $1.134 TN to a record $123.238 TN, with one-year growth of $8.180 TN. 

Financial holdings ended 2019 at $93.937 TN. Financial Holdings ended the quarter at 430% of GDP, versus previous cycle peaks of 373% (Q3 2007) and 354% (Q1 2000).

Household Debt Securities holdings jumped $276 billion to a record $6.199 TN. 

Debt Securities jumped $693.5 billion (12.6%) over the past year and $2.983 TN, or 93%, over three years. 

Treasuries increased $104 billion (one-year $359bn) to a record $2.748 TN, and Agencies gained $127 billion ($205bn) to a record $1.401 TN. 

Over three years, Treasury holdings surged $2.220 TN, or 421%, with Agencies up $865 TN, or 161%. 

Meanwhile, Total Deposits declined $141 billion during Q2 to $14.259 TN (up $40bn y-o-y).

Total Equities (Equities & Mutual Funds) inflated $512 billion (one-year $5.529 TN) to a record $45.989 TN. 

Total Equities inflated $14.665 TN, or 47%, since the end of 2019. 

Total Household Equities holdings-to-GDP ended June at 161%, versus previous cycle peaks 105% (Q2 2007) and 115% (Q1 2000). 

Money Market Fund holdings increased $68 billion to a record $4.128 TN, with one-year growth of $503 billion. 

Money Fund holdings inflated $1.359 TN, or 49%, over the past 12 quarters. Household holdings of Deposits, Treasuries, Agencies, and Money Market Funds inflated $6.895 TN, or 44.1%, over 18 quarters.

Virtually a sideshow, Bank (“Private Depository Institutions”) Assets declined $137 billion from Q1’s record level to $27.717 TN, with most of the decline explained by a reduction in “Interbank Assets.” 

Loans expanded by a notable $176 billion (4.9% annualized) to a record $14.621 TN, the largest gain since Q4 2022. 

Consumer Credit rose $33 billion (4.8% annualized) to a record $2.739 TN. 

On the Liability side, Total Deposits declined $91 billion to $13.576 TN. 

Meanwhile, “Repo” Liabilities rose $52 billion to $871 billion (high since Q2 2009).

Credit Union Assets contracted $5 billion to $2.310 TN – with one-year growth of $87 billion, or 3.9%. 

Finance Companies Assets increased $17 billion over the quarter and $180 billion, or 7.3%, over the past year – to $2.655 TN. 

Credit Union and Finance Companies Assets inflated 50.6% and 73% over 18 quarters.

It’s a precarious backdrop for the Fed to begin aggressively slashing rates. 

The bond market is demonstrating speculative melt-up dynamics, surely fueled by rapid expansion of “basis trade” and “carry trade” leverage. 

At the same time, it’s not unreasonable that the Fed would prefer to get out ahead of mounting financial instability. 

The dollar/yen closed the week at 140.85, as the yen rally surpassed August 5th levels. 

Yen “carry trade” vulnerability persists, while the AI/tech Bubble teeters.

Whether the Fed cuts 50 or 25, acute global instability seems to suggest markets are moving toward some type of accident. 

And by the action of Treasuries, MBS, Gold and Silver, markets seem to buy into the analysis that the Fed and central bank community are trapped by Bubble fragilities – with more QE inevitable.