Q1 2018 Z.1 FLOW OF FUNDS / CREDIT BUBBLE BULLETIN

Q1 2018 Z.1 Flow of Funds

Doug Nolan


The first-quarter 2018 Z.1 "flow of funds" report can be viewed in two ways. From one perspective, key conventional data are un-extraordinary. Household debt expanded at a 3.3% rate during the quarter, down from Q4's 4.6%. Home Mortgage borrowings slowed from 3.4% to 2.9%. Total Business debt grew at a 4.4% pace, unchanged from Q4 and down from Q1 '17's 6.1%. Financial sector borrowings were little changed, after expanding 1.6% during Q4. Bank lending was, as well, unremarkable.

From another perspective, extraordinary Credit growth runs unabated. Total System (non-financial, financial and foreign) Credit expanded at a (record) seasonally-adjusted and annualized rate (SAAR) of $3.513 TN during 2018's first quarter, compared to Q4's SAAR $1.411 TN and Q1 '17's SAAR $860 billion. This booming Credit expansion was fueled by an SAAR $2.519 TN increase of federal borrowings. Granted, this was partially a makeup from Q4's slight contraction in federal debt growth.

In nominal dollars, Total U.S. System Credit expanded a blazing $962 billion during Q1 to a record $69.717 TN (349% of GDP). Non-financial Debt (NFD) expanded a record (nominal) $874 billion, with one-year growth of $2.413 TN. One must return to booming 2007 for a larger ($2.508 TN) four quarter-period of Credit expansion. NFD ended Q1 at a record $49.831 TN, matching a record 250% of GDP. NFD expanded $4.086 TN over the past two years, the strongest expansion since '07/'08.

Outstanding Treasury Securities ended Q1 at a record $17.046 TN, increasing a nominal $615 billion during the quarter. Treasury Securities jumped $1.172 TN during the past four quarters and $1.669 TN over two years. Outstanding Treasury Securities has increased $10.995 TN, or 182%, since the end of 2007. Treasury debt-to-GDP ended Q1 at 85%, more than double 2007's 41%. It's worth adding that total Treasury and Agency Securities ended Q1 at a record $25.920 TN, or 130% of GDP.

Not coincidently, the historic securities boom also runs unabated. Total Debt Securities (TDS) expanded $789 billion during the quarter to a record $43.868 TN. TDS began 2000 at $15.606 TN and closed 2007 at $28.828 TN. TDS ended Q1 at a near record 220% of GDP, up from 2007's 200%. Equities ended Q1 at $45.156 TN, or a near-record 226% of GDP. Equities-to-GDP posted cycle peaks of 181% in Q3 2007 and 202% in Q1 2000. Total (Debt and Equity) Securities ended Q1 at a record $89.024 TN, or 446% of GDP. For comparison, Total Securities were at 379% to end Q3 2007 and 359% at Q1 2000. When it comes to the perceived wealth of U.S. securities markets, "Off the Charts," as they say.

The ballooning Household Balance Sheet continues to be a key Bubble metric. Total Household (and Non-Profits) Assets ended Q1 at a record $116.343 TN, gaining $1.072 TN for the quarter. Household Assets were up $7.169 TN in four quarters and $14.955 TN over two years. Q1 saw Real Estate assets increase $490 billion (y-o-y up $1.868 TN) and Financial Assets gain $511 billion (y-o-y up $5.054 TN). With perceived wealth inflating so rapidly, why would spending not be strong?

Household Liabilities increased $44 billion for the quarter ($538bn y-o-y) to $15.574 TN. Household Net Worth (Assets less Liabilities) surged $1.028 TN during Q1 - surpassing $100 TN ($100.77 TN) for the first time. Household Net Worth inflated $6.630 TN (7.0%) in four quarters and a stunning $13.959 TN (16.1%) the past two years. Household Net Worth-to-GDP, a key stat in Bubble Analysis, ended Q1 at a record 505% of GDP. For comparison, this ratio ended the seventies at 342%, the eighties at 378%, the nineties at 445% and 2007 at 459%. A bonus stat: Household Net Worth ended Q1 about 50% higher than the peak from Q2 2007 ($67.744 TN).

Such an historic inflation requires extraordinary monetary fuel. Today's monetary inflation is unconventional and, candidly, rather convoluted. Commercial Banks ("Private Depository Institutions") expanded (financial assets) SAAR $1.139 TN during the quarter. But of this, SAAR $632 billion was an increase in Reserves at the Fed. Loans expanded SAAR $429 billion, down from Q4's $537 billion and the slowest growth in four quarters. To be sure, there's nothing conventional about this Bubble.

International flows have played a major role in the prolonged U.S. boom. Rest of World (ROW) holdings of U.S. financial assets increased SAAR $753 billion to a record $26.901 TN. This was up from Q3's $535 billion but below typical levels from recent years. After reducing holdings by SAAR $228 billion during Q4, ROW added to Treasuries by SAAR $302 billion in Q1. ROW increased Agency and GSE MBS by a notably large SAAR $130 billion. Also funneling liquidity into U.S. securities markets, ROW increased U.S. Corporate Equities SAAR $192 billion. ROW assets have expanded $13.152 TN since the end of 2008, or 96%. ROW holdings ended the nineties at $5.621 TN.

The Security Broker/Dealers expanded assets SAAR $225 billion to $3.273 TN (high since Q2 '09), although this growth was basically in "Miscellaneous Assets" (to a 14-quarter high $881bn). There was a big (SAAR $283bn) drop in Security Repo assets, with an even larger (SAAR $350bn) gain in Security Repo liabilities. Broker/Dealers expanded Treasury holdings SAAR $84 billion during the quarter.

Wall Street off-balance sheet "Funding Corps" increased financial asset holdings by a notable SAAR $458 billion (second-largest increase since 2008) to $1.804 TN, the highest level since 2009. Funding Corp assets have surged nominal $418 billion in two years, or 27% (four-year growth of 47%). Reminiscent of 2006/07.

We know that corporations have been returning about $1.0 annually to shareholders (buybacks and dividends). What's more, corporations are now benefitting from a dramatic reduction in taxes. This was apparent in Q1 data. Non-financial Corporate Businesses paid taxes at SAAR $165 billion, down from Q1 '17's $278 billion. Corporate Checkable Deposits and Currency jumped another $50 billion during the quarter to $1.193 TN. It is not obvious in the data what impact repatriation of overseas assets is having, but it could be influencing U.S. market liquidity (at the expense of foreign U.S. dollar securities liquidity).

Federal Tax Receipts were reported at SAAR $3.478 TN during Q1, down $110 billion, or 3.1%, from Q1 '17. Meanwhile, federal Expenditures increased $146bn, or 3.4%, to a record SAAR $4.388 TN. Federal Government Total (excluding contingent) Liabilities jumped nominal $492 billion during Q1 to a record $19.696 TN (99% of GDP). State and Local Government Liabilities expanded a notable $130 billion during Q1, explained by rapid growth in "Claims of Pension Fund or Sponsor."

A few miscellaneous categories are deserving of brief mention. Credit Unions expanded assets by nominal $61.5 billion, or 18% annualized, during the quarter to a record $1.404 TN. Open Market Paper surged nominal $82.6 billion, or 34% annualized, to $1.049 TN (almost seven-year high). Checkable Deposits & Currency jumped $137 billion, or 13% annualized - and surged $402 billion, or 10.2%, over the past year - to a record $4.352 TN. Time & Savings Deposits expanded $206 billion, or 7% annualized - and $363 billion, or 3.2%, in four quarters - to a record $11.899 TN. Awash in cash, the growth in outstanding Corporate Bonds slowed to $104 billion, or 3.2%, to $13.055 TN (up $627bn, or 5.0%, y-o-y). Led by an SAAR $159 billion increase in "World Equity Funds," ETF holdings expanded SAAR $250 billion during Q1 to a record $3.411 TN.

Bank Loans expanded SAAR $429 billion during Q1, about in line with the average over the past eight quarters. Keep in mind that this amounts to only 12% of the SAAR $3.513 TN Q1 expansion of Total System Credit. Back in the four-year boom period 2004 through 2007, Bank Loans increased quarterly on average SAAR $670 billion. More than ever before, market-based finance dominates. And while everyone marvels at the wondrous U.S economy these days, I would warn of serious and mounting vulnerability to a market liquidity event.

Again this week, no end in sight for EM liquidity challenges. The South African rand dropped another 2.9%, the Mexican peso 1.7% and the Argentine peso 1.4%. Central banks were forced to aggressively hike rates in defense of dislocating currencies in Turkey and Brazil. The Turkish lira rallied 3.9%. Friday's wild 5.3% rise in Brazil's currency, erased earlier losses (two-year lows against the dollar) and saw the real muster a 1.5% gain for the week. Brazilian stocks sank 5.6% this week, with one-month losses of 14.4%.

Global market instability was not limited to EM. Italian 10-year yields surged 44 bps this week to 3.13%. Italian two-year yields jumped 66 bps to 1.67%. Italy's bank stocks were slammed 6.5% this week. Portuguese 10-year yields rose 18 bps to 2.06%, and Greece yields gained 18 bps to 4.65%. Up three bps to 1.47%, Spanish yields were relatively well-behaved.

The ECB signaled it will discuss a QE exit strategy at next week's meeting. For Italy, and to a lesser extend the Eurozone periphery, this is untimely news. Perhaps there is some recognition in the global central banking community that dollar strength now poses acute risk to the faltering EM Bubble. A more hawkish ECB and stronger euro takes some of the gas out of the appreciating dollar. It also risks taking more air out of the European bond Bubble. Even at the eurozone's "core", German 10-year yields rose six bps (to 45bps) this week and French yields jumped 11 bps (to 82bps). The ECB faces quite a dilemma.

Here at home, there's a speculative Bubble problem in U.S. equities. Reminiscent of Q1 2000, there is a heck of a short squeeze and derivative-related melt-up in the face of a deteriorating global backdrop. The S&P500 rose 1.6% and the Mid Caps jumped 2.2% this week, but these gains don't do justice to some of the pain being meted out on the short side. The retail sector (XRT) jumped 6.3% this week. The S&P Department Store index spiked 11.5%. With almost 39 million shares short, Tesla surged 26 points (8.9%) in five sessions. Other notable short squeezes included Five Below (41.7%), Endo Intl (21.8%), Under Armour (15.9%), Williams-Sonoma (13.5%), Twitter (12.4%), Macy's (12.2%), Wendy's (10.1%) and JD.Com (10.6%) - to name only a few. When the marketplace is transfixed by a short squeeze, little else matters.

An overheated economy and highly speculative equities market should weigh on the FOMC during Tuesday and Wednesday's meeting. And a potentially critical ECB meeting comes Thursday. Currency instability, fragile EM and European periphery and a Bubbling U.S. create quite a challenge for our global monetary commanders. Cracks in the global Bubble have markets betting central bankers don't have the guts to normalize.

And there's this weekend's Trump Tariff focused G7 ("G6 plus the U.S.") meeting in Quebec, followed by Tuesday's Trump/Kim summit in Singapore. Prospects for a breakthrough with North Korea seem brighter than on the trade front. After Singapore, attention will turn to U.S. and Chinese trade negotiations. It's bound to get interesting.

June 8 - Reuters (Ben Blanchard and Denis Pinchuk): "Chinese President Xi Jinping gave visiting Russian President Vladimir Putin China's first friendship medal on Friday, calling him his best friend, underscoring the close ties between the two despite deep reservations many Western nations have of Putin. Meeting in Beijing's Great Hall of the People, Xi lauded their relationship. 'No matter what fluctuations there are in the international situation, China and Russia have always firmly taken the development of relations as a priority,' Xi told Putin at the start of their formal talks."