RISK OFF AND Q2 ´23 Z.1 / CREDIT BUBBLE BULLETIN

Risk Off and Q2 '23 Z.1

Doug Nolan 

Global market “risk off” is gathering momentum. 

China’s currency weakened another 1.06% versus the dollar this week to the weakest level since 2007. 

The Chilean peso dropped 5.0%, the Polish zloty 3.9%, the Mexican peso 2.9%, and the Czech koruna 1.9%. 

Trouble, characteristically, manifests first at the “periphery.”

Mexico’s local currency 10-year yields jumped 19 bps to 9.53%, the high since October. 

Yields were up 18 bps in Indonesia (6.52%), 16 bps in Brazil (11.30%), and 12 bps in South Africa (11.91%). 

EM dollar bonds were under heavy selling pressure. 

Yields jumped 24 bps in Colombia (7.79%), 20 bps in Peru (5.54%), 19 bps in Mexico (5.89%), 15 bps in Chile (5.33%), 15 bps in Russia (18.91%), and 14 bps in the Philippines (5.10%).

Global bond market liquidity appears increasingly under the grips of deleveraging.

September 7 – Dow Jones: 

“China's foreign-exchange reserves dropped in August amid a weakening yuan, according to… the People's Bank of China… Forex reserves fell $44.17 billion in August to $3.160 trillion… The result was slightly lower than the median forecast of $3.184 trillion made by economists…”

September 8 – Bloomberg: 

“China’s short-end government bonds are closing in on their biggest weekly drop this year, caught in a downdraft that’s swept up virtually all of the nation’s assets. 

The yield on one-year yuan securities has jumped 13 bps since Sept. 1, with analysts blaming the increase on dwindling liquidity and waning bets for broad-based easing. 

Interbank funding costs have shot up, reflecting the tightening cash conditions… 

Liquidity is drying up as analysts expect investors to mop up as much as $109bn of special bond issuance this month. 

Banks are less willing to lend to each other in September as they prepare for regulatory checks at the end of the quarter… 

All this is exerting upward pressure on funding costs. 

The overnight repo rate soared 23 bps this week to 1.90%...”

And despite mounting global stress, Treasuries yields are pulled higher. 

Ten-year Treasury yields gained nine bps this week to 4.26%, with benchmark MBS yields rising 11 bps to 6.00%.

September 7 – Bloomberg (Jonnelle Marte): 

“Federal Reserve Bank of New York President John Williams said US monetary policy is ‘in a good place,’ but officials will need to parse through data to decide on how to proceed on interest rates. 

‘I think we’ve gotten monetary policy in a very good place in terms of we have a restrictive stance of policy,’ Williams said… 

The New York Fed chief said policy is having the desired effects of bringing demand and supply more into balance and easing inflation, adding that the Fed has ‘done a lot’ by raising interest rates significantly.”

I often ponder how closely Fed officials “parse through” their Z.1 report. 

Friday’s release of Q2 Credit and flow data made for interesting parsing. 

Seasonally adjusted and annualized Credit growth of about $4.5 TN. 

One-year Treasury debt expansion of about $1.7 TN. 

Non-Financial Debt-to-GDP exceeding previous cycle peak levels. 

The ratio of Total Debt Securities-to-GDP is significantly higher than prior peaks. 

Household holdings of Financial Assets above previous peak levels. 

Household Net Worth inflating $5.5 TN in three months. 

Household Equities holdings as a percentage of GDP higher than previous cycle peaks. 

Analyzing the data, I don’t see our system in a “very good place.”

Non-Financial Debt (NFD) expanded at a 6.34% rate during Q2, up from Q1’s 3.78% to the strongest pace of Credit growth since Q1 2022 (8.34%). 

As has become commonplace, system Credit expansion was driven by heady growth in federal borrowings. 

Federal Debt expanded at a 12.67% pace, the strongest growth since the crazy Q2 2020 pandemic borrowing binge (64.61% annualized). 

Household borrowings expanded at a 2.73% rate, up from Q1’s 2.40% - but less than half of Q2 2022’s 6.89%. 

Corporate borrowings slowed from Q1’s 4.95% to 2.06%, the weakest reading since the pandemic. 

And after back-to-back quarters of annualized double-digit growth, Financial Sector borrowings contracted at a 6.36% rate.

In seasonally-adjusted and annualized dollars (SAAR), NFD expanded $4.445 TN during Q2, up from Q1’s $2.625 TN. 

For perspective, NFD expanded $2.433 TN during (pre-Covid) 2019, while averaging $2.032 TN annually during the decade 2010 through 2019. 

Prior to 2020’s $6.764 TN, the mortgage finance Bubble period’s $2.506 TN 2007 expansion was the all-time high. 

At 266%, NFD as a percentage of GDP exceeds previous peak levels 228% (Q4 2007) and 186% (Q1 2000).

Federal borrowings expanded SAAR $3.440 TN during Q2, second only to Q2 2020. 

Household Borrowings increased SAAR $532 billion, with Corporate borrowings up SAAR $266 billion.

In nominal dollars, system Credit expanded $795 billion during Q2 to a record $96.327 TN, with NFD expanding $1.111 TN (to $71.248 TN), while Financial borrowings contracted $329 billion (to $20.350 TN) (Foreign borrowings were little changed). 

System Credit posted one-year growth of $4.193 TN, or 4.6%. 

Over the 14 quarters since the onset of the pandemic, System Credit has surged $21.457 TN, or 28.7%. 

NFD has inflated $16.722 TN, or 30.7%, since the pandemic - and has doubled (plus $35.675 TN) since 2008.

Total Mortgages expanded nominal $158 billion during the quarter, up from Q1’s $143 billion - but less than half of Q2 ‘22’s $422 billion. 

Total Mortgages expanded $894 billion over four quarters (4.7%), with three-year growth of $3.351 TN, or 20.3%. 

Home Mortgages expanded $2.263 TN over the past three years, or 19.7%. 

Multifamily Mortgages expanded $61.6 billion, or 11.9% annualized, during Q2, with one-year growth of $153 billion, or 7.7%. 

Over three years, Multifamily Mortgages expanded $420 billion, or 25.2%, with Commercial Mortgages increasing $579 billion, or 19.0%.

Bank (“Private Depository Institutions”) Assets contracted (nominal) $233 billion during Q2 to $25.865 TN, a sharp reversal from Q1’s $506 billion expansion - but a slightly smaller contraction than Q2 ‘22’s $251 billion. 

Reserves at the Fed declined $137 billion (to $3.047 TN) and Debt Securities holdings fell $159 billion ($6.128 TN). 

Treasury Securities holdings declined $59 billion (to $1.434 TN), Agency/MBS dropped $78 billion ($3.167 TN), and Corporate Debt holdings were little changed ($968 billion).

Bank Loans expanded $101 billion (2.9% annualized) during Q2 to a record $14.239 TN, up from Q1’s $86 billion, but down significantly from Q2 2022’s $549 billion. 

Bank Loans expanded $893 billion over the past four quarters. 

For perspective, Bank Loans expanded on average $363 billion annually over the 20-year period 2000 through 2019 and $466 billion over the decade ended 2021. 

For the quarter, Mortgage Loans increased $64 billion (3.9% annualized) and Consumer Credit rose $44 billion (6.7% annualized) – with other loans (including business) posting a small contraction.

Things are a little more interesting on the liability side of the Bank balance sheet. 

Total Deposits contracted $77 billion during Q2, less than Q1’s $428 billion decline, Q4 ‘22’s $140 billion, Q3 ‘22’s $179 billion, and Q2 ‘22’s $257 billion. 

Despite five straight quarterly declines, Total Deposits were still up a whopping $4.662 TN, or 30.0%, over the past 14 quarters.

Following Q1’s gangbusters $433 billion, Broker/Dealer Assets expanded only $5 billion to a record $4.809 TN. 

Loans were down slightly ($5bn) to $638 billion, while Miscellaneous Assets rose somewhat ($4bn) to $1.715 TN. 

Broker Loans inflated $209 billion, or 48.5%, over 14 quarters. Q2’s $23 billion decline (to $1.638 TN) in “Repo” Assets reduced one-year growth to $292 billion, or 21.7%.

GSE Assets declined $131 billion during Q2 to $9.409 TN. 

FHLB Loans fell $187 billion during Q2 to $855 billion. 

Still, FHLB Loans posted one-year growth of $335 billion, or 64.3%. 

Over six quarters, FHLB Loans expanded $520 billion, or 155%. 

GSE Assets expanded $1.117 TN, or 13.5%, over six quarters, and $2.279 TN, or 32.0%, over 14 quarters.

Treasury Securities expanded $792 billion during the quarter to a record $27.748 TN, with one-year growth of $1.697 TN. 

Agency Securities declined $69 billion during Q2 to $11.972 TN, while increasing $777 billion over the past year. 

Treasury Securities inflated $9.934 TN, or 55.8%, over four years, with Agency Securities gaining $2.708 TN, or 29.2%. 

Combined Treasury and Agency Securities inflated a staggering $12.642 TN, or 46.7%, over 16 quarters to $39.720 TN. 

Combined Treasury and Agency Securities ended June at 148% of GDP, up from 92% to close 2007.

Total Debt Securities expanded $687 billion during Q2 to a record $60.296 TN, with 15-quarter growth of $13.795 TN, or 30.2%. 

Total Equities jumped $3.743 TN to $72.893 TN. 

Total (Debt and Equities) Securities surged $4.430 TN, or 14.3%, to $127.985 TN, with 15-quarter growth of $31.472 TN, or 32.6%. 

At 482%, the ratio of Total Securities-to-GDP compares to previous cycle peaks 387% (Q3 2007) and 368% (Q1 2000).

The Household Balance Sheet remains at the epicenter of Bubble analysis. 

Household Assets jumped $5.664 TN, or 13.4% annualized, during Q2 to a record $174.419 TN. 

With Liabilities increasing $170 billion (to a record $20.138 TN), Household Net Worth inflated a notable $5.494 TN to a record $154.282 TN. 

It’s worth noting that Q2’s Net Worth gain is the fifth largest ever, lagging only Q1 2019 ($6.242 TN), Q2 2020 ($7.811 TN), Q4 2020 ($8.364 TN), and Q2 2021 ($6.644 TN).

The value of Household Real Estate holdings jumped $2.480 TN to a record $48.870 TN, lagging only Q1 2022’s $3.561 TN increase. 

It’s worth noting that the largest quarterly Real Estate gain during the mortgage finance Bubble period was Q3 2005’s $864 billion. 

Over the past 15 quarters, Household Real Estate holdings inflated $15.809 TN, or 47.8%.

Household holdings of Financial Assets jumped $3.084 TN, or 10.8% annualized, to $116.874 TN. 

Total Equities increased $3.392 TN during the quarter to $59.680 TN. 

Household Equities holdings as a percentage of GDP increased to 223%. 

This was down from Q2 2021’s 266%, but compares to previous cycle peaks 146% (Q2 2007) and 172% (Q1 2000). 

Treasury holdings rose another $154 billion (28.6% annualized) to a record $2.307 TN, with unprecedented one-year growth of $1.462 TN (173%). 

Agency Securities were little changed during Q2 at $1.259 TN, with record one-year growth of $559 billion, or 80%.

Total Household Deposits dropped $203 billion to $14.180 TN, less than Q1’s $406 billion contraction and the smallest decline in four quarters. 

The $1.197 TN one-year decline in Total Deposits reduced 15-quarter growth to $3.578 TN, or 33.4%. 

Money Fund holdings rose another $137 billion during Q2, with one-year growth of $696 billion, or 24.6%. 

Money Fund holdings jumped $1.374 TN, or 64%, over the past 15 quarters. 

This puts 15-quarter combined Deposits, Money Funds, Treasuries and Agency Securities at a staggering $5.992 TN, or 39.2%. 

There’s no mystery surrounding the resilience of consumer spending.

Rest of World (ROW) holdings of U.S. Assets jumped $2.154 TN (19.8% annualized) during Q2 to $45.747 TN, with one-year growth of $4.416 TN, or 10.7%. 

Total Equities (Equities and Mutual Funds) jumped $1.136 TN for the quarter and $1.752 TN y-o-y – to $13.708 TN. 

FDI rose $1.056 TN ($1.948 TN y-o-y) to $12.316 TN. 

Debt Securities holdings increased $114 billion during Q2 to $13.081 TN, with one-year growth of $417 billion, or 3.3%. 

Over the past year, Treasury holdings increased $203 billion (to $7.620 TN), Agency/MBS $113 billion ($1.317 TN), and Corporate Bonds $64 billion ($3.864 TN). 

Total ROW holdings inflated $12.995 TN, or 39.7%, over 13 quarters.

Rather than a “good place,” the latest Z.1 further corroborates the Bubble Thesis.