Weekly Commentary: Q3 2017 Flow Of Funds

by: Doug Noland

Originally published on December 9, 2017

In nominal dollars, Total U.S. System (Non-Financial, Financial and Foreign) borrowings expanded $1.007 TN during the third quarter to a record $68.012 TN. Total Non-Financial Debt (NFD) rose a nominal $732 billion during the quarter to a record $48.635 TN. It's worth noting that NFD has expanded 46% since ending 2007 at $33.26 TN.

Total Non-Financial Debt expanded at a seasonally-adjusted and annualized rate (SAAR) of $2.954 TN during Q3, the strongest Credit growth since Q4 2015. As has often been the case over the past nine years, Washington led the Credit expansion. Federal borrowings jumped to SAAR $1.656 TN, the strongest in seven quarters. Total Business borrowings expanded SAAR $751 billion, up from Q2's $692 billion. Total Household debt growth slipped slightly q/q to $550 billion.

On a percentage basis, Non-Financial Debt expanded at a 6.2% rate during Q3, accelerating from Q2's 3.8%, Q1's 1.7% and Q4 2016's 3.1%. Federal borrowings grew at a 10.3% pace, Total Business at 5.4% and Total Household debt expanded at a rate of 3.7%.

To the naked eye, percentage debt growth figures for the most part don't appear alarming. But there's several unusual factors to keep in mind. First, the outstanding stock of debt has grown so enormous that huge Credit expansions (such as Q3's) don't register as large percentage gains. Second, overall system debt growth continues to be restrained by historically low interest rates and market yields.

Debt simply is not being compounded as it would in a normal rate environment. And third, it's a global Bubble and a large proportion of global Credit growth is occurring in China, Asia and the emerging markets. U.S. securities markets continue to be a big target of international flows.

With global Bubble Dynamics a dominant characteristic of this cycle, it's appropriate to place Rest of World (ROW) data near the top of Flow of Funds analysis. ROW holdings of U.S. Financial Assets jumped $724 billion (nominal) during the quarter to a record $26.347 TN.

This puts growth over the most recent three quarters at a staggering $2.124 TN (16% annualized). What part of these flows has been associated with ongoing rapid expansion of global central bank Credit? It's worth recalling that ROW holdings ended 2007 at $14.705 TN and 1999 at $5.639 TN. As a percentage of GDP, ROW holdings of U.S. Financial Assets ended 1999 at 57%, 2007 at 100%, and Q3 2017 at a record 135%.

ROW holdings increased a seasonally-adjusted and annualized (SAAR) $1.657 TN during the quarter. ROW holdings of U.S. Debt Securities increased SAAR $956 billion during Q3, led by a SAAR $749 billion jump in Treasuries. Corporate Bond holdings rose SAAR $204 billion. Holdings of Equities and Mutual Fund Shares increased SAAR $114.9 billion during the quarter. Direct Foreign Investment rose SAAR $305 billion. Big numbers.

Meanwhile, the Fed's Domestic Financial Sectors category expanded assets SAAR $2.841 TN during Q3 to a record $95.213 TN. In nominal dollars, the Financial Sector boosted assets a notable $5.085 TN over the past three quarters, almost 8% annualized growth. Notably, the sector's holdings of Debt Securities surged a nominal $775 billion in three quarters to a record $25.425 TN. Pension Funds were a huge buyer of Treasuries during the quarter (SAAR $1.075 TN). Over the past three quarters, the Financial Sector boosted holdings of Corporate & Foreign Bonds by a nominal $427 billion to $8.026 TN. More very big numbers.

Banks ("Private Depository Institutions") expanded loan portfolios by SAAR $509 billion during Q3, the strongest expansion in a year. I still see analysis referring to tepid bank lending. And while loan growth has appeared less than boom-like, at least part of this is explained by booming capital markets. Corporate bond issuance has remained near record pace, and there has been as well even a surge in Open Market Paper ("commercial paper") borrowings.

One doesn't have to look much beyond the booming Rest of World and Domestic Financial Sector to explain ongoing over-liquefied securities markets. The numbers confirm a historic financial Bubble.

Total Equities Securities jumped $1.229 TN during the quarter to a record $43.969 TN, with a one-year gain of $5.923 TN (16.4%). Equities jumped to a record 224% of GDP, compared to 181% at the end of Q3 2007 and 202% to end 1999. Debt Securities gained $171 billion during Q3 to a record $42.385 TN, with a one-year gain of $1.080 TN. At 217% of GDP, Debt Securities remain just below the record 223% recorded in 2013.

This puts Total (Debt & Equities) Securities up $1.400 TN during the quarter to a record $86.080 TN. Total Securities inflated $7.003 TN, or 9.1%, over the past year. Total Securities experienced cycle tops of $55.261 TN during Q3 2007 and $36.017 TN to end March 2000. Total Securities ended Q3 2017 at a record 441% of GDP. This outshines the previous cycle peaks of 379% for Q3 2007 and 359% at Q1 2000. One more way to look at post-crisis securities market inflation: Total Securities ended Q3 $30.819 TN, or 56%, higher than the previous cycle peak in Q3 2007.

There's no doubt that financial sector leveraging and foreign flows (especially through the purchase of U.S. securities) continue to play an integral role in the U.S. Bubble. Inflating asset prices and resulting bubbling U.S. Household Net Worth are instrumental in fueling the overall U.S. Bubble Economy.

Household Sector Assets inflated $1.920 TN during Q3 to a record $112.360 TN. And with Household Liabilities little changed at $15.241 TN, Household Net Worth expanded $1.922 TN during the quarter to a record $97.119 TN. Household Net Worth ended September at a record 498% of GDP. This is up from the 378% Q1 2009 trough level. It also surpasses the cycle peaks of 478% back in Q1 2007 and 435% in Q4 1999.

For the quarter by Household Asset category, Financial Asset holdings increased $1.449 TN to a record $78.854 TN. Real Estate holdings gained $411 billion to a record $27.428 TN. Household Net Worth increased $7.389 TN over the past year and $11.870 TN over two years. Household Net Worth has now increased 78% from Q1 2009 lows.

As we think ahead to 2018, the question becomes how vulnerable U.S. securities markets are to waning QE and reduced central bank Credit expansion. Inflating a Bubble creates vulnerability to any slowdown in underlying Credit and attendant financial flows. And it's the final parabolic speculative blow-off that seals a Bubble's fate.

It ensures market dependency to unusually large and inevitably unsustainable flows. The Fed's latest Z.1 report does a nice job of illuminating the historic scope of the U.S. securities Bubble. U.S. securities markets have been on the receiving end of extraordinary international flows, while inflating securities and asset prices have spurred rapid financial sector expansion.

For The Week:

The S&P 500 added 0.4% (up 18.4% y-t-d), and the Dow increased 0.4% (up 23.1%). The Utilities declined 0.9% (up 14.3%). The Banks jumped 1.9% (up 16.2%), and the Broker/Dealers rose 1.5% (up 28.4%). The Transports advanced 2.1% (up 15.0%). The S&P 400 Midcaps slipped 0.2% (up 13.9%), and the small cap Russell 2000 declined 1.0% (up 12.1%). The Nasdaq 100 was little changed (up 30.4%). The Semiconductors fell 1.6% (up 36.6%). The Biotechs slipped 0.5% (up 37.6%). With bullion sinking $32, the HUI gold index dropped 4.7% (down 2.8%).

Three-month Treasury bill rates ended the week at 125 bps. Two-year government yields added two bps to 1.80% (up 61bps y-t-d). Five-year T-note yields increased three bps to 2.14% (up 21bps). Ten-year Treasury yields added a basis point to 2.38% (down 7bps). Long bond yields increased one basis point to 2.77% (down 30bps).

Greek 10-year yields sank 89 bps to an eight-year low 4.47% (down 255bps y-t-d). Ten-year Portuguese yields fell eight bps to 1.81% (down 194bps). Italian 10-year yields declined six bps to 1.65% (down 5bps). Spain's 10-year yields slipped two bps to 1.40% (up 2bps). German bund yields were little changed at 0.31% (up 10bps). French yields rose three bps to 0.63% (down 5bps). The French to German 10-year bond spread widened three to 32 bps. U.K. 10-year gilt yields rose five bps to 1.28% (up 4bps). U.K.'s FTSE equities rallied 1.3% (up 3.5%).

Japan's Nikkei 225 equities index was about unchanged (up 19.3% y-t-d). Japanese 10-year "JGB" yields increased two bps to 0.05% (up 1bp). France's CAC40 recovered 1.5% (up 11.0%). The German DAX equities index jumped 2.3% (up 14.6%). Spain's IBEX 35 equities index rose 2.3% (up 10.4%). Italy's FTSE MIB index surged 3.0% (up 18.4%). EM markets were mixed.

Brazil's Bovespa index increased 0.6% (up 20.8%), and Mexico's Bolsa gained 0.7% (up 4.2%). South Korea's Kospi index declined 0.5% (up 21.6%). India's Sensex equities index rose 1.3% (up 24.9%). China's Shanghai Exchange declined 0.8% (up 6.0%). Turkey's Borsa Istanbul National 100 index surged 4.2% (up 38.1%). Russia's MICEX equities index was unchanged (down 5.7%).

Junk bond mutual funds saw inflows of $216 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates rose four bps to 3.94% (down 19bps y-o-y). Fifteen-year rates jumped six bps to 3.36% (unchanged). Five-year hybrid ARM rates increased three bps to 3.35% (up 18bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.15% (up 1bp).

Federal Reserve Credit last week declined $9.3bn to $4.397 TN. Over the past year, Fed Credit fell $12.9bn. Fed Credit inflated $1.577 TN, or 56%, over the past 265 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt rose $2.9bn last week to $3.390 TN. "Custody holdings" were up $251bn y-o-y, or 8.0%.

M2 (narrow) "money" supply surged $35.1bn last week to a record $13.810 TN. "Narrow money" expanded $630bn, or 4.8%, over the past year. For the week, Currency increased $1.6bn. Total Checkable Deposits added $3.1bn, and Savings Deposits jumped $26.9bn. Small Time Deposits were little changed. Retail Money Funds gained $3.0bn.

Total money market fund assets gained $8.4bn to $2.807 TN. Money Funds rose $71bn y-o-y, or 2.6%.

Total Commercial Paper jumped $9.9bn to $1.053 TN. CP gained $117bn y-o-y, or 12.5%.

Currency Watch:

The U.S. dollar index gained 1.1% to 93.901 (down 8.3% y-t-d). For the week on the upside, the South African rand increased 0.5%. For the week on the downside, the Swiss franc declined 1.7%, the Mexican peso 1.6%, the Australian dollar 1.4%, the Canadian dollar 1.3%, the Japanese yen 1.2%, the Swedish krona 1.1%, the Brazilian real 1.1%, the euro 1.0%, the South Korean won 1.0%, the British pound 0.7%, the New Zealand dollar 0.6%, the Singapore dollar 0.5% and the Norwegian krone 0.1%. The Chinese renminbi was little changed versus the dollar this week (up 4.90% y-t-d).

Commodities Watch:

The Goldman Sachs Commodities Index dropped 2.1% (up 5.5% y-t-d). Spot Gold fell 2.5% to $1,249 (up 8.4%). Silver sank 3.4% to $15.823 (down 1.0%). Crude dropped $1.00 to $57.36 (up 6%). Gasoline declined 1.4% (up 3%), and Natural Gas sank 9.4% (down 26%). Copper lost 3.7% (up 19%). Wheat fell 4.4% (up 3%). Corn dropped 1.7% (unchanged).