Weekly Commentary: Q4 2017 Z.1 Flow Of Funds

by: Doug Noland

So much uncertainty in the world these days. Some things, however, we know with certitude: U.S. Debt, the value of the securities markets and Household Net Worth do grow to the sky. The Fed's latest Z.1 report documents another quarter of inflating Credit, markets and perceived wealth - three additional months of history's greatest Bubble.

Total (non-financial and financial) U.S. System borrowings jumped a nominal $495 billion during the quarter and $2.630 TN in 2017 to a record $68.591 TN. Total Non-Financial Debt (NFD) expanded at a seasonally-adjusted and annualized rate (SAAR) of $1.407 TN during 2017's fourth quarter to a record $49.050 TN ('17 growth of $1.793 TN). Credit growth slowed from Q3's SAAR $3.007 TN and Q2's SAAR $1.921 TN, while it was closely in line with Q4 2016's SAAR $1.435 TN. NFD as a percentage of GDP ended 2017 at 249%. This compares to 230% to end 2007 and 179% in 1999.

By major category for the quarter, Household Debt expanded SAAR $790 billion, a notable acceleration from Q3's $516 billion and Q2's $573 billion. For perspective, one must go back to 2007's $946 billion to see annual growth exceeding Q4's pace of Household borrowings. For 2017, total Household Borrowings expanded $604 billion, up from 2016's $510 billion, '15's $403 billion, '14's $402 billion, '13's $241 billion, and '12's $266 billion. Household Borrowings contracted $51 billion in '11 and $61 billion in '10.

And while Household Mortgage borrowings increased to SAAR $302 billion (from Q3's $282bn), the surge in Household Borrowings was led by a record SAAR $292 billion jump in (non-mortgage) Consumer Credit. Consumer Credit rose SAAR $134 billion in Q3 and SAAR $229 billion in Q4 2016. It's worth noting that Consumer Credit growth posted its previous cycle peak at $181 billion in Q3 2007.

Total Corporate Credit growth slowed markedly during Q4 to SAAR $520 billion, down from Q3's SAAR $840 billion, Q2's $808 billion and Q1's $815 billion - but was ahead of Q4 '16's $314 billion. Total Corporate Borrowings expanded $746 billion in 2017, up from '16's $710 billion but below '15's $819 billion.

Federal government borrowings slowed sharply during the fourth quarter, with massive debt issuance pushed into Q1 '18. For calendar year 2017, federal borrowings dropped to $447 billion from '16's $843 billion. 2018 federal borrowings will be enormous.

On a percentage basis, Non-Financial Debt growth slowed to 3.8% in 2017, down from '16's 4.6%. But this slowdown was chiefly related to a halving of the growth in federal borrowings to 2.8% from 5.6%. Household Debt expanded at a 4.1% pace, up from '16's 3.6% to the strongest growth since 2007's 7.1%.

The Domestic Financial Sector expanded nominal $1.832 TN during the quarter to a record $97.041 TN. During the quarter, Agency/GSE securities gained SAAR $302 billion, Corporate & Foreign Bonds SAAR $517 billion, Fed Funds & Repo SAAR $486 billion and Loans SAAR $898 billion.

Bank (Private Depository Institutions) Assets increased nominal $204 billion, or 4.4% annualized, during Q4 to a record $18.925 TN. Bank Loans jumped nominal $167 billion, or 6.3% annualized, to $10.776 TN. Bank Assets were up $852 billion in 2017 (4.5%), an increase from 2016's $712 billion (3.9%).

From a more conventional perspective, growth in U.S. "money" and Credit doesn't appear all that remarkable. Yet asset-based lending has quietly gained significant momentum. Total Mortgage Credit jumped $573 billion in 2017 (Q4 SAAR $625bn), the strongest expansion since 2007. Q4 multifamily mortgage growth was the strongest in years. Agency Securities gained nominal $337 billion (3.9%) in 2017 to a record $8.857 TN, with a two-year gain of $688 billion.

It's anything but clear why the GSEs should be growing rapidly at this point. Broker/Dealer Assets jumped nominal $116 billion during Q4 (15% annualized) to $2.229 TN, an almost three-year high. Broker/Dealer assets expanded $206 billion in 2017, the largest expansion since 2010's $235 billion. Exchange-traded Funds (ETF) expanded $263 billion during Q4 to $3.400 TN. ETFs expanded $876 billion, or 34.7% in 2017, with a two-year gain of $1.300 TN, or 62%.

After beginning 2008 at $6.051 Trillion (42% of GDP), Treasury Securities ended 2017 at $16.431 TN (83% of GDP). Treasury and Agency Securities combined for $25.288 TN, or 128% of GDP. It's a staggering amount of so-called "risk free" securities underpinning the entire financial system. Also "staggering" and "underpinning," global finance pouring into U.S. securities markets is unrelenting. It's become a primary source of fuel sustaining the Bubble.

Rest of World (ROW) increased holdings of U.S. financial assets by a nominal $646 billion during Q4. For perspective, this is more than triple the Q4 expansion of bank loans. This put 2017 ROW growth at a record $2.817 TN, up from '16's $1.182 TN and surpassing '13's $2.174 TN and '06's $2.125 TN. ROW now holds a record $11.456 TN of U.S. debt securities, $7.888 TN of equites and mutual funds, $737 billion of Repos and $4.699 TN of Foreign Direct Investment. Since the end of 2008, ROW holdings have increased $13.342 TN, or 97%, to end 2017 at a record $27.042 TN. ROW holdings began the nineties at $1.738 TN and ended that decade at $5.621 TN.

Total outstanding Debt Securities (TDS) expanded nominal $441 billion during Q4 to a record $42.826 TN. TDS gained $1.537 TN in 2017, after increasing $1.543 TN in '16. TDS has increased $11.88 TN, or 38%, since the end of 2008. TDS as a percent of GDP remained constant during Q4 at 217%, after ending 2007 at 200%.

Total Equities Securities (TES) jumped $2.285 TN during Q4 to a record $45.825 TN. TES rose $7.403 TN during 2017, or 19.3%. Since the end of '08, TES has surged $30.587 TN, or 201%. As a percentage of GDP, TES ended 2017 at a record 232%. This compares to cycle peaks 181% to end Q3 '07 and 202% during Q1 2000. It's worth mentioning as well that TES as a percentage of GDP didn't recover to 100% until Q3 '95 (106% in 1968). TES as a percentage of GDP ended 1970 at 77%, 1975 at 50%, 1980 at 52%, 1985 at 52%, and 1990 at 59%.

Total (Debt and Equities) Securities ended 2017 at a record $88.651 TN. Total Securities surged to a record 449% of GDP, up from 429% to conclude 2016. For perspective, Total Securities to GDP peaked at 379% ($55.3TN) during Q3 2007 and 359% ($36.0TN) at cycle highs in Q1 2000. Total Securities as a percent of GDP ended 1970 at 148%, 1975 at 122%, 1980 at 128%, 1985 at 155%, 1990 at 189%, and 1995 at 262%.

Massive inflows of international finance have been integral to the U.S. securities market Bubble. Inflating securities and asset prices have inflated perceived household wealth, a dynamic fundamental to the U.S. Bubble Economy.

Household Assets jumped nominal $2.284 TN during Q4 to a record $114.395 TN, with a one-year gain of $7.760 TN and two-year rise of $13.514 TN. For the quarter, Real Estate increased $511 billion to a record $27.848 TN. Financial Assets jumped $1.699 TN in Q4 to a record $80.395 TN, with total equities up $972 billion to $26.562 TN.

With Household Liabilities up $209 billion to $15.650 TN, Household Net Worth jumped $2.076 TN during the quarter to a record $98.746 TN. Household Net Worth inflated $7.162 TN during 2017 to a record 500% of GDP. For comparison, Net Worth to GDP ended 2007 at 459% and 1999 at 445%. Net Worth to GDP ended 1970 at 357%, 1975 at 342%, 1980 at 359%, 1985 at 350%, 1990 at 367% and 1995 at 381%.

I define a Bubble as a self-reinforcing but inevitably unsustainable inflation. Household Net Worth at 500% of GDP is not sustainable. I believe it is unsustainable because I don't believe Total Securities at 449% of GDP is sustainable. And current securities values are unsustainable because the current financial structure is not sustainable.

Too large a percentage of new Credit creation is financing overvalued assets (securities and real estate, in particular), leaving this key source of liquidity vulnerable to asset price reversals. Too much of the new Credit is Treasury and government-related securities that are grossly mispriced in the marketplace. Moreover, enormous foreign-sourced inflows are having a major (if unappreciated) impact on marketplace liquidity. I suspect that a significant portion of these inflows are related to global QE and, somewhat less directly, to speculative leveraging ("carry trades," etc.). These sources of liquidity are increasingly vulnerable to central bank "normalization," higher funding costs and rising global yields.

For the Week:

The S&P500 rallied 3.5% (up 4.2% y-t-d), and the Dow recovered 3.3% (up 2.5%). The Utilities increased 0.7% (down 7.2%). The Banks jumped 3.8% (up 8.8%), and the Broker/Dealers surged 6.8% (up 13.7%). The Transports rose 3.9% (up 1.2%). The S&P 400 Midcaps rallied 3.8% (up 2.6%), and the small cap Russell 2000 surged 4.2% (up 4.0%). The Nasdaq100 jumped 4.2% (up 11.0%). The Semiconductors surged 4.9% (up 14.2%). The Biotechs rose 4.7% (up 15.4%). With bullion about unchanged, the HUI gold index was little changed (down 10.1%).

Three-month Treasury bill rates ended the week to 1.63%. Two-year government yields added two bps to 2.26% (up 38bps y-t-d). Five-year T-note yields rose three bps to 2.65% (up 44bps). Ten-year Treasury yields were up three bps to 2.89% (up 49bps). Long bond yields added two bps to 3.16% (up 42bps).

Greek 10-year yields fell 17 bps to 4.16% (up 9bps y-t-d). Ten-year Portuguese yields dropped 12 bps to 1.86% (down 8bps). Italian 10-year yields gained four bps to 2.01% (unchanged). Spain's 10-year yields fell 11 bps to 1.44% (down 13bps). German bund yields were little changed at 0.65% (up 22bps). French yields declined three bps to 0.89% (up 11bps). The French to German 10-year bond spread narrowed three to 24 bps. U.K. 10-year gilt yields added two bps to 1.49% (up 30bps). U.K.'s FTSE equities index rallied 2.2% (down 6%).

Japan's Nikkei 225 equities index gained 1.4% (down 5.7% y-t-d). Japanese 10-year "JGB" yields declined two bps to 0.05% (up 1bp). France's CAC40 rallied 2.7% (down 0.7%). The German DAX equities index recovered 3.6% (down 4.4%). Spain's IBEX 35 equities index rose 1.6% (down 3.6%). Italy's FTSE MIB index surged 3.8% (up 4.1%). EM markets were mostly higher. Brazil's Bovespa index increased 0.7% (up 13.0%), and Mexico's Bolsa gained 2.1% (down 1.6%). South Korea's Kospi index rose 2.4% (down 0.3%). India's Sensex equities index fell 2.2% (down 2.2%). China's Shanghai Exchange gained 1.6% (unchanged). Turkey's Borsa Istanbul National 100 index was unchanged (up 1.4%). Russia's MICEX equities index rose 1.0% (up 9.6%).

Investment-grade funds saw outflows of $740 million, and junk bond funds had outflows of $525 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates gained three bps to 4.46%, the high since January 2014 (up 25bps y-o-y). Fifteen-year rates rose four bps to 3.94% (up 52bps). Five-year hybrid ARM rates added a basis point to 3.63% (up 40bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates down two bps to 4.59% (up 23bps).

Federal Reserve Credit last week declined $11.8bn to $4.354 TN. Over the past year, Fed Credit contracted $63.3bn, or 1.5%. Fed Credit inflated $1.544 TN, or 55%, over the past 279 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt surged $22.0bn last week to $3.440 TN. "Custody holdings" were up $258bn y-o-y, or 8.1%.

M2 (narrow) "money" supply jumped $32.1bn last week to a record $13.875 TN. "Narrow money" expanded $535bn, or 4.0%, over the past year. For the week, Currency increased $4.2bn. Total Checkable Deposits rose $11.5bn, and savings Deposits gained $15.9bn. Small Time Deposits and Retail Money Funds were little changed.

Total money market fund assets rose $14.3bn to $2.857 TN. Money Funds gained $168bn y-o-y, or 6.3%.

Total Commercial Paper added $1.7bn to $1.094 TN. CP gained $130bn y-o-y, or 13.4%.

Currency Watch:

March 6 - South China Morning Post (Alun John): "A senior Hong Kong Monetary Authority official said… that while the Hong Kong dollar had reached its weakest level in more than 30 years, this valuation was 'well within the design of the system'… The Hong Kong dollar touched new lows against the US dollar, …one US dollar was worth 7.8337 Hong Kong dollars, its lowest level in 33 years…The Hong Kong dollar is pegged to the US dollar, and its value is permitted to fluctuate between 7.75 to 7.85 Hong Kong dollars to one US dollar."

March 6 - Bloomberg (Katherine Greifeld and Liz McCormick): "In foreign-exchange markets, investors aren't waiting to find out if all the tariff threats being thrown around lead to a full-blown trade war. Some money managers have begun piling into traditional havens like the yen; others are trimming currency exposure altogether; and even those who're betting not much will come from the row are hedging just in case. The concern is that President Donald Trump's plan to impose steel and aluminum tariffs will trigger a wave of retaliatory levies that derail the worldwide economic expansion… 'Currencies can be very small but sharp objects, where a little exposure can have a large impact,' said Gene Tannuzzo, a portfolio manager at Columbia Threadneedle Investments. 'So you could see more and more managers just not really stick their neck out as it relates to FX exposure.'"

The U.S. dollar index added 0.2% to 90.093 (down 2.2% y-o-y). For the week on the upside, the Mexican peso increased 1.1%, the Australian dollar 1.1%, the South Korean won 1.0%, the South African rand 0.9%, the New Zealand dollar 0.6%, the Canadian dollar 0.6%, the British pound 0.4%, the Singapore dollar 0.3%, and the Norwegian krone 0.2%. For the week on the downside, the Swiss franc declined 1.5%, the Japanese yen 1.0%, the Brazilian real 0.1% and the euro 0.1%. The Chinese renminbi increased 0.17% versus the dollar this week (up 2.72% y-t-d).

Commodities Watch:

March 6 - Bloomberg (Jessica Summers): "U.S. crude production is poised to accelerate this year, reaching the highest annual average on record. The Energy Information Administration boosted its output forecasts for 2018 and 2019, and said that production would top 11 million barrels a day in October… The forecast comes as U.S. shale producers met with OPEC officials for a dinner on the sidelines of the CERAWeek by IHS Markit conference in Houston… OPEC Secretary General Mohammad Barkindo told Bloomberg after the dinner that he wasn't worried about U.S. production growth because 'demand is very robust, very strong.'"

The Goldman Sachs Commodities Index increased 0.6% (up 0.4% y-t-d). Spot Gold was little changed at $1,323 (up 1.6%). Silver gained 0.9% to $16.608 (down 3.1%). Crude recovered 79 cents to $62.04 (up 2.7%). Gasoline added 0.2% (up 6%), and Natural Gas gained 1.4% (down 8%). Copper increased 0.4% (down 5%). Wheat dropped 2.2% (up 15%). Corn rose 1.4% (up 11%).