Doug Noland: Unparalleled Credit and Global Yields

As a percentage of GDP, Total Securities increased to 426% [Q4 2016] from the year ago 415%. For comparison, Total Securities peaked at $55.3 TN during Q3 2007, or 379% of GDP. At the previous Q1 2000 cycle peak, Total Securities had reached $36.0 TN, or 359% of GDP.


New Fed Q4 Z.1 Credit and flow data was out this week. For the first time since 2007, annual Total Non-Financial Debt (NFD) growth exceeded $2.0 TN – a bogey I’ve used as a rough estimate of sufficient new Credit to fuel self-reinforcing reflation. Based on some nebulous “neutral rate,” the Fed rationalizes that it’s not behind the curve. Robust “money” and Credit growth argues otherwise. A Bloomberg headline from earlier in the week: “Taylor Rule Suggests Fed is About 12 Hikes Behind.”

Though not so boisterous of late, there’s been recurring talk of “deleveraging” – “beautiful” and otherwise – since the crisis. Let’s update some numbers: Total Non-Financial Debt (NFD) ended 2008 at $35.065 TN, or a then record 238% of GDP. NFD ended 2016 at a record $47.307 TN, an unprecedented 255% of GDP. In the eight years since the crisis, NFD has increased $12.243 TN, or 35%. Including Financial Sector (that excludes the Fed) and Foreign U.S. borrowings, Total U.S. Debt has increased $11.422 TN to a record $66.079 TN, or 356% of GDP. It’s worth adding that the $2.337 TN post-crisis contraction in Financial Sector borrowings was more than offset by the surge in Federal Reserve liabilities.

For 2016, NFD expanded $2.117 TN, up from 2015’s $1.929 TN – to the strongest growth since 2007’s record $2.501 TN. Household borrowings increased $521bn, up from 2015’s $384bn, to the strongest pace since 2007’s $947bn. Household mortgage borrowings jumped to $248bn, up from 2015’s $129bn. On the back of an unusually weak Q4, total Business borrowings declined to $724bn last year from 2015’s $812bn (strongest since ‘07’s $1.117 TN).

The Bubble in Federal obligations runs unabated. Federal debt jumped $843bn in 2016, up from 2015’s $725bn increase to the strongest growth since 2013’s $857bn. It’s worth noting that after ending 2007 at $6.074 TN, outstanding Treasury debt has inflated more than 160% to $16.0 TN. As a percentage of GDP, Treasury debt increased from 42% to end 2007 to 86% to close out last year.

Yet Treasury is not Washington’s only aggressive creditor. GSE Securities jumped a notable $352bn in 2016 to a record $8.521 TN, the largest annual increase since 2008. In quite a resurgence, GSE Securities increased almost $1.0 TN over the past four years. Treasury and GSE Securities (federal finance) combined to increase $1.194 TN in 2016 to $24.504 TN, or 132% of GDP. For comparison, at the end of 2007 Treasury and Agency Securities combined for $13.449 TN, or 93% of GDP.

The unprecedented amount of system-wide debt is so enormous that the annual percentage gains no longer appear as alarming. Non-Financial Debt expanded 4.7% in 2016, up from 2015’s 4.4%. Total Household Debt expanded 3.6%, with Total Business borrowings up 5.6%. Financial Sector borrowings expanded 2.9% last year, the strongest expansion since 2008.

Securities markets remain the centerpiece of this long reflationary cycle. Total (debt and equities) Securities jumped $1.50 TN during Q4 to a record $80.344 TN, with a one-year rise of $4.80 TN. As a percentage of GDP, Total Securities increased to 426% from the year ago 415%. For comparison, Total Securities peaked at $55.3 TN during Q3 2007, or 379% of GDP. At the previous Q1 2000 cycle peak, Total Securities had reached $36.0 TN, or 359% of GDP.

The Household Balance Sheet also rather conspicuously illuminates Bubble Dynamics. Household Assets surged $6.0 TN during 2016 to a record $107.91 TN ($9.74 TN 2-yr gain). This compares to the peak Q3 2007 level of $81.9 TN and $70.0 TN to end 2008. Q4 alone saw Household Assets inflate $2.192 TN, with Financial Assets up $1.589 TN and real estate gaining $557bn.

With Household Liabilities increasing $473bn over the past year, Household Net Worth (assets minus liabilities) inflated a notable $5.518 TN in 2016 to a record $92.805 TN. As a percentage of GDP, Net Worth rose to a record 492%. For comparison, Household Net Worth-to-GDP ended 1999 at 435% ($43.1 TN) and 2007 at 453% ($66.5 TN). Net Worth fell to a cycle low 378% of GDP ($54.4TN) in Q1 2009. In terms of Credit Bubble momentum, it’s notable that Net Worth inflated over $2.0 TN in both Q3 and Q4.

March 5 – Bloomberg: “China’s credit engine will keep humming this year, adding the rough equivalent of Germany’s annual economic output to its already massive stock of total social financing, according to estimates derived from the nation’s 2017 targets. Adding higher equity market financing and about 5 trillion yuan ($725bn) worth of local government bond swaps to the official credit growth target of 12%, analysts at UBS Group AG see TSF expansion of 14.8% this year. They calculate that’s equal to a whopping 23 trillion yuan, or $3.3 trillion, addition to the amount of total credit already swishing around the world’s second-largest economy.”

UBS analysts forecast (above) $3.3 TN of 2017 Chinese Total Social Financing (TSF). And with TSF excluding national government deficit spending, let’s add another $300bn and presume 2017 Chinese system Credit growth of around $3.6 TN. As such, it’s possible that China and the U.S. could combine for Credit growth approaching an Unparalleled $6.0 TN. There are, as well, indications of an uptick in lending in the euro zone, and Credit conditions for the most part remain loose throughout EM. Importantly, the inflationary biases that have gained momentum in asset and securities markets and, increasingly, in consumer prices and corporate profits provide a tailwind for Credit expansion.

March 9 – Bloomberg (Hugh Son, Jennifer Surane, and Francine Lacqua): “Jamie Dimon said President Trump’s economic agenda has ignited U.S. business and consumer confidence and he expects at least some of the administration’s proposals to be enacted. ‘It seems like he’s woken up the animal spirits,’ Dimon, chairman and chief executive officer of JPMorgan Chase & Co., said Thursday… Confidence has ‘skyrocketed because it’s a growth agenda,’ Dimon said, adding that he’s not overly concerned about the possibility of a correction in equities markets…”

There are any number of developments that could bring this global Credit party to an end, including a spike in yields and resulting speculative de-leveraging. U.S. Credit expansion did slow meaningfully in Q4. With Business borrowings dropping to 2.6% (Q3 6.3%) and federal debt growth sinking to 2.9% (Q3 8.2%), NFD growth dropped to 2.9% from Q3’s 5.8%. But both should bounce back strongly in Q1. We’ve already seen a huge surge in corporate debt issuance. And it would be atypical if Credit growth failed to respond to surging stock prices and business confidence, loose financial conditions and strengthening inflation trends. And with the nation’s most influential commercial banker talking “animal spirits,” I’ll assume Jamie Dimon is currently observing generally robust demand for Credit.

Ten-year Treasury yields touched 2.61% during Thursday’s session, the high since 2014 (and above Bill Gross’s 2.60% bear market bogey). Five-year yields closed the week up nine bps to 2.10%, an almost six-year high. Finishing the week at the highest level since 2008, two-year Treasury yields jumped five bps this week to 1.36%.

Rising yields aren’t just a U.S. phenomenon. This week saw yields trade to at least one-year highs in Canada, France, Germany, Italy, Spain, Netherlands, Sweden, Norway, Denmark, Belgium, Switzerland, Japan, Australia, New Zealand, South Korea, Israel and China. Italian yields surged 27 bps this week to the high since November 2014. Spanish 10-year yields jumped 21 bps to 1.89%, the high since November 2015. French yields rose 18 bps to 1.12%, the high since July 2015. German yields rose 13 bps this week to 0.49%, the highest level since January 2016.

There’s a huge question as to how much leverage has accumulated globally throughout this Bubble period. Thus far, deleveraging fears have been held in check by the fundamental backdrop, faith in ultra-dovish central bankers and the ongoing enormous QE from the BOJ and ECB. This week saw the first indication that the ECB is preparing to back away from its extreme monetary stimulus.

March 10 – Financial Times (Mehreen Khan): “It has been nearly seven years but investors are finally beginning to focus on the prospect of a tightening in monetary policy for the eurozone. A subtle shift in the signalling from European Central Bank president Mario Draghi this week has pushed up the probability of a December 2017 rate rise to more than 50% from just odds of a tenth at the start of the month. Despite not changing much of its formal language about being ready to provide more monetary medicine to the eurozone, Mr Draghi declared victory over the deflation risks that had prompted the ECB to begin its trillion euro bond-buying programme two years ago… ‘There is no longer that sense of urgency in taking further actions while maintaining the accommodative monetary policy stance including the forward guidance,’ Mr Draghi told journalists… Analysts judged the remarks to be the start of a gradual shift in the ECB’s forward guidance on interest rate rises…”

March 10 – Bloomberg (Jana Randow and Alessandro Speciale): “European Central Bank policy makers considered the question of whether interest rates could rise before their bond-buying program comes to an end, according to people familiar with the matter. Governing Council members meeting on March 9 exchanged views on ways of communicating and sequencing an exit from unconventional stimulus, euro-area central-bank officials said, asking not to be identified…”

Crude dropped 9.1% ($4.84) this week, closing below $50 for the first time in three months. Fearing the impact lower energy prices have on leveraged energy-related borrowers, the high-yield sector experienced abrupt and meaningful outflows this week. Lipper had high-yield fund outflows surging to $2.12 billion ($2.8bn high-yield corporate outflows from EPFR).

March 10 – Bloomberg: “Exchange-traded funds focused on U.S corporate junk bonds saw net outflows of $2.8 billion in the week…, 6% of assets and the second-largest outflow in 12 months… The Bloomberg Barclays U.S. Corporate High Yield bond index is almost 25% allocated to energy and materials issuers. The index’s option-adjusted spread to Treasuries jumped 24 bps last week from a two-year low 344 bps.”

A timely reminder: It’s that combination of rising sovereign yields and widening Credit spreads that risks sparking de-risking/de-leveraging dynamics. So far the investment grade corporate debt market has remained bulletproof. Simultaneous losses in highly-correlated stocks, bonds and commodities would be problematic for “risk parity” and similar leveraged strategies. Considering that global bond yields are flirting with an upside breakout, complacency seems rather deeply embedded. Analyzing Credit trends, it’s clear that monetary policy and global yields have barely even begun the long and treacherous path toward normalization.


Original Post 10 March 2017

Categories: Doug Noland, Perspectives