Q2 2010 Flow of Funds

By: Doug Noland | Fri, Sep 24, 2010
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For the week, the S&P500 jumped 2.1% (up 3.0% y-t-d), and the Dow gained 2.4% (up 4.1%). The S&P 400 Mid-Caps rose 2.0% (up 9.6%), and the small cap Russell 2000 jumped 3.0% (up 7.3%). The Morgan Stanley Cyclicals rose 1.9% (up 6.6%), and the Transports increased 1.8% (up 10.1%). The Morgan Stanley Consumer index gained 2.1% (up 5.1%), and the Utilities increased 2.0% (up 1.5%). The Banks added 0.2% (up 9.0%), while the Broker/Dealers were little changed (down 9.3%). The Nasdaq100 surged 3.5% (up 8.8%), and the Morgan Stanley High Tech index jumped 2.6% (up 1.5%). The Semiconductors rallied 3.5% (down 3.8%). The InteractiveWeek Internet index jumped 3.9% (up 19.1%). The Biotechs gained 1.5%, boosting 2010 gains to 24.1%. With bullion jumping $22, the HUI gold index rose 2.0% (up 17.5%).

One-month Treasury bill rates ended the week at 8 bps and three-month bills closed at 14 bps. Two-year government yields declined 2 bps to 0.43%. Five-year T-note yields dropped 9 bps to 1.32%. Ten-year yields sank 14 bps to 2.60%. Long bond yields fell 11 bps to 3.78%. Benchmark Fannie MBS yields were down 14 bps to 3.44%. The spread between 10-year Treasury yields and benchmark MBS yields was little changed at 84 bps. Agency 10-yr debt spreads were unchanged at 27 bps. The implied yield on December 2010 eurodollar futures declined 3.5 bps to 0.375%. The 10-year dollar swap spread increased 1.75 to 3.50. The 30-year swap spread declined 1.0 to negative 36.50. Corporate bond spreads were mixed. An index of investment grade bond risk rose 4 to 108 bps. An index of junk bond risk declined 2 to 544 bps.

It was yet another big week of debt issuance. Investment grade issuers included Microsoft $4.75bn, Dupont $2.0bn, MetLife $2.2bn, Citigroup $1.5bn, Anglo American $1.25bn, MassMutual $700 million, Mattel $500 million, KKR Group $500 million, Alterra $350 million, Liberty Property $350 million, Washington REIT $250 million, Entergy Louisiana $250 million,and DCP Midstream $250 million.

Junk issuers included Pinafore $1.15bn, CCO Holdings $1.0bn, ABI $850 million, Hertz $700 million, Genon $1.25bn, Freescale Semiconductor $750 million, NBTY $650 million, Valeant Pharmaceuticals $2.1bn, Gannett $500 million, Lifepoint Hospitals $400 million, Whiting Petroleum $350 million, CMS Energy $250 million, Sinclair Television $250 million, Liberty Tire Recycling $200 million, Titan International $200 million, Stoneridge $175 million, and Exopack $100 million.

Converts issues included Vertex Pharmaceuticals $375 million and CBIZ $115 million.

The list of international dollar debt sales included Credit Agricole $1.6bn, Stadshypotek $1.6bn, Gerdau $1.25bn, Warner Chilcott $1.25bn, CHC Helicopter $1.1bn, National Australia Bank $1.0bn, TransCanada Pipeline $1.0bn, ENI $800 million, HSBC $750 million, Petroleos Mexicanos $750 million, Harvest Operations $500 million, Rhodia $400 million, Canadian Pacific $350 million, WPE Intl $275 million, Westpac Banking $250 million, Evertec $220 million and Credito Real $210 million.

September 23 - Bloomberg (Lee Spears): "Companies in the U.S. are raising less this year from initial public offerings than any time in at least a decade compared with the amount they filed to sell. IPOs on the New York Stock Exchange and the Nasdaq Stock Market have raised $19.1 billion in 2010..."

U.K. 10-year gilt yields dropped 8 bps to 3.04%, and German bund yields fell 8 bps to 2.34%. Greek 10-year bond yields sank 50 bps to 11.04%, while 10-year Portuguese yields surged 31 bps to 6.37%. Ireland yields jumped 17 bps to 6.47%. The German DAX equities index gained 1.4% (up 5.7% y-t-d). Japanese 10-year "JGB" yields fell 7 bps to 1.00%. The Nikkei 225 dropped 1.6% (down 10.2%). Emerging equity markets were mostly higher. For the week, Brazil's Bovespa equities index gained 1.7% (down 0.6%), and Mexico's Bolsa added 0.7% (up 3.6%). Russia's RTS equities index rose 1.8% (up 3.3%). India's Sensex equities index jumped 2.3% (up 14.8%), to a new 2010 high. China's Shanghai Exchange was closed most of the week for holiday (down 20.9%). Brazil's benchmark dollar bond yields declined 7 bps to 3.90%, and Mexico's benchmark bond yields fell 14 bps to 3.88%.

Freddie Mac 30-year fixed mortgage rates were unchanged last week at 4.37% (down 67bps y-o-y). Fifteen-year fixed rates were unchanged at 3.82% (down 54bps y-o-y). One-year ARMs jumped 6 bps to 3.44% (down 96bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates up one basis point to 5.33% (down 81bps y-o-y).

Federal Reserve Credit declined $2.8bn to $2.287 TN. Fed Credit was up $66.6bn y-t-d (4.1% annualized) and $154bn, or 7.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 9/22) rose $3.7bn (15-wk gain of $138bn) to $3.213 TN. "Custody holdings" have increased $258bn y-t-d (12.0% annualized), with a one-year rise of $359bn, or 12.6%.

M2 (narrow) "money" supply gained $4.9bn to $8.704 TN. Narrow "money" has increased $171bn y-t-d, or 2.8% annualized. Over the past year, M2 grew 2.9%. For the week, Currency added $1.1bn, while Demand & Checkable Deposits declined $14.8bn. Savings Deposits jumped $24.5bn, while Small Denominated Deposits fell $6.3bn. Retail Money Fund assets increased $0.3bn.

Total Money Market Fund assets (from Invest Co Inst) declined $10.6bn to $2.803 TN. In the first 38 weeks of the year, money fund assets droped $490bn, with a one-year decline of $679bn, or 19.5%.

Total Commercial Paper outstanding jumped $27.8bn to $1.064 TN. CP has declined $106bn, or 12.4% annualized, year-to-date, and was down $148bn from a year ago.

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.367 TN y-o-y, or 19.0%, to $8.578 TN.

Global Credit Market Watch:

September 24 - Bloomberg (Tim Catts): "Banks are sitting out the busiest September for corporate bond sales in a sign they may refrain from lending while the Federal Reserve considers how to jolt the economic recovery. Microsoft... led $124.3 billion of U.S. issuance this month, on pace to beat the high of $125.1 billion in September 2009..."

September 20 - Bloomberg (Lynn Thomasson and Alexis Xydias): "Record-low interest rates are stoking the biggest increase in U.S. share buybacks ever. American companies announced $55.9 billion in repurchases since June, data compiled by Birinyi Associates Inc. show. That adds to $93.5 billion in the second quarter and $108.3 billion during the first three months of the year, compared with $125 billion in all of 2009. Corporations are using debt to pay for buybacks..."

September 21 - Bloomberg (Kate Haywood and Sonja Cheung): "Sales of European corporate hybrid bonds, shunned by investors in the credit crisis, surged to a five-year high of 5.2 billion euros ($6.8bn) in 2010 as investors snap up the high-yielding equity-like securities."

September 23 - Bloomberg (Tatiana Bautzer and Gabrielle Coppola): "Sales of securities backed by Brazilian real estate assets are surging to a record as homebuilders and mall owners expand amid the fastest economic growth in two decades. Debt offerings tied to homebuyer contracts and retail lease payments... are on pace to reach 6 billion reais ($3.5bn) this year, up from 3.2 billion reais in 2009..."

September 23 - Bloomberg (Jason Kelly and Cristina Alesci): "Blackstone Group LP, the world's biggest private-equity firm, said a $10 billion company buyout is possible with banks' growing willingness to lend, and that the real estate market is stabilizing. Garrett Moran, a senior managing director at the...firm, said lenders can provide $5 billion in financing, making such a deal possible. 'We have a very workable market,' oran said..."

September 24 - Bloomberg (Richard Bravo): "Leveraged-loan returns rose to their highest level of the year this week as Brickman Group Holdings Inc. took advantage of investor demand and marketed a loan without financial-maintenance requirements... Investors in search of extra yield have turned to high- risk, high-return loans, driving supply to more than double this year and allowing companies to bring so-called covenant-lite deals to market. Those loans are devoid of restrictions such as a mandate on maximum leverage, or debt to earnings before interest, taxes, depreciation and amortization."

September 22 - Bloomberg (Kristen Haunss and Katrina Nicholas): "The number of U.S. companies at greatest risk of default dropped to the lowest level in two years as Federal Reserve efforts bolstered the economy, according to Moody's... Companies rated at or below B3 with a negative outlook declined to 195 as of Sept. 1 from a high of 288 in June 2009..."

Global Government Finance Bubble Watch:

September 22 - Bloomberg (Scott Lanman and Joshua Zumbrun): "The Federal Reserve moved closer to a second wave of unconventional monetary easing and said for the first time that too-low inflation, in addition to sluggish growth, would warrant taking action. The Federal Open Market Committee's statement... that inflation is 'somewhat below' levels consistent with its congressional mandate for stable prices pushed yields on two- year Treasuries to a record low. The language evoked FOMC warnings in 2003 of the risk of inflation 'becoming undesirably low' that justified the era's low-rate policy."

September 24 - Bloomberg (Joshua Zumbrun and Matthias Wabl): "Federal Reserve Bank of Philadelphia President Charles Plosser said the central bank might be pressured into policies that spur inflation unless a limit is placed on the size of its balance sheet. 'Without explicit constraints on the size of the balance sheet, the Fed runs the risk of being pressured to use its balance sheet to engage in policies whose goals have nothing to do with monetary policy,' Plosser said... Plosser's warning comes as U.S. central bankers consider further expanding the Fed's $2.31 trillion balance sheet to boost growth... Without constraints on the Fed, 'the temptation may be too great to renege on the pre-announced policy and pursue policies that deliver temporary economic benefits that may be inconsistent with longer-run goals,' Plosser said... 'In the context of monetary policy, this time inconsistency typically results in higher than desired inflation.'"

September 21 - Bloomberg (Denise Pellegrini): "Ally Financial Inc.'s GMAC Mortgage unit told brokers and agents to halt evictions tied to foreclosures on homeowners in 23 states including Florida, Connecticut and New York... Brokers were told to immediately stop evictions, cash- for-key transactions and lockouts, according to the document, addressed to GMAC preferred agents. The lender will also suspend sales of properties on which it has already taken possession."

September 21 - Bloomberg: "China needs to increase domestic consumption to help survive in a global economic environment that is growing more challenging, Li Daokui, an adviser to the People's Bank of China, said... China's economy retains strong growth potential even as the international situation grows more complicated after the global financial crisis, said Li... 'Pressure for yuan appreciation is just starting and far from ending,' Li told an audience of corporate leaders. 'China faces challenges including the housing price surge that's impeding progress in urbanization.'"

September 20 - Bloomberg (Chris Fournier and Christopher Donville): "International investors frustrated with some of the lowest yields on record for U.S. housing bonds are turning to Canada for higher returns. Canada Housing Trust sold C$6.25 billion ($6.1bn) of five-year bonds last week to yield 24.5 bps more than benchmark rates... Non-Canadians took 37% of the sale, versus an average of 25% to 30% over the past two years, said Mark Chamie,... treasurer of Canada Mortgage and Housing Corp."

Currency Watch:

The dollar index sank 2.6% to 79.283 (up 3.2% y-t-d). For the week on the upside, the Norwegian krone increased 4.0%, the Swedish krona 3.9%, the Euro 3.4%, the Danish krone 3.3%, the Swiss franc 2.5%, the Australian dollar 2.5%, the Mexican peso 2.1%, the Japanese yen 2.0%, the South African rand 1.8%, the British pound 1.2%, the New Zealand dollar 1.2%, the Singapore dollar 1.1%, the Canadian dollar 0.8%, the Taiwanese dollar 0.6%, the Brazilian real 0.6%, and the South Korean won 0.5%. For the week on the downside, the the dollar did gain 2.7% against the Iranian rial.

Commodities Watch:

September 21 - Bloomberg (Jeff Wilson): "The price of Class III milk, used to make cheese, rose in Chicago to the highest level in almost two years as global demand for dairy products increases. Cheese exports by major milk producers, including the European Union, New Zealand, Australia and the U.S., will rise 10% this year, the U.S. Department of Agriculture said... Wholesale-cheese prices are up 22% since the end of June, butter gained 25% and Class III milk rose 16%... 'Export demand continues to improve' for U.S. dairy products, said Roy Huckabay, the executive vice president for the Linn Group... 'Milk is playing catch-up with the gains in butter and cheese.'"

September 21 - Bloomberg: "Imports of refined copper by China, the largest consumer, gained for the second consecutive month in August, as traders ordered material to benefit from a profitable arbitrage window. Inbound shipments totaled 267,153 metric tons last month... That's 19% higher than... July and 22% more than...a year earlier..."

September 21 - Financial Times (Gregory Meyer): "The price of jeans and T-shirts could be about to rise. The world's textile mills, nervous about a global shortage of cotton, have propelled prices of the fibre to their highest in more than a decade. This week's jump in cotton prices above the $1 a pound level, for only the second time since the US civil war, has been a long time coming."

September 21 - Bloomberg (Aya Takada): "Rubber advanced to the highest level in almost five months amid expectation that the global market is set for the worst shortage in four years next year as weather constrains supply and demand keeps expanding... The price increased for a second day and has gained 10% this year."

September 21 - Bloomberg (Aya Takada and Supunnabul Suwannakij): "Bridgestone Corp., the largest tiremaker by sales, is raising European prices for the second time this year and Goodyear Tire & Rubber Co. is charging more as rubber gains on prospects for the biggest shortage since 2007. 'Drought earlier this year and heavy rains later on hampered tree-tapping across Asian plantations,' said Pongsak Kerdvongbundit, managing director of... Von Bundit Co., the largest natural-rubber producer and exporter in the world's biggest supplier. 'Global production will lag behind soaring demand for at least another two years.'"

The CRB index gained 1.4% (up 0.1% y-t-d). The Goldman Sachs Commodities Index (GSCI) also added 1.4% (up 1.8% y-t-d). Spot Gold rose another 1.8% to $1,297 (up 18.2% y-t-d). Silver surged 3.2% to $21.475 (up 27.5% y-t-d). November Crude rose $1.59 to $76.51 (down 3.6% y-t-d). October Gasoline rose 1.5% (down 5% y-t-d), while October Natural Gas dropped 3.4% (down 30% y-t-d). December Copper jumped 2.9% (up 8.3% y-t-d). December Wheat declined 2.6% (up 33% y-t-d), while December Corn gained 1.7% (up 26% y-t-d).

China Watch:

September 23 - Bloomberg (Ye Xie): "Chinese Premier Wen Jiabao said a 20% rise in the yuan would cause severe job losses and trigger social instability, putting the nation on course for a clash with U.S. lawmakers demanding a stronger currency. 'We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside' should China acquiesce to demands for a 20% to 40% gain, Wen said... 'China would suffer major social upheaval.'"

September 21 - Bloomberg: "China may announce property tax measures as early as the October National Day holidays to cool home prices, China Business News reported... The new tax, which will be extended to include residential property, is more likely to be implemented at the start of next year.... The government currently imposes a tariff on business-use real estate and exempts individuals' residential housing."

September 20 - Bloomberg (Sophie Leung): "China should expand investment channels to avoid asset bubbles, Radio Television Hong Kong reported... citing Fan Gang, a former central bank adviser. Inflation in China is unlikely to accelerate to the peak in 2007 and 2008, RTHK cited Fan as saying."

September 21 - Bloomberg (Sophie Leung): "Hong Kong's inflation accelerated to the fastest pace in 19 months in August... Consumer prices gained 3% from a year earlier..."

India Watch:

September 21 - Bloomberg (Anil Varma and V. Ramakrishnan): "Investors are the most confident in India's rupee since May 2009 as global funds pour an unprecedented $25 billion into the nation's stocks and bonds."

Asia Bubble Watch:

September 21 - Bloomberg: "China's rising labor costs prompted Top Form International Ltd., a bra maker for Calvin Klein, to pick Southeast Asia for a new factory, adding to signs of a reshaping of the economy away from export-tied regions. 'We've halted plans to open a fourth factory in China,' Eddie Wong, group managing director..."

September 21 - Bloomberg (Shiyin Chen): "Asian companies outside of Japan may raise a further $116 billion in share sales by the end of the year, taking the total for 2010 to a record $291 billion, Citigroup Inc. said."

September 21 - Bloomberg (Simon Packard): "Tokyo and Seoul moved up in a global ranking of the most expensive store rents as the Asia- Pacific region's economic outlook made international retailers and luxury brands compete to open stores there. Tokyo's Ginza district rose two places to third, and Seoul's Myeongdong climbed to eighth from 11th, according to... Cushman & Wakefield Inc. A 9.6% increase in rents kept Hong Kong's Causeway Bay in second place after New York's Fifth Avenue, which had an 8.8% gain. London's New Bond Street saw a 19% jump in rents, replacing Paris's Avenue des Champs Elysees as Europe's most expensive street."

September 23 - Bloomberg (Chinmei Sung): "Taiwan's industrial production rose more than estimated, gaining for a 12th straight month, while the jobless rate fell to a 20-month low... Output advanced 23.4% in August from a year earlier... Taiwan's 13.1% first-half economic growth spurred factory output and employment as well as home prices, raising the risk of a property bubble."

September 21 - Bloomberg (David Yong): "Malaysia's ringgit traded near a 13-year high on speculation the nation's yield advantage over developed countries will lure more overseas investment."

September 21 - Bloomberg (Barry Porter and Ranjeetha Pakiam): "Malaysia plans to develop a nuclear energy industry, build a mass rail network and create a shopping district to rival Singapore's Orchard Road as part of efforts to boost investment and spur growth. These are among $444 billion worth of potential private- sector-led projects..."

Latin America Watch:

September 20 - Bloomberg (Andre Soliani): "Brazilian central bank President Henrique Meirelles is making his boldest bid in 11 months to contain gains in the real as traders estimate he's buying as much as $1 billion a day in the foreign-exchange market. The central bank purchased about $4 billion in the first four days of last week as the real jumped to the strongest since December... While central banks from Japan to Colombia are beginning to weaken their currencies, Meirelles faces additional pressure as investors move money into Brazil to take part in a $78 billion share sale by state-run Petroleo Brasileiro SA."

September 24 - Bloomberg (Peter Millard): "Petroleo Brasileiro SA, the state-controlled oil company, raised 120.4 billion reais ($70bn) from the Brazilian government and other investors in the world's largest share sale as it seeks cash to develop offshore fields."

Unbalanced Global Economy Watch:

September 21 - Bloomberg (Scott Hamilton): "Britain posted the largest budget deficit for any August since records began in 1993 as debt costs soared... Net borrowing was 15.3 billion pounds ($23.7bn), compared with 13.5 billion pounds a year earlier..."

September 23 - Bloomberg (Emma Ross-Thomas): "Growth in Europe's services and manufacturing industries weakened more than economists forecast in September... A composite index based on a survey of euro-area purchasing managers in both industries declined to 53.8 from 56.2 in August..."

September 24 - Bloomberg (Jana Randow): "German business confidence unexpectedly rose to the highest level in more than three years in September, suggesting companies can weather weaker demand from abroad as the global economic recovery slows."

September 21 - Bloomberg (Emma Ross-Thomas and Joao Lima): "Portugal's budget gap widened in the first eight months of the year... The central government's shortfall rose to 9.19 billion euros ($12bn) from 8.74 billion euros a year earlier... Tax revenue rose 3.3%... and spending increased 2.7%..."

September 21 - Bloomberg (Kati Pohjanpalo): "Finland's economy is rebounding at a 'fast pace' from last year's decline, the Helsinki-based PTT research institute said... PTT raised its forecast for GDP growth to 3.4% this year..."

September 21 - Bloomberg (Wendy Pugh): "Australia, the world's largest shipper of coal, iron ore and wool, raised its forecast for commodity exports this fiscal year to a record amid increasing demand and climbing prices. Sales may be A$214.9 billion ($203.4 billion) in the year... That compares with its June estimate of A$202.5 billion and a revised A$170.6 billion for the previous year."

September 21 - Bloomberg (Jacob Greber): "Australia is likely to need higher interest rates if the central bank's forecast is realized for the nation's economy to continue expanding at its trend pace or faster, policy makers said."

U.S. Bubble Economy Watch:

September 24 - Bloomberg (Vivien Lou Chen and Joshua Zumbrun): "Former Federal Reserve Chairman Paul Volcker... said he doesn't expect a broad-based decline in prices. 'I'm not worried about deflation,' Volcker said... 'I think we're on a path to price stability.' 'I do not think we should be worried about and consumed by the problem of a potential deflation that doesn't exist,' he said."

September 22 - Bloomberg (Ye Xie): "Chinese Premier Wen Jiabao said the yuan's value isn't causing the U.S. trade deficit with his country, rejecting President Barack Obama's assessment that China is keeping the currency cheap to aid exports. 'The main cause of the U.S. trade deficit is not the exchange rate of the Chinese currency, but the structure of investment and savings,' Wen said... 'There's a trade imbalance between the U.S. and China, which is not something we want to see. China doesn't pursue a trade surplus intentionally.'"

September 23 - Bloomberg (Lu Wang): "U.S. corporate pensions face their biggest funding shortfalls since at least 1999, forcing companies to use profits and cash stockpiles to pay retirees instead of investing in their businesses, according to Credit Suisse Group AG. Defined-benefit pension plans at companies in the S&P 500 Index are probably 75% funded, below the previous trough of 78% in 2008, leaving a total $402 billion in shortfalls..."

September 21 - Bloomberg (Mike Dorning): "The U.S. has fallen behind emerging markets in Brazil, China and India as the preferred place to invest, a Bloomberg survey shows... Along with the slipping perceptions of the U.S. markets in the most recent survey, conducted Sept. 16-17, poll respondents say the Federal Reserve is likely to take further steps to try to bolster the economy."

Central Bank Watch:

September 22 - Bloomberg (Scott Lanman and Jana Randow): "The world's major central banks are finding it tough to exit crisis mode, dusting off unconventional stimulus tools shelved earlier this year or prolonging aid as the global recovery loses momentum. The U.S. Federal Reserve... said it's prepared to ease monetary policy further if needed and has highlighted asset purchases as an option. The Bank of England today signaled policy makers are moving closer to adding stimulus. The European Central Bank extended liquidity support for banks into 2011... The stances are a turnabout from early 2010, before Greece's debt crisis came to a head in May, when central bankers were halting stimulus or discussing how to tighten policy."

September 22 - Bloomberg (Svenja O'Donnell): "The Bank of England signaled that policy makers are moving closer to adding more stimulus to the economy, joining the Federal Reserve in contemplating further bond purchases to revive a flagging recovery."

Muni Watch:

September 23 - Bloomberg (Darrell Preston): "Illinois, facing the worst financial crisis in its history, received a negative outlook on $25 billion of general obligation bonds from Moody's... after failing to address a deficit that almost tripled in one year."

September 22 - Bloomberg (Darrell Preston and Brendan A. McGrail): "Texas, which may face a budget deficit of $21 billion a year from now, is set to cut its cost on a $1 billion highway-bond sale as investors receive about 17% less yield than in a previous issue."

California Watch:

September 24 - Bloomberg (Michael B. Marois and Christopher Palmeri): "California Governor Arnold Schwarzenegger and top lawmakers agreed on a 'framework' to close a $19 billion deficit that left the most populous U.S. state without a budget for almost three months. The governor and the Democratic and Republican leaders of the Senate and the Assembly, known as the Big Five, will hammer out the details at a meeting in Sacramento on Sept. 27..."

Speculator Watch:

September 21 - Bloomberg (Bei Hu): "As much as 20% of hedge funds globally may be liquidated by the first quarter because smaller managers are starved for fees and new capital, according to Bank of America... Hedge fund managers overseeing less than $100 million may be the worst hit, said Justin Fredericks... head of U.S. capital introductions, a prime brokerage team... Hedge funds globally returned on average 1.65% this year... About 93% of the $9.5 billion net inflows into the industry in the second quarter went to managers overseeing $5 billion or more, said HFR."


Q2 2010 Flow of Funds

From the Fed's Q2 2010 Z.1 - "Flow of Funds," Total Non-financial Credit growth expanded at a respectable 4.8% pace. This compares to Q1's 4.5%, and it was actually the strongest rate of growth since Q4 2008's 5.7%. The bad news is that federal government Credit continues to completely dominate. During Q2, federal borrowings expanded at a 24.4% rate, up from Q1's 20.5% and Q4 '09's 11.9%. With Household Mortgage Credit contracting at a 2.3% rate (down from Q1's 4.3%), Total Household Debt also declined at a 2.3% pace during the period. Corporate debt grew at a 3.8% rate, down from Q1's 5.8%. State & Local borrowings contracted at a 1.3% pace, a notable reversal from Q1's 5.7% rate of expansion.

In nominal dollars, Total (non-financial and financial) outstanding System Credit was little changed during the quarter at $52.055 TN. Total Credit was down $455bn, or 0.9% from a year earlier. And from the peak set Q1 2009, Total System Credit has declined a $694bn, or 1.3%. It's worth recalling that Total Credit began the decade at $25.389 TN. Total Credit ended the second quarter at 357% of GDP, after beginning the decade at about 260%. While it can be said that the household sector is somewhat "de-leveraging," the same is not true of the system overall.

In Seasonally-Adjusted and Annualized Rates (SAAR), Total Non-financial borrowings increased $1.671 TN during the quarter. This was up from Q1's $1.563 TN, to the strongest Credit growth since Q4 2008's $1.90 TN. Federal borrowings increased to a SAAR $2.00 TN, up from Q1's $1.60 TN and second only to Q4 2008's $2.10 TN. Total Household debt contracted SAAR $309bn during the quarter, while Corporate debt expanded SAAR $278bn. State & Local borrowings contracted SAAR $32bn.

The massive inflation of government Credit continues to coincide with the "de-Bubbling" of the U.S. financial sector. Financial sector borrowings contracted SAAR $1.070 TN, or a pace of negative 7.1%. This was, however, the slowest rate of contraction in six quarters. By financial sector category for the quarter, Open Market Paper contracted SAAR $277bn; GSE Issues contracted SAAR $110bn; Corporate Bonds contracted SAAR $482bn; Bank Loans (business) contracted SAAR $83bn; and Other Loans & Advances contracted SAAR $140bn. Expanding during the quarter, Agency MBS increased SAAR $245bn and Mortgages rose SAAR $2.0bn.

Banking sector stagnation ran unabated. Total Bank Assets declined slightly during Q2 to $14.411 TN. At the same time, Bank Credit contracted at a 5.6% pace during the quarter to $9.394 TN. Bank Credit was down 1.3% from a year ago. Bank (business) Loans declined at a 6.7% annualized rate and were down 14.4% y-o-y. Mortgage loans contracted at a 5.7% pace (down 4.9% y-o-y), as write-downs continue. Meanwhile, Bank holdings of government debt were up 12.1% y-o-y to $1.507 TN. And Miscellaneous Bank Assets jumped (nominal) $177bn during the quarter to $4.069 TN (up 0.2% y-o-y).

Broker/Dealer assets dropped (nominal) $120bn during the quarter to $1.966 TN, with assets down 2.3% y-o-y. Elsewhere, Finance Company assets declined at a 5.4% pace (down 7.5% y-o-y). Savings Institution assets fell at a 5.5% rate to $1.245 TN, with a y-o-y decline of 10.9%. Credit Unions bucked the trend, with 3.2% quarterly and 3.9% y-o-y growth - to $903bn. REIT liabilities expanded at a 1.1% rate to $488bn (down 0.2% y-o-y).

The ongoing financial sector contraction has not been an indication of a systemic downward debt spiral. There have been ongoing write-downs of problem mortgages and loans, while lending has remained weak generally. Yet it is important to also recognize that the massive expansion of government debt has been playing an integral role in spurring financial sector contraction. During a private-sector Credit boom, financial sector liabilities grow as part of the debt intermediation process. Bank Credit expands as loans are made and deposits are created. MBS and ABS expand as mortgage and consumer Credit are intermediated through the securitization marketplace. The expansion and financial sector intermediation of private-sector Credit would increase a wide range of the sector's liabilities and assets.

The ballooning of the government's balance sheets (expansion in public Credit) has altogether different effects on financial sector assets and liabilities. Importantly, there is little need to intermediate government borrowings. The government issues its own debt and sells it directly into the marketplace (in contrast to mortgage Credit extended during the boom).

Today's government finance Bubble also feeds enormous amounts of income and "cash flow" throughout the household, corporate and financial sectors. This would tend to support so-called "de-leveraging" (debt repayment) for households and corporations, in the process reducing the need for financial sector risk intermediation. This helps to explain the stagnation in "money" supply and Bank Credit - and why these traditional indicators of system "liquidity" have lost much of their relevance.

It is worth noting that National Income ended Q2 up 5.3% y-o-y at $12.767 TN. This was the strongest 12-month growth since Q1 2008. National Income has almost recovered back to its Q3 2008 high of $12.781 TN. Total Compensation enjoyed its strongest quarterly growth in two years. While employment and overall economic performance have badly lagged during this recovery, there should be no disputing that the massive issuance of government debt has worked wonders in stabilizing incomes and overall expenditures (at inflated Bubble levels).

The media jumped on the $1.521 TN quarterly decline in Household Net Worth. Most of this decline was due to the stock market drop. It should be noted that equities were near their low for the year as of June 30, and have since rallied about 10%. Despite weaker stocks, Household Net Worth was up 6.3% y-o-y to $53.50 TN. This was up from the Q1 2009 low of $48.80 TN low, but still significantly below the Q4 2007 high of $64.24 TN. Household Net Worth is today probably near the early 2006 level. Total Household Assets ended Q2 at $67.413 TN (up 4.6% y-o-y), with Liabilities at $13.913 TN (down 1.5% y-o-y).

Rest of World (ROW) holdings of U.S. financial assets expanded SAAR $972bn during the quarter to $16.255 TN. Keep in mind that this number began the 1990s at about $1.9 TN and started this decade at $6.1 TN. For the quarter, ROW increased holdings of Treasurys SAAR $709bn, with Agency securities up SAAR $147bn. ROW reduced holdings in "repos" (SAAR $359bn) and corporate bonds (SAAR $120bn). ROW holdings of U.S. financial assets were up $1.436 TN y-o-y, or 9.7%. Treasury holdings were up 12.1% y-o-y to $4.014 TN. Corporate bond holdings were up $375bn y-o-y to $2.278 TN.

On a year-over-year basis, Federal government expenditures were up 5.0% to $3.704 TN (expenditures up 30% from three years ago). Over the past nine quarters, federal expenditures have jumped from about 21% to 25% of GDP. Federal receipts were up 8.5% y-o-y during Q2 to $2.378 TN, or 16.3% of GDP. During the past nine quarters, receipts have fallen from about 19% of GDP. State & Local receipts grew 6.4% y-o-y to $2.113 TN, while State & Local expenditures were up 3.5% y-o-y to $2.092 TN. Total government expenditures during the quarter jumped to 40% of GDP.

The Government Finance Bubble thesis holds that government debt is the latest - and greatest - episode of Hyman Minsky's "Ponzi Finance." During Q2, the markets accommodated a $2.0 Trillion annualized pace of federal debt growth. In just eight quarters, federal government debt expanded $3.610 TN, or 54%, to $10.308 TN. In a short 24 months, federal debt has jumped from 46% to 71% of GDP. And as long as the markets allow such unprecedented issuance of non-productive Credit at historically low yields, it's quite possible that household incomes, corporate earnings, the general economy, and the securities markets might appear ok. Heck, Washington seems awfully determined to resuscitate asset prices. But we don't have to look back too many quarters for a stark reminder of the nature of Ponzi Dynamics and Fragilities.

 


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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TRUE MONEY SUPPLY

Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
austrian-money-supply/