LunaticTrader

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Posts Tagged ‘Fed’

In debt we trust

Posted by Danny on December 10, 2019

On Twitter, Stocktwits and sites like Zerohedge you keep seeing messages contending that debt is getting too high and thus the US economy must be on its way to another collapse. Not rarely you will see this kind of “news” backed up with data and charts taken straight from the Fed’s FRED website (https://fred.stlouisfed.org/). The problem is that many people don’t know (or don’t want to know) when to use a semi-log scale on a chart. They also don’t know how to make better use of the FRED site. In this article I will give a few examples how to make better use of this resource.

Today I saw this chart on Twitter with the comment that consumer credit has started exploding since the gold standard was abandoned in 1971: https://fred.stlouisfed.org/series/TOTALSL

totalsl

Well, it sure looks like it started going up faster and faster around 1971. I wouldn’t blame any person to conclude that debt is exploding when they see this chart. But a nominal chart over a 70 year period cannot properly show whether debt is exploding or not. There are a few easy ways to fix that by using the orange “Edit Graph” button in the top right.

After clicking that button we see this. By changing the “units” to “Percent change from year ago” we get much more useful chart showing how quickly or slowly consumer credit went up (or down) since WW2:

TOTALSL_2

We can see that consumer credit was growing fast in the 50s, 60s and 70s, with a typical slowdown around recessions. The last 15 years we see relatively slow consumer credit growth on a YoY basis. The nominal chart we saw at the start of this article did not show us that kind of details.

Another way to get a more useful view is by changing the display to semi-log scale. Starting from the first nominal chart we again click the “Edit Graph” button and now we go to the “Format” tab where we can switch to log scale:

TOTALSL_3

What we see here is consistent with what we discovered in the second chart. Consumer credit showed steep growth after WW2 until the late 1950s. Then it changed to a slower growth rate, which stayed very constant until 2008, with the usual pauses around recessions. Since the financial crisis in 2009 consumer credit has resumed its upward trajectory, but the growth rate is still visibly slower than it was 1960-2007.

There is more we can do on the FRED site. Nominal increases in consumer credit could still be very problematic if consumer debt goes up faster than income or total assets. Dividing total consumer credit by the total households net worth will give us a better idea what’s going on. Again we use the “Edit Graph” button:

TOTALSL_vs_networth

There are two steps here. First we add the series for Households net worth, just start typing and it will appear. Then click “add” and it will appear as “b” under the consumer credit series we already have as “a”. As a second step we will then enter “a/b” as a formula and click “Apply”. If you try this you will get an empty screen. What’s the problem? Well, the Households net worth series only starts from late 1945, so we are trying to divide by zero in the first years of our consumer credit series. To fix this we have to change the date range before we do the two steps as described. This is the resulting chart (note the starting date was set to 1950 and then everything went fine):

TOTALSL_vs_networth2

We see that consumer credit as a percentage of total household net worth has been hovering around 3.5% since 1966, when it first climbed above 3.5%. So, there is no abnormal explosion in consumer credit, not in 1971 and not now.
But maybe consumers are still being crushed by mortgage debt and that’s why consumer credit looks normal? Well let’s check it:

MDOAH-vs_NW

I have added the total mortgage debt as series a, and the households net worth as series b. But we see something that you will encounter more often if you try to use FRED in more advanced ways. Series a is shown in “millions of dollars” while series b is in “billions of dollars”. I solve this by changing the formula:

MDOAH-vs_NW2

Using “a/(1000*b)” compensates for the factor 1000 difference in units used. We see that total mortgage debt has recently dropped below 14%, it’s lowest level since the mid 1970s. So, neither consumer credit nor total mortgage debt is at unusually high levels at the moment. Mortgage debt was clearly at abnormally high levels in 2009, when it reached a peak of 24% of net worth.

And what about corporate debt? With all the stock buybacks it must be very high, right? Well, we can find a number of stats about that. E.g. https://fred.stlouisfed.org/series/NCBCMDPMVCE

corp

Corporate debt as a percentage of market value. We can see it is rather low at the moment and as low as it was in the 50s and 60s. During the roaring 80s corporate debt was much higher than now, and the world didn’t end. One could say that stock prices are too high now (and maybe they are) and that causes corporate debt to be lower relative to “market value”, as was also the case in 1999. Well, the stock market could crash 50% tomorrow, halving the market value and this stat would jump to 70, which is where it also was in the 2009 financial crisis. Previous spikes to 70 or more were not the end of the world, so why would the next spike be?

It is not money creation itself that causes hyperinflation and/or depression. What is the money used for? If it is used for war or war repayments (Germany 1930s) then high inflation becomes inevitable because it is not used for new productive capacity and war worsens shortages. If money is used for new ideas or new capacity then it can actually cause deflation through overcapacity. That’s what developed countries have experienced for 10+ years now. It is capacity utilization that needs to be watched for signs of future inflation. That stat is here: https://fred.stlouisfed.org/series/TCU

capU

Capacity utilization went very high in the 60s and 70s and those bottlenecks/shortages eventually caused inflation. Since the financial crisis capacity utilization has consistently stayed below 80%, despite QE programs. There is no shortage of anything, so no upward pressure on most prices. CapU is now dropping again, so I wouldn’t look for higher inflation and/or higher interest rates as long as that’s the case. A possible drop below 75% would probably revive fears of deflation. This remains an important stat to watch for the coming years.

You will probably keep seeing claims about unsustainable debt, inevitable inflation or impending collapse of the economy… The FRED site will not give you all the answers. And there can be valid reasons to doubt some (if not all) of the numbers our bureaucrats crank out. But verifying some claims on the FRED site is usually better than nothing. And how the data gets collected and calculated is normally also public information. There is no good substitute for doing your own homework.

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Putting the QE toothpaste back in the tube

Posted by Danny on November 19, 2018

Last year I wrote an article on what to look for when the Fed unwinds its QE program: Quantitative squeezing – what you need to know.
Since the start of QT (quantitative tightening) the stock market is more or less flat and long term bonds are down about 10% yoy.

Let’s have a look at how the unwind is progressing and detect possible implications for investors.

The Fed’s balance sheet remains the main chart to watch (https://fred.stlouisfed.org/series/WALCL):

Fed_assets

From $4.46T a year ago the balance sheet is down to $4.14T, or an unwind of $320 billion. At this rate it would take about 10 years to get to a balance sheet that is back in line with the levels prior to 2009. As I pointed out last year, that’s not going to happen. Trying to put all the QE toothpaste back into the tube would create an economic crisis that is worse than the one they claim to have “solved” with their QE program.

I pointed to excess reserves held by commercial banks as the prime candidate to pay for the unwind. Here is the current situation (https://fred.stlouisfed.org/series/EXCSRESNS#):

excess

From $2.2T excess reserves a year ago the banks are down to $1.75T. That’s a reduction of $450 billion. It does look like those excess reserves are indeed picking up the QT tab. But the interesting thing to note is that a $320 billion QE unwind came with a $450 billion reduction in excess reserves. A reduction at this rate could continue for another 3 years, bringing the Fed balance sheet to around $3T, but that would still be three times higher than it was before the crisis. Essentially, the excess reserves of banks are back down to late 2011 levels already, with the Fed’s balance sheet still $1.3T above its late 2011 levels. This is a strong indication that only a partial unwind of QE will be possible.

I also keep an eye on commercial banks’ holdings of government paper (https://fred.stlouisfed.org/series/USGSEC#0):

banks_treas

There is only a small rise from $2.49T a year ago to $2.56T now, an increase of $70 billion. This means banks are not showing much appetite for the debt paper that the Fed is unwinding, which is what I expected.
How about foreign buyers? Official foreign holdings of US treasuries were around $6.3T a year ago and are down to $6.2T now. Largest holders China and Japan have reduced their holdings and Russia has sold almost all its US treasuries. Predictably, those foreign buyers are also refusing to become QT bagholders: http://ticdata.treasury.gov/Publish/mfh.txt.

This weak demand by major participants is why longer term treasury bond prices are down 10% over the year:

tlt

How about cash on the sidelines held by stock investors? The data are now here: http://www.finra.org/investors/margin-statistics
Stock investors have about $340 billion in cash and $650 billion in margin debt. Not much change. With those numbers we can’t expect stock owners to play much of a role in a $3T QE unwind. If anything they may panic alongside bond holders at some point, because margin interest rates go up together with rising Fed funds rates.

The question becomes: how much more QT can be done before it causes global bond market stress and starts choking the economy? We may be reaching that point already. If Europe and Japan start their own QT it could become even more interesting.

My guess is that QT in the US will be stopped (paused) as soon as excess reserves at commercial banks approach zero. It may be stopped even before that point. Stock and bond markets could show a very positive response to any such announcement. That’s going to be a wild card for investors in the year(s) to come. At some point it will be concluded that it is more desirable to freeze central bank’s balance sheets at their elevated post-2010 levels. Europe, Japan and China may never start their own QT (or only do a small symbolic reduction) because their economy remains too weak to take it.

A possible side-effect of doing too much QT would be an unexpectedly strong US dollar because it makes dollars more scarce.

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Quantitative squeezing – what you need to know

Posted by Danny on October 16, 2017

Stock markets keep inching higher and people probably start thinking that nothing can bring them down. Real volatility has also dropped to new all time lows. That’s strange because there is unusual uncertainty on the horizon already. The US Fed has announced that it will start unwinding its decade old QE programs and that’s something that has never been tried before. They present it as a non-event that will be like watching paint dry and maybe enough investors are believing them… Anyway, I will give my observations on how this “quantitative squeezing” is likely to unfold, but first a look at the current S&P 500 chart:

^SP500 (Daily) 1_26_2016 - 10_13_2017

This market keeps advancing within the narrow channel (red) it has been occupying for most of the year (with the exception of a brief breakout attempt in February). The S&P is at new record highs and bumping into the ceiling of this trend channel. This advance has lifted the MoM index into the +8 euphoric zone, which usually marks peaks. The Earl (blue line) has turned down already with a bearish divergence in place. The Earl2 (orange line) is still climbing and has reached its highest level since early January. When the Earl2 turns down we will probably have an important peak in place. This not the kind of setup to do new buying. The risk/reward is too poor. Our LT wave for October shows a peak on the 19th, so that’s something I would also keep an eye on this week.

Now, let’s have a look at quantitative easing (QE) and what will happen when it reverses into quantitative squeezing (QS). Will it be a non-event, as they want us to believe? If so, then why are they starting it with a paltry $10B in the first month(s)? The reality is they are shaking in their boots. This is not mere tightening like when rates are being raised. This is about squeezing a few trillion $ out of an economy over the course of a few years. If putting those $trillions in supposedly saved the economy then it makes no sense to think that taking them back out will have no effects. That’s like putting the engine off in a helicopter and tell the passengers that it will keep flying all the same.

There are a few charts that you will want to watch as this QS gets underway. All can be found on the Fed’s own websites. The first one is the so-called balance sheet of the Fed (https://fred.stlouisfed.org/series/WALCL):

CB_assets

It is easy to see how their holdings have jumped up with the asset purchases done for the QE programs since 2008. I have extrapolated the original growth rate of their total assets prior to the QE experiment (orange line) and that shows us the Fed has to unload about $3.3T worth of paper if it wants to get back to “normal”. They say they will do that gradually by not rolling over some of the bonds at maturity, thereby suggesting they will not do any direct selling. But that’s just smoke and mirrors. When the Fed doesn’t roll over some Treasuries when they are being refinanced then new buyers need to be found for that portion the Fed is unwinding. When bonds mature it is not like a lottery ticket that expires worthless. The principal needs to be payed back (+ interests) and that money will have to be found elsewhere if the Fed doesn’t roll over its assets. So, where will those new buyers come from? Well, not everyone has $ billions lying around, but the first candidate buyers can be seen here (https://fred.stlouisfed.org/series/EXCSRESNS#):

Excess_Res

Most of the QE money went into excess reserves at commercial banks. They still have a little over $2 trillion in excess reserves and that money will inevitably become a buyer of the assets the Fed is unwinding because primary dealers are required to pick up the unsold portion on treasury auctions. You will want to watch this chart during QS to see how quickly their excess reserves dwindle. Once that money starts running out it will become problematic for the Fed to continue unwinding because then buyers with deep pockets will have to be found elsewhere. Problems may start well before that point because commercial banks could balk at picking up more treasuries unless a more attractive long term interest rate is offered. Historically commercial banks have held a portion of their assets in government paper and this is the third chart you will want to watch as QS unfolds (https://fred.stlouisfed.org/series/USGSEC#0):

bank_own

Banks have typically held about 10% of their total assets in government paper. That was also the case in 2008. Since the start of QE banks have been net buyers of $1.2T worth of treasury and agency securities, doubling their stake and now more than 15% of total assets. We can easily see where all the QE money has gone: two thirds went into excess reserves and the rest was used to buy government paper. Are those banks now going to be eager to use all their excess reserves to buy another $2T worth of bonds for their own accounts? They would be well on their way to become a bond ETF rather than a bank if they do so. Those bankers will try to unload some bonds on the public and this chart will tell us how successful they are in doing so. If their treasury holdings go up just as quickly as the Fed unwinds theirs (chart 1) then we will know that the broader public has little or no appetite for this paper and then QS will be in trouble.

Of course they could use a few tricks to boost public appetite for treasuries. E.g. Fed could announce that long term inflation target has been lowered to 1%, saying that low inflation has become a permanent feature of the economy. In a 1% inflation world a long term bond yielding 3% would look OK, especially compared to richly priced stocks. And a stock market crash could also beef up the demand for bonds. But for how long? NYSE tells us that stock investors currently have some $291 billion cash in their accounts and $550 billion in margin debt (http://www.nyxdata.com/nysedata/asp/factbook/viewer_edition.asp?mode=tables&key=50&category=8). Good luck in trying to peddle them a portion of the assets the Fed will be unwinding.

Will foreign investors pick up the tab? Not likely. Official foreign holdings of US treasuries is around $6T. Latest data suggest they are trying to reduce their holdings: http://ticdata.treasury.gov/Publish/mfh.txt.

Investors understood that QE was like having a persistently large buyer in the bond markets and that money spread into other markets. They will soon realize that QS is like having a persistently large seller in the market and that transition will feel like a kind of squeeze because money is taken out. My guess is that QS will seem to go smooth in the beginning, especially when other central banks like ECB are still in ongoing QE programs. But as excess reserves dwindle at commercial banks it could turn ugly without any warning. So, I think they will be forced to stop QS well before their balance sheet gets anywhere near the old “normal”. Trying to unwind all the way to “normal” would cause a financial crisis that is worse than the one they happily believe to have solved with QE. Once that is understood they will settle for freezing their balance sheet at a high level for an indeterminate period of time. And they will still want us to believe that their actions have saved the economy. But in reality the economy will have saved their actions.

Posted in Market Commentary | Tagged: , , , | 6 Comments »

 
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