This is the second of three installments of a yearend analysis of the bond market by Strategy Asset Managers, LLC.
Follow the money
The Federal Reserve recently released its quarterly flow of funds study for the period ending September 30th. Despite a brisk pace of federal government borrowing, aggregate credit demands remained weak. Total non-financial debt grew at about a 4% pace as households shrank their borrowings. This provided plenty of space for federal government debt to expand. Meanwhile, the Federal Reserve was dumping huge amounts of money into the economy. A broad measure of money supply–so-called M2–increased 9.8% over the last year. Lots of money and little credit demand resulted in very low interest rates. This could change quickly, however.
The US consumer has been tightening his/her belt since 2007. The bursting of the housing bubble resulted in lower home prices, lower turnover and a decline in mortgage debt outstanding–from $14.8 trillion in June 2008 to $13.6 trillion in September 2011. Faced with a troubling job market, consumers reduced non-mortgage debt as well. This peaked at $2.6 trillion in 2008 and now stands at $2.47 trillion. This borrowing metric seems to have stabilized recently as consumer confidence in future economic prospects has improved.
While the household sector of the economy has been paring back debt, the financial sector–commercial banks and savings & loans–has been reducing debt and balance sheet leverage. This explains why few are worried about the leakage of European banking problems into our financial system. So, once folks are ready to buy a new car or upgrade to a bigger house, banks will be able to provide them credit. Despite the massive (+300%) growth in federal government borrowings over the last decade, households remain the largest sector of the credit market with $13.2 trillion of debt outstanding versus $10.1 trillion of federal government debt. If household borrowings increase by just 5%–less than half the rate experienced in the first half of the last decade–aggregate credit demand could rise by 7%. This rate of expansion is not compatible with the current low level of interest rates.
That’s it for today. SAM, LLC’s conclusions tomorrow.
Here’s yesterday’s initial post in this series.