Inflated Household Net Worth
June 13, 2022
The ten year yield dropped 11 bps on the week to 1.45%, with CPI clocking in at 5% yoy. JOLTS data last week was off the charts at 9286k, indicating powerful demand to fill job openings.
This week features the June FOMC meeting. The Fed has apparently won the “inflation is transitory” argument, because a ten year yield below 1.5% simply does not make sense with inflation at 5% (or at 3% or at 2% for that matter). Nor does a new record low in hi-yield at 4.08%. The G7 meeting found common ground in the need to continue shoveling fiscal support. Certainly, the conversation to begin tapering should occur, but any action will occur at a later date. An adjustment to IOER higher by 5 bps is likely to be the only tangible outcome of the meeting.
The Fed’s Z.1 flow of funds report was released last week. Focus is typically on the Household Net Worth number, which of course hit a new record high of $137 trillion, up $5T on the quarter. Yes, we’re all getting “richer”, (isn’t that simply fantastic?) What I would note is that the “getting richer” slope over the past four or five quarters is quite a bit steeper than the trend from 2011 to 2018.
The Credit Bubble Bulletin has these comments relating to Z.1: “Household Assets inflated $5.184 TN, or almost 14% annualized during Q1 to a record $154.2TN… Household Assets-to-GDP ended the quarter at a record 699% of GDP – up 100 percentage points in 14 quarters.” Further, “HH Net Worth surged $4.997 T during Q1 to a record $136.9T. For perspective, growth in Net Worth averaged $830 billion quarterly over the 20-yr period prior to 2019. Net Worth inflated $31.4T over five quarters. HH Net Worth ended March at a record 621% of GDP. This was up from previous cycle peaks 491% (Q1 2007) and 445% (Q1 2000).”
I would put this data in the inflation category. Moreover, I would also have to characterize these ratios as transitory. While growth has clearly come roaring back, my opinion is that Net Worth to GDP is at an unsustainable level. What I haven’t read much about recently, (though I have personally observed it) is the wealth effect on consumption. I believe it operates with a lag and is likely to be a large support for consumption over the next several quarters. My thesis is that the Fed, in concert with fiscal spending, has over-inflated the value of financial assets relative to GDP. What is comforting, at least on the household side, is that total liabilities (the red bars on the above chart) have barely increased at all. In fact, on the quarter, liabilities increased less than $200 billion to $17.24T. These assets are being blown up by someone’s debt, but it’s not that of the HH sector, it’s the government. I suppose one might surmise that a moderating influence on consumption would be future tax liabilities on households, but that’s been pushed to the back burner by Modern Monetary Theory.
The chart above has bearing on household net worth, yield levels, and the taper discussion. Note that in 2013, when yields surged in response to Bernanke’s suggestion of taper, the balance sheet was, in fact, growing the entire time. Another fun fact is that while the FF target was exactly the same then as it is now, the starting point for the tantrum surge in tens was the exact same level as it is now.
There is, of course, a lot of focus on the tapering schedule, but current concerns seem rather overblown because in this case, the Fed won’t actually be decreasing the balance sheet, but merely slowing its growth rate, though of course changes at the margin matter. It was in 2018 when the Fed was both hiking AND actually cutting the size of the balance sheet that proved too much for financial markets, as stocks tanked in Q4 2018 and bond yields followed suit. On the chart above, yields would appear to have significant room to the upside even with a slight decrease in the trajectory of balance sheet growth. Of course, the narrative is that without the Fed buying every bond, yields have to increase. I think a taper at this point will have a more significant effect on equities than bonds.
A couple of words about commodities and the inflation debate. Some have pointed to the hard break in lumber off May’s high, which accelerated this past week, as evidence that high prices are unsustainable. We are not seeing the same sort of price action in grains, and certainly not in oil. Both the near WTI contract and deferred calendar spreads made new highs. CLN1 closed at 70.91, highest since Q4 2018 (when Fed hikes and balance sheet reduction hit oil and stocks simultaneously). CLZ1/CLZ2 ended the week at the highs of 5.53, having started the year at 1.31. CLZ1 100 calls have drawn some attention, and now show nearly 16k in open interest, settling at 27 cents vs 67.84. Dec Corn ended the week at 609 ¾, near the high of the year. Hot and dry weather is underpinning strength in grains. I like to refer back to Sue Martin’s interview on Feb 26 of this year with Iowa PBS, where she forecasts extremely high prices in 2023 as a result of tight stocks: “I think it’s possible that in 2023, we can see, and I’ll pace it, we could see $30 beans. I think corn, maybe 18-19, and wheat goes to 42 to 45.” If she’s correct about $19/bushel corn next year, it will be mighty interesting to see where we are on the broader inflation question.
https://www.iowapbs.org/mtom/story/38230/market-plus-sue-martin
(start around 9 min mark)
OTHER MARKET THOUGHTS/TRADES
The 2yr/5yr treasury spread topped at 77.5 in March. This week it made a low of 56.2 and ended at 59. The two-year note under 15 bps indicates not much of a hike chance over the period, though EDH’22/EDH’23 at a settlement of 26 forecasts at least one hike over that period. I continue to believe that the Fed will be forced into a hike in late 2022, as high inflation persists and financial stability is imperiled. I do not think Biden will retain Powell next year, and instead will move to Brainard, who may not bring as strong of a hand to the table in terms of Fed board allies.
While the long end rally has compressed many spreads, the trend toward steepening remains intact. There might be a bit more of a pull back, but my thought is that the August change in the Fed’s framework sparked a move that will continue, unless trendlines off August lows in spreads are broken. Using 2/5 as an example, the spread began the year at 25, and the August trendline comes in around 40 currently.
| 6/4/2021 | 6/11/2021 | chg | ||
| UST 2Y | 14.9 | 14.7 | -0.2 | |
| UST 5Y | 78.4 | 73.9 | -4.5 | |
| UST 10Y | 156.2 | 145.2 | -11.0 | |
| UST 30Y | 224.2 | 213.8 | -10.4 | |
| GERM 2Y | -67.1 | -68.3 | -1.2 | |
| GERM 10Y | -21.3 | -27.3 | -6.0 | |
| JPN 30Y | 69.0 | 65.1 | -3.9 | |
| CHINA 10Y | 313.0 | 315.0 | 2.0 | |
| EURO$ U1/U2 | 14.0 | 14.0 | 0.0 | |
| EURO$ U2/U3 | 53.0 | 50.0 | -3.0 | |
| EURO$ U3/U4 | 58.5 | 53.5 | -5.0 | |
| EUR | 121.68 | 121.11 | -0.57 | |
| CRUDE (active) | 69.62 | 70.91 | 1.29 | |
| SPX | 4229.89 | 4247.44 | 17.55 | 0.4% |
| VIX | 16.42 | 15.65 | -0.77 | |
https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/table/
