Jim Kochan

Still no cyclical revival in private-sector borrowing

AdvantageVoice® Blog—12-20-12
James Kochan, Chief Fixed-Income Strategist

The latest Flow of Funds report from the Federal Reserve shows that, through the third quarter, the cyclical recovery in private-sector borrowing remains exceptionally slow. The pace of borrowing in the capital markets by households and businesses is only a $435 billion annual rate thus far this year, which is not significantly faster than in 2011. Before the recession, in 2006-07, private-sector borrowing was expanding by $2 trillion per year, with $1 trillion accounted for by the mortgage market. The dollar volume of mortgages outstanding has declined since the start of 2008, and it fell again last quarter. The decline in mortgage debt has been unprecedented, totaling over $1 trillion since the 2007 peak. Business borrowing, which peaked at a $1.3 trillion annual rate in 2007, expanded at only a $500 billion annual rate in 2012. This anemic pace of private-sector borrowing is a major reason why interest rates have stayed at cyclical lows four years into this recovery.

The Treasury remains by far the major borrower in the credit markets, but it has been helped immensely by demand from overseas. In 2011, 80% of the net new issuance of Treasury debt was purchased by foreign investors. Thus far in 2012, almost one-half of the new Treasury debt was purchased by foreign investors. In the third quarter, almost 100% of the Treasury’s net issuance was purchased by those investors. Money market funds and mutual funds were the other major buyers of Treasuries. The Fed has not been a net buyer of Treasuries this year because, with Operation Twist, purchases of longer maturities are offset with sales of shorter notes.

In 2013, however, the Fed will purchase $45 billion of notes and bonds each month, and Operation Twist will expire, ending the sale of shorter notes. That will be equal to approximately 75% of the Treasury’s net issuance in those maturities. In addition, the Fed will continue to purchase $40 billion of mortgage-backed securities per month. In so doing, the Fed will remove $480 billion per year from a market where net issuance has been essentially zero for the past two years.

Net issuance of corporate bonds has been at a moderate pace thus far in 2012, primarily because banks have been retiring debt. Excluding the banks, net issuance has been approximately $450 billion per year, only slightly faster than in 2010 and 2011. Net issuance of municipal bonds remained anemic in 2012 as state and local governments have been forced to adopt more conservative spending and borrowing strategies.

Watch the housing market for indications of a recovery of private-sector borrowing

Borrowing in the U.S. capital markets has been weak since the onset of the recession in 2008. Only the Treasury has been a major borrower, and the combination of foreign buying and Fed purchases has absorbed a major share of those new issues. Moreover, in past cycles, the strength or weakness of private-sector borrowing has been the principal driver of interest rates. The current combination of low interest rates and weakness in private-sector borrowing is in keeping with those previous cyclical patterns. Since the housing sector is such a big user of borrowed money, the pace of private-sector borrowing might stay weak until housing becomes much stronger. In view of the depressed levels of housing activity and forecasts of a moderate recovery in 2013, that might not be the case until sometime in 2014.

The views expressed are as of 12-20-12 and are those of Chief Fixed-Income Strategist James Kochan and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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