For the week, the S&P500 rallied 2.5% (down 2.1% y-t-d), and the Dow jumped 2.8% (down 2.1% y-t-d). The Banks gained 2.7% (up 14.6%), and the Broker/Dealers added 0.2% (down 7.3%). The Morgan Stanley Cyclicals recovered 4.0% (up 1.6%), and the Transports gained 3.9% (up 5.4%). The Morgan Stanley Consumer index increased 2.2% (up 0.1%), and the Utilities surged 3.6% (down 6.8%). The S&P 400 Mid-Caps jumped 3.0% (up 4.4%), and the small cap Russell 2000 gained 2.4% (up 3.8%). The Nasdaq100 increased 0.8% (down 0.7%), and the Morgan Stanley High Tech index rose 1.4% (down 4.5%). The Semiconductors added 0.3% (down 2.9%). The InteractiveWeek Internet index rose 1.7% (up 1.9%). The Biotechs gained 2.3%, boosting 2010 gains to 13.3%. With bullion up about $6, the HUI gold index jumped 4.0% (up 7.5%).

One-month Treasury bill rates ended the week at 6 bps and three-month bills closed at 13 bps. Two-year government yields were little changed at 0.69%. Five-year T-note yields rose 4 bps to 1.97%. Ten-year yields increased 3 bps to 3.23%. Long bond yields added 2 bps to 4.15%. Benchmark Fannie MBS yields declined 7 bps to 3.98%. The spread between 10-year Treasury and benchmark MBS yields narrowed 10 to 74 bps. Agency 10-yr debt spreads narrowed one basis point to 33 bps. The implied yield on December 2010 eurodollar futures dropped 14 bps to 0.81%. The 10-year dollar swap spread declined 1.25 to 10.0. The 30-year swap spread was little changed at negative 15.5. Corporate bond spreads were mixed. An index of investment grade spreads narrowed one to 124 bps, while an index of junk bond spreads widened 29 to an eight-month high 611 bps.

June 11 - Bloomberg (Craig Trudell and Caroline Hyde): "U.S. Bancorp, the Minnesota lender, and tobacco company Altria Group Inc. led $7.9 billion of corporate bond sales in the U.S. as issuance fell short of the 2010 average for a seventh straight week."

Debt issuance remained slow. Investment grade issuers included Citigroup $1.875bn, US Bank $1.0bn, Altria Group $800 million, Bank of New York Mellon $650 million, John Deere $500 million, Maxim Integrated Products $300 million and PACCAR $250 million, Interstate Power $150 million and Wisconsin P&L $150 million.

Junk issuers included Trans Union $645 million, Triumph Group $350 million, and Bway Holding $205 million.

Converts issues included Microsoft $1.15bn and National Financial $125 million.

International dollar debt sales included Ontario $2.5bn, International Bank of Reconstruction & Development $1.0bn, Bank of Nova Scotia $1.0bn, and Vestjysk Bank $500 million.

U.K. 10-year gilt yields fell 5 bps to 3.46%, and German bund yields declined 2 bps to 2.56%. Greek 10-year bond yields rose 3 bps to 8.17%, while 10-year Portuguese yields declined 3 bps to 5.08%. The German DAX equities index rallied 1.8% (up 1.5% y-t-d). Japanese 10-year "JGB" yields fell 4 bps to 1.23%. The Nikkei 225 dropped 2.0% (down 8.0%). Emerging markets were mostly higher. For the week, Brazil's Bovespa equities index jumped 3.1% (down 7.3%), and Mexico's Bolsa rose 3.7% (unchanged). Russia's RTS equities index gained 1.2% (down 6.0%). India's Sensex equities index slipped 0.3% (down 2.3%). China's Shanghai Exchange increased 0.6% (down 21.6%). Brazil's benchmark dollar bond yields declined 3 bps to 4.87%, while Mexico's benchmark bond yields were little changed at 4.83%.

Freddie Mac 30-year fixed mortgage rates dropped 7 bps last week to 4.72% (down 87bps y-o-y). Fifteen-year fixed rates declined 3 bps to 4.17% (down 89bps y-o-y). One-year ARMs declined 4 bps to 3.91% (down 113bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 8 bps to 5.57% (down 108bps y-o-y).

Federal Reserve Credit declined $6.2bn last week to $2.314 TN. Fed Credit was up $93.7bn y-t-d (9.5% annualized) and $288bn, or 14.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 6/9) were little changed at $3.076 TN. "Custody holdings" have increased $121bn y-t-d (9.2% annualized), with a one-year rise of $326bn, or 11.9%.

M2 (narrow) "money" supply jumped $21.1bn to $8.595 TN (week of 5/31). Narrow "money" has increased $82bn y-t-d. Over the past year, M2 grew 1.8%. For the week, Currency added $0.3bn, and Demand & Checkable Deposits rose $27.4bn. Savings Deposits declined $6.7bn, and Small Denominated Deposits fell $4.3bn. Retail Money Fund assets increased $4.3bn.

Total Money Market Fund assets (from Invest Co Inst) were little changed at $2.841 TN. In the first 23 weeks of the year, money fund assets dropped $453bn, with a one-year decline of $907bn, or 24.2%.

Total Commercial Paper outstanding added $1.3bn last week to $1.065 TN. CP has declined $106bn, or 20.4% annualized, year-to-date, and was down $165bn from a year ago.

International reserve assets (excluding gold) - as tallied by Bloomberg's Alex Tanzi - were up $1.529 TN y-o-y, or 22.5%, to $8.327 TN.

Global Credit Market Watch:

June 10 - Bloomberg (Zoe Schneeweiss and Benjamin Purvis): "George Soros told a conference in Vienna today that 'we have just entered act two' of the crisis. The billionaire investor said the current situation is reminiscent of the 1930s and that markets are not capable of correcting their own excesses."

June 7 - Bloomberg (Tony Czuczka and Brian Parkin): "German Chancellor Angela Merkel's Cabinet approved levies on banks, air travel and nuclear-power plants as part of what she called an "unprecedented" round of budget cuts, rejecting U.S. calls to spur growth. The program, a mixture of spending cuts and revenue-raising steps, amounts to 81.6 billion euros ($97.5 billion) from 2011 through 2014, the government said. Equivalent to about 2.7% of last year's gross domestic product, the package also includes welfare reductions and a restructuring of the armed forces and pushes back plans to rebuild Berlin's royal palace."

June 9 - Bloomberg (Ben Moshinsky and Gregory Viscusi): "France and Germany called on the European Union to speed up curbs on financial speculation, saying some bets against stocks and government bonds should be banned... In a joint two-page letter, French President Nicolas Sarkozy and German Chancellor Angela Merkel sought proposals from European Commission President Jose Manuel Barroso on a ban on so-called naked short sales of 'certain' stock and bonds, as well as on naked credit-default swaps on sovereign bonds."

June 8 - Bloomberg (Gonzalo Vina and Lukanyo Mnyanda): "British Prime Minister David Cameron needs to accelerate budget-deficit cuts to protect the nation's top credit rating, Fitch Ratings said... 'The scale of the United Kingdom's fiscal challenge is formidable and warrants a strong medium-term consolidation strategy -- including a faster pace of deficit reduction than set out in the April 2010 budget,' Fitch said."

June 8 - Bloomberg (Phil Mattingly): "Debate in the U.S. Congress over whether to restrict swaps-trading by commercial banks has taken the spotlight away from other proposed derivatives rules that may soon be approved. Lawmakers are set to negotiate a bill passed May 20 by the Senate that would require standardized derivative trades to be cleared through a third party and traded on an exchange or so-called swap-execution facility; place a fiduciary duty on dealers in transactions with municipalities; and subject the foreign exchange swaps market to regulation. As the large Wall Street banks that dominate the $615 trillion over-the-counter derivatives market... have focused on trying to kill the most contentious rule -- one that would require them to push out their swaps-trading desks to subsidiaries -- the other provisions have moved a few votes away from law."

June 8 - Bloomberg (Yalman Onaran and Jody Shenn): "U.S. banks are fighting to preserve the use of securities that help them appear better capitalized, even as their investments in each others' notes perpetuate what one regulator calls a 'downward spiral' of losses. The cross-ownership, largely unnoticed by bank supervisors who generally discourage the practice, was made possible by a Wall Street innovation like the ones that allowed subprime mortgages to flourish. Small lenders... were able to sell trust-preferred securities, known as TruPS, because investment bankers packaged them with those issued by dozens of other financial institutions."

Global Government Finance Bubble Watch:

June 10 - Bloomberg (Simone Meier and Jana Randow): "Jean-Claude Trichet said the European Central Bank will extend its offerings of unlimited cash and keep buying government bonds as it tries to ease tensions in money markets and fight the European debt crisis. 'It's appropriate to continue to do what we've decided' on purchases of sovereign and corporate bonds, Trichet...said... 'We have a money market which is not functioning perfectly.' The ECB is buying state debt and pumping unlimited funds into the banking system as part of a strategy by European policy makers to stop the euro region from breaking apart."

June 10 - Bloomberg (James G. Neuger): "European Union President Herman Van Rompuy said the 750 billion-euro ($905 billion) rescue package would be expanded if it doesn't quell the debt crisis, becoming the first EU leader to float the idea of a larger fund. 'Currently there isn't even the hint of a request to put this rescue plan into practice,' Van Rompuy told Belgium's Trends magazine. 'And if the plan were to prove insufficient, my answer is simple: in this case, we'll do more.'"

Currency Watch:

The dollar index declined 1.1% to 87.30 (up 12.1% y-t-d). For the week on the upside, the Australian dollar increased 3.3%, the Brazilian real 3.2%, the New Zealand dollar 3.0%, the Canadian dollar 2.8%, the Mexican peso 2.3%, the Norwegian krone 2.0%, the South African rand 1.5%, the Swedish krona 1.3%, the Euro 1.2%, the Danish krone 1.2%, the Swiss franc 1.1%, the Singapore dollar 0.9%, the British pound 0.7% and the Japanese yen 0.2%. For the week on the downside, the South Korean won declined 3.6% and the Taiwanese dollar 0.6%.

Commodities Watch:

June 10 - Bloomberg: "China, the world's second-biggest energy consumer, imported 29% more crude oil in the first five months of the year as faster economic growth boosted demand for motor fuel and electricity. Oil purchases in the January-to-May period climbed to 95.7 million metric tons from a year earlier..."

The CRB index rallied 2.8% (down 9.7% y-t-d). The Goldman Sachs Commodities Index (GSCI) jumped 3.9% (down 6.0% y-t-d). Spot Gold gained 0.5% to $1,226 (up 11.7% y-t-d). Silver rose 5.4% to $18.23 (up 8.2% y-t-d). July Crude recovered $2.74 to $74.25 (down 6.4% y-t-d). July Gasoline rallied 3.3% (unchanged), while July Natural Gas was little changed (down 14% y-t-d). July Copper gained 3.7% (down 13% y-t-d). July Wheat increased 1.1% (down 19% y-t-d), and July Corn rose 2.8% (down 16% y-t-d).

China Watch:

June 8 - Bloomberg: "China's economic growth may slip to between 10% and 11% this quarter as industrial production and investment expand at a slower pace, a researcher for the nation's cabinet said. 'The 11.9% growth rate in the first quarter won't be sustained and the outlook for investment and export growth is uncertain,' Zhang Liqun, a researcher at the State Council's Development and Research Center, said... The nation's policies 'shouldn't be adjusted too readily' until a clearer picture emerges of second-quarter economic performance, Zhang said."

June 9 - Bloomberg: "China's inflation rate, export growth and bank loans exceeded economists' forecasts in May, Reuters reported, spurring an rally in stocks by showing no evidence Europe's debt crisis is impairing the Chinese expansion. Consumer prices rose 3.1% from a year earlier, exports jumped about 50% and new loans totaled 630 billion yuan ($92.3 billion)..."

June 11 - Bloomberg: "China's gains in retail sales, consumer prices and industrial production challenged the government's assessment that the recovery isn't 'solid,' and escalated pressure on policy makers to let the yuan rise. Inflation accelerated to an annual 3.1% pace in May, surpassing officials' target for the full year, retail sales gains quickened to 18.7% and industrial production jumped 16.5%..."

June 8 - Bloomberg: "Chinese employers' hiring plans reached a six-year high as a recovery in the world's third-largest economy and the Shanghai World Expo boosted demand, a private survey showed."

June 10 - Wall Street Journal Asia: "The recent strikes at Honda factories in southern China represent another data point in an emerging trend: Cheap labor won't be the source of the Chinese economy's competitive advantage much longer. The automaker has caved and given workers a 24% pay increase to restart one assembly line. Foxconn, the contract electronics producer which has experienced a string of worker suicides, has also announced substantial raises... The supply of Chinese migrant workers from the countryside, once thought to be endless, is running dry, and that is giving workers leverage to demand bigger pay packets."

June 8 - Wall Street Journal Asia (Andrew Batson and Norihiko Shirouzu): "China's workers are successfully demanding higher wages and better working conditions, a shift that promises to accelerate the nation's transition to an economy more driven by the spending power of its own people. On Monday, Honda Motor Co. was jolted by a strike at a Chinese company that supplies it with exhaust pipes. Less than a week earlier, the Japanese auto maker settled a strike at another supplier -- which paralyzed its manufacturing operation in China for 10 days -- by granting workers a 24% increase in pay and benefits. The Honda strikes are part of a series of labor disputes involving major global companies in recent weeks..."

June 9 - Financial Times (Tom Mitchell and Robin Kwong): "Chinese labour protests that have forced shutdowns at foreign factories have spread beyond south China's industrial heartland, posing a dangerous new challenge for Beijing. Workers at a Taiwanese machinery factory outside Shanghai clashed with police on Tuesday, leaving about 50 protesters injured. The confrontation represented an escalation of recent industrial action in the country..."

June 9 - Bloomberg (Kelvin Wong and Sophie Leung): "The Hong Kong government's HK$10.9 billion ($1.4bn) sale of a residential site at a public auction beat estimates and showed home demand is withstanding efforts to cool the market... Home prices have risen 41% since the end of 2008, prompting the government to tighten down-payment requirements for luxury homes in October to curtail speculation after record-low interest rates fueled the surge."

Japan Watch:

June 8 - Bloomberg (Toru Fujioka and Mayumi Otsuma): "Japan's current-account surplus widened in April, evidence that the exports are sustaining an expansion in the world's second-largest economy. The gap rose 88% to 1.242 trillion yen ($13.6bn) from a year earlier, the Ministry of Finance said... The report supports Bank of Japan Governor Masaaki Shirakawa's view that Japan's recovery is making 'firm progress' toward becoming more sustainable."

June 10 - Bloomberg (Kazuyo Sawa): "Spending by Japanese businessmen on beer and sake is at an eight-year low as tighter household budgets squeeze their entertainment expenses. Salarymen go out drinking on average 2.9 times a month, spending about 4,190 yen ($46) each time, a 19% decline from a year earlier, according to a Shinsei Financial Co. online survey."

June 9 - Bloomberg (Wes Goodman and Theresa Barraclough): "Japanese women are seeking men who invest in government bonds, according to an advertisement being run by the Ministry of Finance. 'I want my future husband to be diligent about money,' a 27-year-old woman says in an ad being run in free magazines promoting a fixed-rate, three-year note that Japan started selling last week. 'Playboys are no good.' She's one of five women featured in the page, which says 'Men who hold JGBs are popular with women!!'"

Asia Bubble Watch:

June 11 - Bloomberg (Yumi Teso and David Yong): "The world's biggest expected swings in foreign-exchange markets and the euro's record depreciation are prompting Asian exporters to seek currency controls. TLtek Co., a South Korean exporter... called on policy makers to limit volatility caused by 'gambling' on the won... Policy makers in South Korea, Taiwan and China are responding to Europe's debt crisis by selling their own currencies, limiting investment inflows and delaying interest- rate increases."

June 9 - Bloomberg (Eunkyung Seo): "South Korea's unemployment rate declined in May to the lowest level since October 2008 as the nation's strengthening economy prompted companies to hire. The jobless rate fell to 3.2% from 3.7% in April..."

June 9 - Bloomberg (Sangim Han and Eunkyung Seo): "South Korea will tighten limits on capital flows to reduce swings in its currency and won't raise interest rates without evidence of a sustainable economic recovery, Vice Finance Minister Yim Jong Yong said. The government will announce the steps 'soon' to rein in excessive flows and reduce currency-market volatility... 'All we want is to reduce the currency-market volatility and avert a financial crisis,' Yim said... 'I don't think the domestic and international situations are stable enough to declare a shift to tightening.'"

Latin America Watch:

June 8 - Bloomberg (Matthew Bristow): "Brazil's economy grew at its fastest annual rate since 1995 in the first quarter... Gross domestic product expanded 9% from a year earlier, faster than any other Latin American economy."

June 8 - Bloomberg (Carla Simoes and Iuri Dantas): "Brazil is running out of beer cans and farmers are leaving crops in the field as surging demand and Chinese-like growth leads to shortages in Latin America's biggest economy. Cia de Bebidas das Americas, the region's largest brewer, had to import beer cans for the first time in its 125-year history after local supplies were exhausted. Acucar Guarani SA, the country's third-biggest sugar producer by market value, left 10% of its crop sitting in the fields an extra 40 days because of a shortage of tires for its harvesters, even after the commodity hit a 29-year high in February."

June 11 - Bloomberg (Veronica Navarro Espinosa): "Brazilian companies refrained from selling international bonds for a sixth straight week, the longest stretch in 14 months, as Europe's debt crisis drove up borrowing costs and caused a surge in volatility."

June 7 - Bloomberg (Sebastian Boyd): "Chile's economy grew 8.2% in April from March, the fastest expansion since at least 1996... The economy expanded 4.6% in April from a year earlier..."

June 10 - Bloomberg (John Quigley): "Peru's central bank may raise its benchmark lending rate today for a second straight month as 8.8% economic growth and inflation exceed economists' estimates.

Unbalanced Global Economy Watch:

Kati Pohjanpalo Goodman and Theresa Barraclough): "Finland's economy unexpectedly slipped back into a recession in the first quarter as lack of demand for its goods abroad was aggravated by a port strike that cut off exports for more than two weeks. Gross domestic product adjusted for seasonal variations fell 0.4% in the quarter..."

June 8 - Bloomberg (Maria Petrakis): "Greek inflation accelerated to the fastest in at least a decade in May amid higher prices for fuel, alcohol and tobacco products. Consumer prices in the country... increased 5.4% from a year earlier after a 4.8% gain in April..."

U.S. Bubble Economy Watch:

June 10 - Bloomberg (Courtney Schlisserman): "The trade deficit in the U.S. widened in April to the highest in more than a year as exports and imports both declined. The gap grew 0.6% to $40.3 billion, the most since December 2008... A separate report showed more Americans than anticipated filed claims for jobless benefits last week."

June 11 - Bloomberg (Bob Willis): "Sales at U.S. retailers unexpectedly dropped in May for the first time in eight months, indicating the rebound in consumer spending is cooling as Americans boost savings. Purchases fell 1.2%...

Central Bank Watch:

June 11 - Bloomberg (Scott Lanman): "Federal Reserve Vice Chairman Donald Kohn said he will remain at the central bank until a new governor is appointed instead of departing June 23 as he announced in March... The Senate has failed to act yet on President Barack Obama's April nominations of three Fed governors, including San Francisco Fed President Janet Yellen for vice chairman."

Fiscal Watch:

June 9 - Bloomberg (Rodney Jefferson): "Edinburgh's two biggest fund companies have a warning to investors: don't overlook the U.S. when scouring the world for nations with too much debt. Standard Life Investments is questioning when... Obama's administration can reduce borrowings, said Andrew Milligan, the company's head of global strategy. Scottish Widows Investment Partnership sold U.S. stocks in March on concern an eventual reduction in spending would weigh on economic growth. The amount of total marketable U.S. debt outstanding has risen to $7.96 trillion from $4.4 trillion in mid-2007. 'I don't know how long the U.S. can afford not to focus on the issue and take action,' Ken Adams, the top strategist at Scottish Widows, said... 'It's like Greece. It's very hard to pick the point at which confidence suddenly goes.'"

June 8 - Reuters: "The U.S. debt will top $13.6 trillion this year and climb to an estimated $19.6 trillion by 2015, according to a Treasury Department report... The report that was sent to lawmakers Friday night with no fanfare said the ratio of debt to the gross domestic product would rise to 102% by 2015 from 93% this year."

June 9 - New York Times (David E. Sanger and Sewell Chan): "At a moment when many economists warn that the American economic recovery is likely to be imperiled by prolonged high unemployment and slow growth, President Obama is discovering that the tools available to him last year -- a big economic stimulus and action by the Federal Reserve -- are both now politically untenable. The mood in both parties of Congress has turned decidedly anti-deficit, meaning that the job-creation programs once favored by the White House and Democratic leaders in Congress have been cut back, then cut again."

Real Estate Watch:

June 11 - Bloomberg (John Gittelsohn): "BP Plc's oil spill may drive down the Gulf Coast's shore-area property values by 10% for at least three years, according to CoStar Group Inc. Losses may total $4.3 billion along the 600-mile stretch from the Louisiana bayous to Clearwater, Florida... 'It's just another blow to an already depressed real estate market,' Norm Miller, CoStar's vice president of analytics, said... 'The best thing you can do if you're in real estate in this area is bide your time, don't panic and don't try to sell in this environment.'"

June 10 - Bloomberg (John Gittelsohn): "Two Connecticut real estate agents found a way to profit in the U.S. housing bust: Buy low, sell fast. Their tactic was also illegal... Their crime involved persuading lenders to approve the sale of homes for less than the balance owed --known as a short sale -- without disclosing that there were better offers. They then flipped the houses for a profit. The Federal Bureau of Investigation, the California Department of Real Estate and mortgage finance company Freddie Mac have warned that such schemes may be spreading..."

Muni Watch:

June 11 - Bloomberg (Allison Bennett and Brendan A. McGrail): "Municipal bond yields rose two days in a row...reaching a four-week high, as investors refrained from buying in hopes of better returns... The issue is absolute yields are so low, so you're seeing a lot of investor resistance,' said Alan Schankel, a managing director at... Janney Montgomery Scott LLC. 'There are a lot of bonds in dealers' inventory because it's hard to move them with such absolute lows.'"

June 10 - Bloomberg (Christopher Palmeri and Terrence Dopp): "Los Angeles City Councilman Jose Huizar had $10 million to spend on a parking garage for his district. Fellow lawmakers voted instead to use the money for expenses such as payroll... States and cities haven't cut jobs with the same vigor as companies even as they face deficits projected by the Center on Budget and Policy Priorities and the National League of Cities to reach $200 billion in the year beginning July 1. That's raised investor concerns about more public debt defaults..."

June 7 - Bloomberg (Dunstan McNichol): "The Internal Revenue Service and U.S. Securities and Exchange Commission are using concern that Build America Bonds are being mispriced as an opportunity to impose restrictions on municipal borrowers, a panel of public issuers said... An IRS plan to audit some Build America issuers is a sign of enforcement that some members of the Government Finance Officers Association's Committee on Governmental Debt Management consider 'over-reaching,' said Frank Hoadley, chairman of the panel and Wisconsin's director of capital finance."

Speculator Watch:

June 9 - Financial Times (Sam Jones): "May has been the worst month for the average hedge fund since the collapse of Lehman Brothers in October 2008...and for many it is a reminder that, in spite of 18 months of bullish markets, the world is still walking a financial tightrope. Indeed, to some hedge fund traders' eyes, the way individual names moved during the now infamous May 6 movements in the Dow was disconcertingly similar to the events of August 2007 - when previously imperceptible subprime jitters in the credit markets translated into a mass computerised dumping of stocks by the giant quantitative hedge funds..."

June 10 - Bloomberg (Chanyaporn Chanjaroen): "Clive Capital LLP's $3.9 billion commodity hedge fund fell 6% in May, the biggest drop since July 2008, mostly because of losses in energy and metals."

Q1 2010 Flow of Funds

I'll be the first to admit that analyzing the Fed's Z.1 "flow of funds" data offered more fascinating detail and nuance back during the Wall Street/mortgage finance Bubble period. All the same, dissecting Credit and financial flow data remains fundamental to our quest for clearer understanding of what remains an extraordinary financial and economic backdrop.

Total Non-Financial Credit expanded at a 3.4% rate during Q1, up from Q4 2009's 1.3% and Q3 2009's 2.7%. For the seventh consecutive quarter, federal Credit completely dominated system Credit creation. Federal borrowings (included in non-financial Credit) expanded at an 18.5% annualized rate, up from Q4's 12.6% - although slightly lower than Q3's 20.6%. State & Local debt slowed slightly from Q4's 4.6% pace to Q1 2010's 4.3%. Total Household debt contracted at a 2.4% rate, versus Q4's 1.6% pace of decline. Total Business borrowings were about unchanged, a notable improvement from Q4's negative 3.5%, Q3's negative 3.0% and Q2's negative 2.9%.

In a Seasonally-Adjusted and Annualized Rate (SAAR), Total Financial Credit expanded $1.214 TN during Q1. This was up sharply from Q4's $454bn and Q3's $927bn - yet at the same time remains far below 2007's $2.5 TN and 2008's $1.9 TN expansions. Federal borrowings expanded SAAR $1.446 TN during Q1, up slightly from the year ago $1.440 TN. This massive expansion of federal Credit offset a SAAR $330bn contraction in Household borrowings during the quarter. State & Local borrowings expanded SAAR $101bn, while total Business borrowings were about flat during Q1.

In nominal (non-annualized) dollars, Non-Financial Credit expanded $425bn during Q1 to a record $35.08 TN. This was the strongest debt expansion in five quarters. In the fifth consecutive quarter of contraction, Financial Credit dropped $646bn during the quarter to $14.96 TN. Total (non-financial and financial) system Credit declined $202bn during Q1 to $52.127 TN, or 357% of GDP.

In only 21 months (7 quarters), outstanding federal debt increased $3.274 TN or, 48.9%, to $9.971 TN. Over this period, federal debt growth has been running at an unprecedented rate of about 13% of GDP. As a percentage of annual GDP, federal debt jumped from 46% to 68% in only seven quarters. Of course, the amount of outstanding debt is dwarfed by our federal government's massive contingent liabilities (i.e. future healthcare, social security and pension obligations). There is, as well, the festering issue of the government-sponsored enterprises (GSEs).

In past analyses, I have combined the growth in Treasury debt to the expansion of federally-backed MBS - referring to this aggregate as "federal finance." In the six quarters ended December 31, 2009, this "federal finance" had expanded $3.1 TN. Well, the Federal Reserve threw a monkey wrench in my work this quarter by reclassifying Fannie and Freddie MBS.

From the Z.1: "Beginning 2010:Q1, almost all Fannie Mae and Freddie Mac mortgage pools are consolidated on Fannie Mae's and Freddie Mac's balance sheets." After this reclassification, GSE assets expanded $3.874 TN during the quarter to $6.887 TN. Confusing the issue, "Agency- and GSE-backed Mortgage Pools" declined $4.328 TN during the quarter. That leaves $455bn of MBS unaccounted for, perhaps partially explained by large write-downs. And in another confounding twist, Asset-Backed Securities (ABS) contracted $580bn during the quarter to $2.798 TN. Combined GSE, MBS and ABS dropped $1.035 TN during Q1 to $10.733 TN. I'm at a loss

Total Mortgage debt contracted a nominal - and quarterly record - $140bn during Q1 (3.9% annualized). Home Mortgage debt fell $110bn (to $10.75 TN), with a one-year decline of $311bn (2.8%). Commercial Mortgage debt dropped $34bn during Q1 (to $2.46 TN), with a one-year contraction of 4.5%. Q1 changes to the holding quantities of Total Mortgage debt is inconsistent with the presentation of GSE, mortgage pool/MBS and ABS assets (on separate Z.1 pages) - though this presentation does make more sense. Mortgage pool holdings of mortgages dropped $4.328 TN, while (reclassified) GSE holdings jumped $4.363 TN. ABS holdings of mortgages declined $98bn.

Bank assets expanded (nominal) $306bn in Q1 to $14.439 TN, with Bank Credit up a notable $241bn to $9.538 TN. Yet the Fed's seasonally-adjusted "flows" data present an ongoing contraction in Bank assets and Credit. For Q1, Bank loans contracted SAAR $251bn and Mortgages contracted SAAR $369bn. On the growth side, Reserves at the Federal Reserve expanded SAAR $215bn (to nominal $964bn) and Treasury Securities jumped SAAR $236bn (to nominal $252bn). With Bank business loans down five straight quarters, one has to be a real optimist to see positive trends in Bank Credit.

The bulls can, however, look to income data for some encouragement. National Income expanded at a decent clip again during Q1, posting a y-o-y increase of 3.2% to $12.602 TN. Total compensation expanded for the first time in six quarters, in the process bringing y-o-y compensation back to down only 0.2%. Massive fiscal stimulus has succeeded - for now - in stabilizing national incomes (and spending!).

Fiscal and monetary stimulus has also worked to shore up the Household Balance Sheet. Household sector Assets increased $965bn during Q1 to $68.536 TN. And with Liabilities down another $98bn (to $13.970 TN), Household Net Worth increased $1.063 TN during the quarter (7.9% annualized) to $54.565 TN. Certainly helping to explain the consumer's relatively upbeat mood and spending habits, Household Net Worth was up $6.297 TN y-o-y, or 13.0%. Examining the past year's gain in Household wealth, it is worth noting that Financial Assets increased (inflated) $5.514 TN (13.8%) and Real Estate gained $545bn (3.1%).

It's not only households that are boosting holdings of securities. Rest of World (ROW) holdings of U.S. Financial Assets jumped $299bn during Q1 to $15.625 TN. Treasury holdings rose $198bn to $3.936 TN. Treasury holdings increased $553bn over the past year and $1.437 TN over the past two years. "Security Repos" increased $47bn during Q1. Holdings of U.S. corporate bonds declined, while holdings of our equities increased.

Examining the broader U.S. financial sector, there is a pulse but no sign of vigor. Securities Broker Assets were little changed during Q1 at $2.081 TN. Holdings of Treasuries, agencies and municipal securities grew a little, while equities, Security Credit, and Misc. Assets declined a little. Funding Corp asset dropped $96bn during the quarter to $2.391 TN, with a one-year drop of $457bn (16.1%).

Life Insurance assets expanded 7.8% annualized to $4.919 TN (up 11.2% y-o-y). Savings Institution assets expanded 0.9% annualized during Q1 to $1.127 TN. Finance Company assets were also up less than 1% annualized during the quarter, to $1.666 TN. Credit Union Assets expanded at a 4.4% pace to $892bn (up 4.3% y-o-y). REIT Assets increased at an 11.6% rate to $263bn (up $4.3bn y-o-y).

Money Market Fund assets declined $328bn during the quarter to $2.931 TN. Money Fund assets were down $1.312 TN from Q1 2009, an unprecedented one-year decline. In the past seven quarters, Federal Reserve assets expanded $1.387 TN, or 146%. Fed assets grew $71.5bn during Q1 to $2.339 TN, with a one-year gain of $221bn (10.5%). After closing 2008 at just under $20bn, the Fed's holdings of Agency- and GSE-backed securities ended Q1 at $1.238 TN.

My thesis holds that our markets and economy have been reflated by a Government Finance Bubble (massive debt issuance, bailouts, zero rates, Trillion-plus monetization, etc.). With this in mind, let's take a little closer look at government spending and receipts data. Q1 Federal expenditures were up 13.2% y-o-y to SAAR $3.654 TN, or 25% of GDP (receipts up 2.2% y-o-y to $2.301 TN). Keep in mind that annual Federal expenditures surpassed $1.8 TN for the first time in 2000. Federal Expenditures were less than 19% of GDP in 2000; less than 20% in years 2001-2002; less than 21% in 2003-2007; 21.6% in 2008; and 24.2% in 2009. In contrast, Federal Receipts, which began the decade at about 20%, were 15.6% of GDP in 2009 and were running at 15.7% in Q1 2010.

At SAAR $2.046 TN, Q1 State & Local expenditures were about 14% of GDP. Combined State & Local and federal expenditures were 39% of GDP in Q1, after beginning the decade at about 32%.

Massive federal borrowings have sustained U.S. financial and economic recoveries. These recoveries have thus far bolstered acutely vulnerable state & local finances. Thus far, markets have accommodated the ongoing accumulation of government debt at quite low interest rates. Some have compared U.S. governmental finances to that of Greece, while others have dismissed such talk as ludicrous. It is fair to say that the U.S. system has - and continues to build - enormous risk to rising market yields and/or debt market disruption. I would argue that this risk is more dangerous than previous Bubble exposure to disruptions in mortgage Credit - risks identifiable during those Bubble years right there in the Fed's "flow of funds" Credit data. Thanks for reading.