Credit market borrowing by US non-financial corporations – encompassing securities issuance and direct loans from banks and others – surged to $901.9 billion at an annualised rate in the fourth quarter of 2012, according to the Fed’s flow of funds accounts. Borrowing was the equivalent of 5.7% of GDP – the highest such proportion since 2007. Bond issuance accounted for $782.0 billion, or a record 4.9% of GDP.

Similar surges in borrowing in the late 1990s and mid 2000s occurred ahead of a significant widening of the yield spread between lower-rated corporate bonds and Treasuries – see first chart.

High borrowing, however, need not imply deteriorating financial health. Bond-holders should worry when fund-raising reflects insufficient internal cash generation, or is used to retire equity. This was the case in the two prior episodes – the corporate “financing gap” between investment and retained profits was large, while the sum of equity buy-backs and cash take-overs far exceeded new issuance.

By contrast, the corporate financial balance is currently in small surplus, i.e. net free cash flow is positive. Above-average equity retirement* is contributing to high credit market borrowing but, in addition, corporations appear to be taking advantage of low bond yields to accumulate financial assets and replace other liabilities.

A superior gauge of economic / financial risk, therefore, is total net borrowing, i.e. the difference between changes in non-equity liabilities and financial assets**. This was 2.3% of GDP in the fourth quarter – far below peaks of 6.8% and 9.2% respectively reached in 1998 and 2007.

Total net borrowing is a more reliable leading indicator of the corporate / Treasury yield spread than the credit market component – second chart. The rising trend in net borrowing suggests that the spread will drift higher in 2013-14 but a dramatic widening is unlikely.

*Equal to 2.7% of GDP in the fourth quarter versus an average since 1985 of 1.8%.

**Calculated here as the sum of the financing gap and net equity retirement.

The optimism here about UK growth prospects for 2013, based on faster real money supply expansion during 2012, is supported by encouraging February surveys of services and retailing. The new business index of the services purchasing managers’ survey reached a nine-month high, while British Retail Consortium members reported annual sales growth of 4.4% – the best since April 2011 (artificially boosted by Easter timings).

The pick-up in these sectors increases the probability of an expansion of GDP in the current quarter and should quell tiresome “triple-dip” talk*. Weaker February purchasing managers’ survey results for manufacturing and construction appear partly to reflect temporary disruption due to bad weather. As noted in a post last week, a rebound in construction orders during the second half of 2012 suggests that the sector will contribute to growth during the first half – orders are a more reliable guide to future output than the construction PMI.

Incorporating the PMI results, the “MPC-ometer” model followed here – which predicted that several members would vote for additional stimulus at the February meeting – continues to suggest a “hold” decision this week.

In other UK news today, the Office for National Statistics reported that the value of mergers and acquisitions involving a UK target in the fourth quarter of 2012 was the lowest since the second quarter of 2009. M&A activity, however, has picked up in early 2013, with Bloomberg reporting deals worth £38.8 billion so far versus £33.7 billion in the fourth quarter. Surging corporate liquidity – see previous post – suggests a further rise.

*As previously discussed, the onshore economy has yet to suffer a double-dip and, adjusted for the Olympics boost, expanded in both the third and fourth quarters of 2012.

With data available for all but one country (Korea), six-month growth in G7 plus emerging E7 real narrow money is estimated to have firmed to 3.6% (not annualised) in January from 3.5% in December. The January estimate is down from 4.2% in October but is solid by historical standards – see chart. Allowing for the usual half-year lead from money to the economy, the suggestion is that six-month industrial output expansion will peak in the spring but remain respectable into the summer.

Global real narrow money correctly signalled last year’s economic weakness – its six-month growth slumped from 4.8% in October 2011 to 1.9% in April 2012, before reviving to the October peak. Global industrial momentum slowed sharply over the spring and summer of 2012, reaching a low in September, i.e. five months after the real money trough. The subsequent recovery in global industrial activity appears to have extended in February, judging from manufacturing purchasing managers’ surveys released last week.

While narrow money works better empirically, broad money trends also suggest continuing economic expansion – six-month G7 plus E7 real broad money growth was an estimated 2.6% in January.

The January global money numbers may have benefited from a temporary boost to Chinese data from the late New Year holiday. China will issue February statistics next week.

The next key release for assessing global economic prospects will be the January update of the OECD’s country leading indicators on Monday 11 March. As previously discussed, the global longer leading indicator calculated here from the OECD data currently suggests a modest economic slowdown from the spring, echoing the message from real money trends.