US non-financial corporations' financial surplus – the difference between their retained earnings and capital spending – rose to 1.3% of GDP in the third quarter, according to flow of funds accounts data released yesterday. Excluding the third and fourth quarters of 2005, which were distorted by a one-off repatriation of foreign profits to take advantage of temporary tax incentives, the surplus was the highest since the fourth quarter of 1960 – see first chart.

The further improvement last quarter reflected a combination of stronger profits and cuts in dividends and fixed investment, partly offset by slower destocking.

On top of this surplus, corporations raised cash from equity transactions for a second quarter, i.e. issuance exceeded share buy-backs and retirements due to cash take-overs – second chart. Bond issuance fell back from its record first-half pace but was again substantial.

Strong internal cash generation combined with capital market issuance allowed firms to increase their holdings of liquid assets and pay down short-term debt. The liquidity ratio – liquid assets divided by short-term liabilities – continued to surge, therefore, reaching its highest level since the fourth quarter of 1959 – third chart. This mirrors improvements in the Euroland and UK and supports hopes of a recovery in hiring and investment.

Some commentators have interpreted the contraction of bank lending to companies as supply-driven and likely to curtail business expansion. The flow of funds accounts suggest that bank debt repayment has been mostly voluntary, reflecting the financial surplus and fund-raising in share and bond markets. Bank loans and commercial paper outstanding fell more slowly last quarter and may stabilise and recover as destocking ends – second chart.

The yield spread of non-investment-grade corporate bonds over Treasuries is inversely related, with a lag, to the sum of the financial surplus and equity sales, expressed as a percentage of GDP. This remained historically high last quarter, suggesting scope for further spread compression – final chart.