This week’s economic data included the biggest-ever gain in Pending Home Sales, a leading indicator for the housing market. Meanwhile, mortgage rates pushed down to new all-time lows yet again.
But at what cost?
The most pessimistic way to explain the surge in home sales is to say it was only made possible by the record-setting declines in the past few months.
That’s mostly true, but it fails to give credit to what the industry and government officials have been doing to help jump start economic activity. Would sales bounce back like this without all-time low mortgage rates and a stock market recovery (both made possible by emergency intervention from the Federal Reserve)? Would consumers be as comfortable spending money without the promise of additional fiscal stimulus and other support programs already in place?
While we can’t say exactly how big the impact would be if we removed those helping hands, we have to assume things would be worse without them, at least in the here and now. Critics contend that the emergency programs could cause issues in the future, but as is always the case with emergency support from the Fed or the US government, the preference is to avoid present day pain even if it simply delays the inevitable.
It’s also important to keep in mind that we’re really only talking about the early stages of an economic recovery. Many other economic indicators suggest we’ve only taken a small bite out of the broader damage caused by coronavirus.
For instance, consumer confidence jumped much higher, but it’s nowhere near pre-coronavirus levels.
The unemployment rate fell much more than economists expected, but it remains at levels that would be considered borderline catastrophic relative to recent precedent.
The true test for an economic rebound will be HOW MUCH of the recent precedent can be recovered. The jury is very much out on that one, and it’s going to take plenty of time for that to change.
Financial markets know this. They’ve settled into the role of spectators in the battle between coronavirus numbers and economic progress. Several states have been in the spotlight recently, serving as a warning that it may not be a simple task to reopen local economies without risking an unacceptable increase in case counts.
And yes, we should all be cognizant of the nuances created by increased testing capacity. That’s why the focus has shifted from case counts to include positive test rates and hospitalizations. In some cases, increased testing explains most of the surge. But in general, the states with troubling increases in numbers are seeing hospitalizations ramp up as well.
As the correlation between economic reopening and these covid numbers came to the forefront in June, both sides of the financial market (equities/stocks and debt/bonds/rates) halted their prevailing momentum and circled the wagons. In other words, stocks were surging, but since early June, they’ve been sideways in a narrower range. The bond market is also consolidating, but with slight bias toward lower rates.
10yr Treasury yields are historically an excellent indicator for mortgage rates. They still are to some extent, but it’s important to remember that mortgage rates did so much worse than Treasuries in March that they’ve had some extra room to improve recently. That’s why mortgage rates were able to hit all-time lows yet again this week even as 10yr yields remain well above their recent lows.
One word of caution on the chart above. It may look like mortgage rates (orange line) are destined to rejoin the blue line, but there are several reasons that they’ll have a hard time doing that. At the very least, it would take months and months. Simply put, the chart does not guarantee additional improvements in mortgage rates or that they would be immune to rising Treasury yields.
Financial markets closed early on Thursday in observance of Independence Day and will be fully closed on Friday. When trading resumes next week, we can expect stocks and bonds to continue taking cues from each other as they both watch the debate between economic performance and coronavirus numbers. The following chart shows the correlation between stocks and bonds that we tend to see on most days.
Loan Originator Perspective
Bonds are rallying nicely on this shortened trading today. With markets closed tomorrow, lenders will be reluctant to pass along the gains ahead of the 3 day weekend. So, i favor floating over this weekend and evaluate pricing on Monday. – Victor Burek
Bonds shrugged off today’s relatively strong NFP, as covid concerns continued to inform markets. It’s a long holiday weekend, pricing is as strong as I’ve seen, seems like locking is the safe route for folks happy with their current pricing. –Ted Rood
July 2, 2020 — The strange year which 2020 has become hit its halfway point this week. We seem to now be at a place where there’s some good near-term economic news to help counterbalance a less-favorable outlook. Make no mistake about it, though; despite improvements, we have a long, long way yet to go to get to anything close to a full recovery from the pandemic shutdown. Still, the good news continues to pour in, and that’s reason enough for at least cautious optimism.
Unfortunately, the strength and durability of the recovery will be dictated by what happens with the COVID-19 outbreak, and at the moment the disease seems to have gained the upper hand. Rising rates of infection — whether from community spread or increased testing picking up more of those infected without symptoms — threatens to see new or extended curtailments placed on economic activity in a growing number of states where fresh outbreaks aren’t being well contained.
Record low mortgage rates were achieved (again) this week, and as we cheer the rebound in activity, we must keep in mind that record low rates are a result of terrible economic conditions, even as signs of a rebound are all around us. Phased re-openings of segments of economic activity in May and in June have seen a spurt of activity, which would be expected after a period of near-standstill, and true recovery still remains more of a hope than reality.
The health of the labor market is both an indicator of what’s happening across a wide swath of the economy and a factor in its potential for future growth. After unprecedented job losses of more than 22 million in March and April, improvement came a bit faster in May than was expected and actually accelerated in June. For the month, the Bureau of Labor Statistics reported that 4.8 million new hires took place, a figure above forecasts for a second straight month. Of the 22 million jobs lost earlier this year, the last two months have seen a collective 7.499 million recovered, so the economy has taken back one-third of the losses in just two months’ time. With the bounce in hiring, the unemployment rate declined by 2.2 percentage points to 11.1%, a still horrible level, and the labor force participation rate edged 1.3 points higher to 61.5% for the month.
The 33% rebound in jobs in two months is great, but the outsized gains will need to continue for months yet — at least four more at the current unprecedented rate — to get us back to employment levels seen in February. That seems unlikely, given that the downward pace of initial claims for unemployment benefits have essentially stalled at a very elevated level. Progress continues to be made on this front, but unlike April and May and into early June, declines in new claims are no longer in the 200 to 300,000 range per week; rather, this pace of decline has diminished markedly of late, with new claims sliding only 26K, 58K and 55K over the last three weeks. With only minimal decline, this has left the level of initial claims at a very elevated 1.427 million in the week ending June 27. Pre-pandemic, the former record high was in the mid-600,000s, and with claims some 2.5 times that amount it is quite clear that businesses are still shedding workers at a rapid pace. As evidence of this, the outplacement firm of Challenger, Gray and Christmas tallied 170,219 job cuts in June, and while that’s certainly better than the 397,000 for May, it’s still more than 300% above last June’s levels.
We learned last week that sales of existing homes fell in May, but since those closings largely reflect demand in April, when the economic closure was at its tightest, it doesn’t tell us much about the present market. However, the National Association of Realtors Pending Home Sales Index does give us a sense of that, and for May (sales that may come to a close in June or July) the PHSI rose by 30.6 points to 99.6 for the month — a significant rebound, if one that leaves the indicator 11.8 points shy of February levels. With some pent-up demand from the winter-spring lockdown and record low mortgage rates in place, the “spring homebuying season” will likely be extended well into summer this year. As with many facets of the economy, though, we may fall short of a full recovery anytime soon, since folks receiving unemployment benefits can’t use that income to qualify for mortgages, and millions of homeowners in mortgage payment forbearance programs are probably not looking to sell and rent (at least not yet).
That said, record low rates may not be sufficient to keep demand elevated, especially if potential homebuyers start to think that even lower rates may yet come this year. Applications for mortgages have softened a bit of late, and in the week ending June 26, a 1.8% decline in overall applications was reported by the Mortgage Bankers Association. Purchase-money applications dipped by 1.3% in the latest week, following a 3% slip the prior, while applications for refinancing dipped 2.2% after an 11.2% drop. It may be that we’re seeing just a bit of a pause in applications for both purposes, but as far as refinancing or purchases go, there’s little practical difference between a record low rate of 3.13% (last week) or 3.07% (this week), so the affordability component of the transaction isn’t much improved for purchases and there’s no significant increase in urgency to get a refinance started, either.
In recent weeks, we’ve been tracking signs of a reasonable rebound in manufacturing activity via regional Fed reports. This week came a national confirmation of the uptick, as the Institute for Supply Management’s barometer shot higher. For June, an increase of 9.5 points in the ISM manufacturing index was recorded, pushing the indicator to 52.6 for the month. This was not only a move above the breakeven level of 50, but also to a value high enough to be the best in a year. A submeasure tracking new orders stormed 24.6 points higher to 56.4, a very solid reading, while one covering employment bounced up by 10 points to 42.1 — still weak, but much improved nonetheless. Of course, the gain in the top line index and that for new orders represents pent-up demand and a bit of catching up; what remains unclear is whether or not there will be continued demand. The still-soft hiring component suggests manufacturers remain cautious about hiring amid this uncertainty.
June’s flare in the ISM report certainly reflects the 8% gain in overall factory orders the Census Bureau reported for May. Orders for durable goods led the way, as demand for cars, appliance and other items designed to last longer than three years kicked 15.7% higher. Orders for non-durable goods also picked up a bit with a 2% rise, and the gains in both cases ate into the significant declines in factory orders seen in both March and April. As with many other data series, the rebound has begun, but even an 8% rise overall doesn’t fully erase declines of 11% and 13.5% of March and April. Still, there should continue to be some support for durables next month, at least from the transportation side, as sales of new vehicles continue to stage a modest recovery. According to AutoData, an annualized 12.7 million new cars and light trucks were sold in June, improving on the 12.1 for May, and certainly above the Great Recession-like 9 million of April. Tighter financing conditions and limited inventories of vehicles for sale from manufacturing interruptions over the last few months may be tempering sales growth, but the uptrend in sales seems likely to continue to improve, if slowly.
The nation’s imbalance of trade expanded in May, rising to $54.6 billion for the month. Imports mostly held their own, sliding by just $1.8 billion, and were likely supported by the gradual reopenings of local and state jurisdictions. Exports, though remained pretty soft, posting a $6.6 billion decline, but it’s hard to reckon from the data how much of this is attributable to slack demand or impaired production. Regardless of reason, trade flows have declined sharply in the last few months and so have plenty of ground to make up.
Construction spending was unsurprisingly weak in May, sliding 2.1% overall. Outlays for residential projects were a drag for a third month in a row, declining by 4%, but with the housing market picking back up this should change before long. Non-residential spending was also off by 2.4%, has now posted declines in five of the last six months, and with malls, stores and office buildings still waiting for occupants to return, there’s no reason to expect much of a rebound here anytime soon. Spending for public-works projects — roads, schools, libraries, hospitals and the like — can be more erratic but managed a gain of 1.2% for May and have been a regular contributor this year.
Minutes of the June 9-10 FOMC meeting were released this week, and the discussion and briefings that happened at that get-together were full of concern about the economic climate. As well, much time was spent by the Committee discussing how to manage monetary policy with the official policy rate at the Effective Lower Bound (ELB) (read: federal funds rate at or near zero). The Committee discussed continuing to use “forward guidance” as a means to help convey how long interest rates will remain low, and whether this guidance should also have date-based target (e.g. a rate change won’t even be considered until some future point in time, or an outcome-based one (that is, a rate change won’t even be considered until unemployment falls to, say 5% or inflation rises to, say 2.5%).
The Fed also dusted off for consideration long-shelved policies employing yield caps or targets (YCT), where they would set a peg for market-based Treasury yields (whether for one term of Treasury debt or many terms) to help signal to the markets their policy intentions. These have been used by the central banks of Japan and Australia, but there were some considerable reservations expressed regarding their implementation and it was decided that more study was warranted. In the end, no decision on how to best more forward was decided, but the body will continue to hash out a strategy in the coming months, and probably reveal whatever method they choose after their on-going internal review of communicating monetary policy has been completed. Regardless, the Fed did re-iterate its commitment to use all tools at its disposal to try to again move us closer to full employment with stable inflation, the twin tenets of its dual mandate.
Although it’s not clear how the resurgent outbreak will affect them, consumer moods have generally improved since recent nadirs. The Conference Board’s measure of Consumer Confidence powered higher in June, adding 12.2 points to rise to a value of 98.1 for the month. The gain represents a rebound of about one-quarter of the decline in confidence seen from February to April, so it’s a start, at least. Assessments of current conditions rose 17.8 points to 86.2 for the month, but this is only still about half the value seen in January. As far as the future goes, the outlook component rose by 8.4 points to 106.0 for the month, and this is actually a number on par with those seen in the months leading up to the coronavirus outbreak, so optimism for the future seems to have fully returned. Let’s hope it holds.
In all the above, there can be found are plenty of reasons for optimism as well as plenty of reasons to be pessimistic. That said, this too represents a considerable improvement over the dark clouds of uncertainty and the increasingly bleak outlook in the Feb-April period, which fostered only pessimism. At the halfway mark of 2020, we don’t know how the virus will play out as we wend our way forward. We don’t know if more economic interruption is in the offing, and we don’t know how or if the economy will continue to rebound or how strong that rebound may be. What we do know is that we have begun the journey, for better or worse, and hold out the hope with each passing day that we are one day closer to both effective treatment and a vaccine.
Mortgage rates are on a glide path at the moment, what with a holiday-shortened week this week and the glut of first-week-of-the-month data digested by the markets. A light calendar of data is due next week, and arguably, it’s the beginning of vacation season and the summer doldrums for markets, so we think that mortgage rates will be mostly unchanged, even if the slightest downward movement would trigger “new record low” headlines.
In the meanwhile, it’s Independence Day on Saturday. The fourth of July is just a date on a calendar, but Independence Day should be celebrated by all Americans, even as we may disagree what this means to each of us. That we are free to discuss our views and even freely protest for them isn’t a right conveyed everywhere around the world, and we should never lose sight of this, or what the Declaration of Independence set in motion, even if there remains much work to be done.
by Tyler DurdenFri, 07/03/2020
With stock-markets barely ruffled, few are thinking beyond the very short-term and they are mostly guessing anyway. Other than possibly the very short-term as we emerge from lockdowns, the economic situation is actually dire, and any hope of a V-shaped recovery is wishful thinking or just brokers’ propaganda. But for now, monetary policy is to buy off all reality by printing money without limit and almost no one is thinking about the consequences.
Transmitting money into the real economy is proving difficult, with banks wanting to reduce their balance sheets, and very reluctant to expand credit. Furthermore, banks are weaker today than ahead of the last credit crisis, and payment failures on the June quarter-day just passed could trigger a systemic crisis before this month is out.
Sooner or later bank failures are inevitable and will be a wake-up call for markets. Monetary inflation will then become an obvious issue as central banks and government treasury departments become desperate to prevent an economic slump by doing the only thing they know; inflate or die.
Foreigners, who are incredibly long of dollars and dollar assets will almost certainly start a chain of events leading to significant falls in the dollar’s purchasing power. And when ordinary Americans finally begin to discard their dollars in favour of goods, the dollar will be finished along with all fiat currencies that are tied to it.
Introduction – monetary transmission problems
Between different schools of economics there is much confusion over the link between changes in the quantity of money and prices, exposed afresh by the collapse in GDP due to COVID-19 and the aggressive monetary response from the authorities to contain the economic consequences.
Neo-Keynesians appear to understand the link exists, but for them inflation is always of prices which can be managed by adjusting monetary policy subsequently.
Monetarists follow a mechanical quantity theory leading to a relatively straightforward relationship between changes in the quantity of money and of prices after a time lag of a year or so. The principal difference with the neo-Keynesians is in the timing: monetarists see monetary inflation occurring long before the price effect, and neo-Keynesians in charge of central bank monetary policy assume rising prices can be controlled subsequently by varying interest rates.
The Austrian school, which is banished from these proceedings, explains that inflation is of money and nothing else, and the effect on the general price level is determined by a combination of changes in the money quantity and of consumers’ relative preferences for holding money relative to goods.
But central banks operate exclusively on neo-Keynesian lines. They feel free to expand the money quantity so long as the general level of prices does not exceed a targeted 2%; except when it does there is usually an excuse not to restrict money supply growth immediately. Keynesian Inflationism offers problems on so many levels, not least being it is rather like driving a vehicle using a rear-view mirror for guidance. But importantly for our analysis, central banks do not seem to realise current monetary policies guarantee the death of their currencies.
Central bankers act as if money supply increases after prices, which is what monetary policy amounts to. They have other nonsensical beliefs, such as through an inflation tax despite robbing consumers of their wealth, it stimulates them to buy. Whoever thought that one up as a lasting policy beyond short-term distortions deserves an Ignoble prize for idiocy.
Ah! That was Lord Keynes. And perversely, his disciples are today’s main recipients of the Nobel prize for economics. We are now seeing central banks, like some latter-day Aztec priests, trying to appease their gods with human sacrifices. We are the sacrifices, lesser mortals trying to do the best for our families and ourselves, being slaughtered by monetary means.
Figure 1 indicates the alarming debasement of our savings, earnings, and pensions so far through monetary expansion and explains why the dollar’s purchasing power has been declining faster than the CPI suggests.
The fiat money quantity reflects not only money in circulation, that is to say true money as defined by Austrian economists, but additionally the banks’ deposit reserves held at the Fed, the last data being for 1 May. It captures fiat money both in circulation and theoretically available for circulation.
From 2009 it shows the excess monetary inflation that followed the Lehman crisis in 2008, which until 1 February this year grew at an annualised monthly compound rate of 9.5%, compared with the pre-Lehman average long-run rate of about 5.9%.
No wonder independent analysts calculating the rate of price inflation tell us that it is running at 8%—10% (Shadowstats.com and Chapwood Index), instead of the CPI’s 1.5—2.0%. And if that was not bad enough, the recent sharp increase at an annualised rate of 98% since March comes on top of it, putting FMQ at more than double where it would be if Lehman had not happened. FMQ now also exceeds GDP, telling us there is more fiat money than US output, and yet more liquidity is demanded through the banks by failing businesses.
The Fed has increased base money at an unprecedented rate to provide liquidity, allegedly for the non-financial sector. For this to get to businesses banks must be prepared to increase their lending to non-financials and bank credit must not contract. But as Figure 2 shows, bank balance sheets have stopped growing and even contracted since the end of April.
Between 26 February and 29 April bank balance sheets increased by $2,489bn. These figures include the uplift in total reserves held at the Fed and not in public circulation, which over the same period increased by $1,083bn. Therefore, banks increased their other assets by $1,406bn between these dates. Those other assets are split between financials and non-financials, the evidence of rising financial asset prices relative to commercial business’s decline strongly suggesting Wall Street has been favoured over Main Street
Subsequently, up to 17 June bank balance sheets contracted by $169bn. The extent to which banks are increasing financial activities will be balanced by an even sharper contraction in bank credit for non-financials than indicated by the overall balance sheet.
Central banks with their reliance on inflation now have a problem: the banks are failing to pass on extra money to the non-financial sector by expanding their balance sheets. Yet, the disruptions to supply chains, the onshore component totalling some $38 trillion and an unquantifiable offshore component feeding into it, are still there and their problems are growing by the day. In short, we face a continuing liquidity crisis with limited means of relieving it.
Economic prospects for the next few months
Before we proceed in our analysis of the price effects of inflation, we must assess the economic outlook,as the backdrop to the likely consequences for the scale of monetary inflation, and then we can have a stab at evaluating the effect on prices.
The first clue is in Figure 2 above, which shows that bank lending is contracting, and it is important to understand why. At this stage of the credit cycle, which began expanding following the aftermath of the Lehman crisis over a decade ago, a sharp contraction of bank credit to non-financials is normal. It is what drives periodic recessions slumps and depressions, and monetary stimulus by central banks is intended to help commercial bankers recover their mojo and resume lending.
The relevant history of central bankers’ attitudes to bank credit goes back to Irving Fisher’s description of how contracting bank credit intensified the 1930s depression by the liquidation of debt, forcing collateral values down and leading to bank runs and the bankruptcy of thousands of banks. Ever since, monetary policy is guided by the fear of a repeat performance. But the Keynesian stimulus at the start of the credit cycle only increases the destabilising nature of bankers’ behaviour, consisting of long periods of growing greed for profitable loan business, interspersed by sudden reversions to fear of loan risk. It results in a cycle of credit expansion and contraction, which in recent cycles have been resolved temporarily by increasingly aggressive expansions of base money along with government actions to support ailing industries.
It is a sticking-plaster approach which allows the wound to fester out of sight.
Following Lehman’s failure, a similar pattern to the one unfolding today of a rapid increase in bank assets through the newly invented QE was followed by a contraction of bank credit which lasted about fifteen months. But that crisis was about financial assets in the mortgage market, which had knock-on effects in the non-financials. Difficult though it was, its resolution was relatively predictable.
This crisis started in the non-financials and is therefore more damaging to the economy; its severity is likely to lead to a banking crisis far larger than the Lehman failure and possibly greater than anything seen since the 1930s depression.
Commercial bankers are now waking up to this possibility. For them, the immediate danger is associated with this quarter-end just passed, when demand for credit to pay quarterly charges increases significantly. Already, businesses are in arrears as never before, with many shopping malls, office blocks and factories unused and rents unpaid. It is this problem, shared by banks around the world, which due to the severity of current business conditions is likely to tip the banking system over the edge and into an immediate crisis. The extent of the problem is likely to be revealed any time in this month of July.
Excluding the subsequent effects, the Lehman crisis cost the US Government and its agencies over $10 trillion in support and rescue operations. This time, being in the non-financial sector with knock-on effects for the financial economy, this crisis is much deeper than Lehman and will require a far larger bailout cheque for collapsing industries. Part of the problem are the broken supply chains needing bridging finance. And none of this can be done without the Fed funding it all directly or indirectly through quantitative easing. Despite the massive monetary inflation already underway there can be no doubt that aggregate consumer demand and the production of goods to satisfy it will take an enormous hit this year and beyond, and there is little doubt about the state’s will be on the hook for even more monetary financing.
Unemployment of previously productive labour is already rising dramatically, and as bankruptcies increase the rise in the unemployment numbers will continue to do so. Let us therefore assume that compared with last year the production of goods and services and consumer demand for them will decline by at least 25%. Note that we avoid using money-totals, since they are meaningless; it is the exchange of labour being converted into physical products and services that matters.
Into this situation is injected enormous quantities of money, none of which defeats the constraints on true supply of goods, nor for overall demand in a high unemployment economy. Put in a more familiar way, we will have too much money chasing not enough goods. There is only one outcome, other things being equal; the purchasing power of the dollar in terms of consumer goods will be driven significantly lower. But central bank analysis rules this out, associating too much money chasing too few goods with only an expanding, over-stimulated economy.
This explains stagflation, the situation where an economy stagnating in overall demand is accompanied by rising prices. Nor are other things ever equal, the condition for the paragraph above. The early receivers of inflated money will spend it, driving up the prices of the goods and services they acquire before the prices of other goods and services are affected. These early receivers include the Federal Government, which in an election year is doubly unlikely to hold back. Distribution of state money will increasingly be in the form of welfare to the unemployed, skewing spending towards life’s essentials. Inevitably, in an economy with subdued activity not responding quickly enough to produce the volumes of products desired, prices, mainly of essential items, will increase sharply.
Almost certainly, a broad index of prices will not capture this secular effect until too late. The CPI includes a majority of items which are only occasionally bought by individuals. Poor demand for non-essentials where there is now an oversupply puts downward pressure on their prices even in an inflationary environment. It is therefore possible for the CPI to record little or no price inflation as an average when food and energy prices are rising strongly, particularly when statistical methods designed to show little or no increase in price inflation are additionally taken into account.
Consequently, central banks are already being badly misled by the CPI’s statistical method. And when prices for essentials are soaring, they will continue to increase the quantity of money in circulation, distracted by that 2% increase in the CPI target. By the time it creeps up above that rate it will be too late, much monetary water having already flowed under the bridge.
The politicians will likely dismiss rising prices for food and fuel as the result of profiteering — they always do and then contemplate introducing price controls, making this outcome even worse.
Let us stand back from what is happening — or shortly will be — and estimate the inflation scene as far as we know it:
- After growing at an average annual rate of 9.5% since the Lehman crisis, broad money in the form of FMQ accelerated to an annualised growth rate of 98% from February this year. Bank balance sheets increased by just under $2.5 trillion in March and April but are now beginning to contract. More increases in base money from the Fed are sure to follow, compensating for lack of bank credit expansion.
- The Fed is underwriting the whole US corporate debt market in an attempt to ensure the flow of finance for all borrowers, bypassing the banks and suppressing yields in the markets. The secondary market for non-financial debt in the US alone is $9.6 trillion, probably requiring an initial trillion or so of Fed buying in the foreseeable future to keep yield spreads suppressed.
- The quarter-end two days ago will be marked by a significant rise in missed payments. But demands for more bank credit will be resisted by the banks leading to many more existing loans going sour. Under the weight of non-performing loans, it will be a miracle if a banking crisis is not triggered by missed payments in the US, or elsewhere where banking systems are even weaker. Wherever it starts, the Fed is committed to underwrite the whole US banking system, along with all its commercial borrowers with falling sales and disrupted supply chains, to prevent unemployment spiralling out of control. The monetary inflation required for this alone could easily be at least twice the cost of the Lehman crisis.
- The Fed is also attempting to underwrite the whole market for financial assets by inflating the quantity of dollars being fed into it in order for the necessary financial and economic confidence to be maintained.
- Monetary expansion on this scale is bound to undermine the dollar in the foreign exchanges as foreigners liquidate portfolio investments, US Treasury stock, agency stock and the excess of bills and bank deposits not required for reserve currency liquidity purposes. This will leave the Fed funding a government deficit escalating beyond control, and if it is to keep borrowing costs low, it must also absorb sales of foreign-held Treasury and agency debt which currently total $6.77 trillion.
Measured in current dollars, even the quantity of narrow M1 money after all this inflationary financing is likely to grow to much more than 2019’s US GDP, which will be contracting sharply in terms of physical output and consumption. This is the recipe for a monetary collapse, as John Law illustrated in France in 1720.
Apart from keeping the banking system up and running, the other of the Fed’s overriding objectives is to ensure the US Government is funded. There can be no doubt that its budget deficit is already out of control. Before COVID-19, the White House was already on course for a trillion-dollar plus deficit. That has widened as a result of tax shortfalls and increased spending costs. In May, the Congressional Budget Office estimated the deficit for the first eight months of fiscal 2019/20 had more than doubled to $1,905 billion, of which $1,162 was incurred just in April and May. If the deficit continues at this rate, then the outturn for the fiscal year will at least $3 trillion.
The administration had proposed a $2 trillion stimulus, some of which is reflected in figures for April and May. Congress went even further, proposing a $3 trillion stimulus. If elements of Congress’s extra spending are adopted, we can amend our expectations and pencil in a budget deficit rising towards $4 trillion at an annualised rate.
The belief that funding sums of this magnitude in the markets can be achieved at current interest rates is a fallacy. It can only be attempted with unlimited monetary creation, which ultimately undermines this solution.
Before the virus hit, it was estimated by the White House that annual borrowing costs would be $422 bn. If the deficit increases by $3 trillion, this will rise to about $480bn on the White House’s current interest rate assumptions. With the interest rate burden already accounting for over 40% of the pre-COVID-19 budget deficit estimates, we can see why the Fed and US Treasury are keen to keep bond yields suppressed. In a nutshell, if they rise a funding crisis is the only result.
Following a near certain banking crisis there is bound to be a flight out of deposits and risk assets into the perceived safety of US Treasuries. For a brief period, the government will be able to fund its deficit without a rise in interest rates. But unless the increased issue of Treasury bonds is bought by the Fed, the economic effect will be to drain funds from the financial and non-financial private sectors. Therefore, the Fed is almost certain to cover almost all of it by quantitative easing.
In summary, government finances started in this presidential election year with the largest deficit on record. We now have an economic disaster unfolding, driven not only by the COVID-19 lockdowns but by a confluence of a turn in the bank credit cycle and rising trade protectionism. It is no exaggeration to suggest we are on the brink of an economic catastrophe; a descent into an economic dark age. Not only is the budget deficit escalating to multiples of that expected as recently as last March, but there is no prospect of it declining at any time.
To this outlook we can add other negative factors. The contraction of cross-border trade globally is indicative of a spreading slump in business activity. The trend for increasing trade protectionism by America is growing. The retreat into nationalistic isolation is spreading. These trends are plain to see for those who care to observe them. And for America, in a presidential election year political factors are likely to make things even worse.
How monetary inflation translates into higher prices
We can expect to see two stages in the process of the dollar’s purchasing power being undermined. The first appears to have already commenced with the dollar weakening in the foreign exchanges, and the second, yet to come, is a public rejection of it as a means of exchange.
A year ago, foreign holders on the last reported figures held over $20.5 trillion of US securities to which must be added bank deposits, bills, CDs etc., totalling a further $6,452bn for a total of almost $27 trillion. The contraction in cross-border trade and the isolationism that goes with economic downturns suggest that foreigners now require smaller dollar balances, leading to the repatriation of dollar funds into foreign currencies.
Also compelling foreigners to sell are political developments. The Trump administration has been destabilised by its failure to contain the coronavirus with lockdowns, and a socialistic Joe Biden is now ahead in the opinion polls. If Biden is elected, then all the dollar’s gains during the Trump administration could be lost.
We must also not forget that unless the US’s savings rate increases, in normal times a higher budget deficit leads to matching higher trade deficits. When monetary capital arising from trade deficits is recycled, the budget deficit becomes funded directly or indirectly by foreigners. Indeed, this is why foreigners have accumulated dollars and dollar investments significantly in excess of US GDP. But if this virtuous circle is disrupted, the twin deficit still exists without the net dollar proceeds in foreign hands continuing to accumulate. Instead, the dollars are sold for other currencies and commodities.
Therefore, foreigners have two separate dollar problems to consider: the level of their current holdings which are now too high, and the increasing quantities of dollars in their hands from current and future trade. And with the budget deficit escalating towards $4 trillion, the trade deficit will increase to a similar amount. Unless, that is, the American people increase their savings. They might do so for the very short-term as a reaction to rising economic uncertainty, but not on the scale required, nor for long enough to make a significant dent in the twin deficit relationship.
In his remaining months as president, Trump is likely to respond to a rising trade deficit by increasing tariffs on increasing quantities of imported goods, extending his trade policy against China to other jurisdictions. If so, production costs for consumer goods will rise, driven by a combination of a falling dollar in the foreign exchanges and escalating tariffs on imported goods. It then becomes a vicious circle with foreigners seeing their dollar earnings collapsing in value, encouraging them to liquidate more of their existing holdings.
The price effect of these factors is bound to be noticed eventually by American consumers and will affect the relative preference individuals will have between holding a monetary reserve and owning goods. A small change in the aggregate level of consumer preferences in this regard can have a significant impact on prices, and if they desire collectively to hold less liquidity and more goods, prices of commonly desired goods will rise sharply. With COVID-19 and changing economic conditions, preferences are likely to increase for essentials, particularly food and energy, and with capacities for essential products deprived of the capital required to expand output the ability of manufacturers to respond by increasing production will be badly restricted.
In the final stages of an inflation driven crisis the general public becomes indiscriminate in their purchases of goods, even to the point of selling property in order to survive. A currency which no one wants then loses all its objective value for transaction purposes.
This is what happens following all monetary inflations. Once the general public loses confidence that a fiat currency will retain its objective value in transactions, it begins to dispose of it as rapidly as possible and it is too late to stabilise it. This has been the experience of every fiat currency which has died in the past.
The text-book example was the great inflation in Germany’s post-war Weimar Republic. Then, as is increasingly the case today, the government relied on monetary inflation as its principal source of funding. The final collapse, when the German people no longer accepted the paper mark as money for transactions, took place between about May and November, taking roughly six months. The time taken was a combination of an understanding of what was happening spreading throughout the economy and the foreign exchanges, and the time taken to obtain cash — which was in short supply due the demand for it — and find the goods, which were also in short supply, to buy. It was described at the time as the crack-up boom, the final boom into goods and real values that marks the end of a seemingly endless inflation, being the complete breakdown of a monetary system.
Today, the time taken for the dollar’s final descent into oblivion will be set by the same human values, quickened by today’s instant communications and payment systems, potentially making the collapse more rapid.
In conclusion, don’t be misled by the common belief that a decline in the US economy will lead to falling prices. The inflationary response from the Fed, which will be immense, will ensure far too much money ends up driving demand for a diminished quantity of needed goods.
The fates of the economy, the housing market, and interest rates remain closely intertwined with coronavirus. The pandemic is clearly responsible for the record-setting drop in economic activity (including the housing market).
And it has clearly been the key source of motivation for both stocks and interest rates (which we can follow most objectively via 10yr Treasury yields). A shorter-term chart shows how closely they’ve been following one another as they digest coronavirus updates.
As the initial panic of March and early April subsided, and people began returning to work, it was perfectly reasonable to expect markets and the economy to begin bouncing back (i.e. higher stocks and bond yields).
That is arguably what happened in April and May. We’ve even seen several areas of the economy experience their first corrective bounce, such as New Home Sales (note: this chart of New Home Sales looks nothing like the Existing Home Sales chart above because it constitutes a smaller portion of the market, and pertains exclusively to new construction).
But now the market is having second thoughts due to accelerating case counts (and hospitalizations) in several states. Stocks and bond yields have been trending lower since topping out in early June.
The fate of this market correction will be decided by the course of the pandemic–especially the resurgence of cases in the U.S. If more people can return to work without hospitals being overwhelmed, the less resistance there will be for interest rates and stocks to move higher. In fact, it’s safe to say that WILLhappen. The question is “when?”
There are other questions too. Which parts of the market and the economy will bounce back sooner and better? After all, we’ve already seen a pronounced difference between mortgage rates and the Treasury yields that typically follow the same trajectory.
A US Treasury Note is a debt instrument just like a mortgage. The 10yr US Treasury yield is a rate of return just like a mortgage rate. Historically, the average 30yr fixed mortgage lasts less than 10 years before the home is sold or the mortgage is refinanced. As such, 10yr Treasury yields should behave similarly to mortgage rates over time as both offer investors a fixed rate of return over a certain period of time.
But mortgage rates can deviate tremendously from Treasury yields on limited occasions. The onset of the pandemic was just such an occasion. At the time, mortgage rates weren’t even remotely capable of keeping up with Treasuries. The unforeseen benefit is that mortgage rates have been able to move lowereven as Treasury yields suggested the opposite.
The gap between the two was much wider in April and May. As the normal relationship slowly returns, mortgage rates will be less capable of defying marching orders from the broader bond market.
In other words, if the market finds a reason for stocks and bond yields to move higher, mortgage rates are increasingly likely to follow.
So will the market find that reason? Again, we already know THAT it will. We just don’t know WHEN it will. That answer depends entirely on coronavirus. What we DO know is that the bond market’s movement is similar to that seen during the financial crisis–something we didn’t expect to see again so quickly.
That past example suggests some caution. In early 2009, the economy hadn’t even bottomed out yet. Few were expecting to see rates move higher in any sort of threatening way, but that’s exactly what they did. This speaks to a certain market psychology that spontaneously finds a limit to how much lower rates can go and for how long.
The chart above contains 10yr Treasury yields. Mortgage rates wouldn’t move higher nearly as fast in this unpleasant scenario, but they would still move higher. To be clear, this is not a prediction. It is a fact. Rates will move higher. We just don’t know when. The point is to be ready to react when that happens. What does readiness look like for you?
June 26, 2020 — When the imposed economic collapse from the pandemic shutdown was in its early and middle stages, prognosticators had already started to try to describe the shape of the expected recovery using certain letters of the alphabet — usually “V”, “U” and “W”. While it’s way too soon to coalesce around one character or another, at least for the broad economy, it bears considering that the shape of the recovery will be very different for differing facets of the economy, and some may bear little relation to any known letters.
Moreover, arguments can be made for about what constitutes a component of a letter; for example, retail sales plummeted by 8.2% in March and another 14.7% in April, then rebounded by 17.7% for May. Does this constitute a “V” shape, even if the percentage changes leave us only at about 92% of the sales level that existed in February… or is it more of an incomplete “V”? Or does it become a “U” if June sales are sufficient to complete the shape… but what if they falter, and there is no discernible letter whatsoever?
This is just one example of thousands of national, regional and local economic components, and what kind of letter each may ultimately achieve (if any) is unclear at best. The reality is that it really doesn’t matter; while a rapid return to pre-pandemic levels would be wonderful, it bears remembering that the viral outbreak put a violent end to the longest economic expansion in history. Given the depths of the decline from the economic shutdown, it may be a very long time before the economy fully returns to reliably firing on all cylinders again.
More important, then, would be steady progress, letter shapes or no. Certainly, it’s encouraging to see improvement as activity returns; however, it’s also important not to get lost even in sizable month-to-month gains and to realize that even outsized changes likely still mean a large gap to overcome to get back to where we so reliably were just a few months ago.
Even as new and encouraging economic data covering May and June emerge, a surge in new cases of COVID-19 in a number of states over the past few weeks has raised concerns about the sustainability of the improvement. In turn, investors have expressed their concerns about a weaker climate by moving away from stocks and into relatively safer bonds and gold. The move into bonds pushes yields lower, and lower yields on bonds that influence mortgages likely means lower rates.
Mortgage rates are already at record lows, and this is helping to drive demand for housing, even if its a bit hard to see at the moment. Sales of existing homes dropped 9.7% in May, sliding to a 3.91 million annualized rate of sale, and coupled with declines over the two prior months, sales of existing homes have fallen by about 26% since February. The hard drop in sales means that the ratio of inventory relative to sales rose to its highest level in a good long while, but even the current 4.8 months of supply remains well below optimal levels. Before you start to think that the inventory situation has improved much, consider that the 1.55 million homes for sale in May was still almost 19% below the same month a year ago. A lack of buyers in the market also quelled the outsized increases in home prices, which had been running quite hot, but eased to a gain of just 2.3% in May compared to a year ago.
Of course, May’s existing home sales represent activity in the market in March and April, when the pandemic shutdown was at its most intense, so sales and prices will likely revive in the next couple of months. What’s unclear is the degree that both demand and supply remain tempered by millions of folks on unemployment, seeing reduced hours and incomes or in mortgage payment forbearance programs.
Sales of new homes are recorded differently, and are perhaps more reflective of demand closer to today, even as they lag by a month. In May, sales of new homes rose by a stout 16.6% from a downwardly-revised 580,000 units sold in April. At 676,000 (annualized) homes sold during the month, it’ll take another 14.5% jump just to return us to where we began the year, but the resumption of activity here is solid. The flare in demand was such to pull the supply of homes down to a 5.6-month level (318K actual units built and ready for sale), a figure low enough that should see builders stepping up the pace of new construction into the summer. Renewed demand allowed the price of a new home to rise again after a three-month skid, and prices of a newly-built home were 5.6% higher this May than last.
How much follow-through to the uptick in new home sales (and what will eventually show as a rebound in existing homes sales) remains to be seen. Record low mortgage rates are fine, but underwriting conditions for mortgages remain tight. As well, demand at the margins may be crimped from high levels of unemployment, as these benefits can’t generally be counted as income for the purposes of qualifying for a mortgage. Those collecting unemployment benefits won’t be able to buy homes any time soon, and folks who already own their homes won’t be able to refinance, either. Even with record-low rates in the market, applications for new mortgages declined by 8.7% in the week of June 19; the Mortgage Bankers Association noted that apps for purchase-money mortgages fell by 3%, breaking a nine-week string of increases, while apps for refinance dropped 11.7% for the week.
Although it’ll be another month until we get the first report for the second quarter, the nation’s Gross Domestic Product was already in retreat in the first quarter of 2020, and the final look at Q1 GDP put the decline at a full 5% for the period. The second quarter figure will be much worse, but how much worse remains to be seen, as the data for June is yet to come. To be fair, the current estimated run rate for second quarter GDP is improving, but the Atlanta Fed’s GDPNow model currently puts the figure at an unbelievable -39.5% for the quarter so far. A few weeks ago, this figure was nearly -55%, and even if we see steady improvement as the June data are incorporated into the model the number will still continue to be awful.
Perhaps the key to a faster, “V”-shaped recovery is getting folks off the unemployment rolls and back to work quickly. Unfortunately, this beneficial process seems to have largely stalled in the last couple of weeks. Although initial claims for unemployment assistance are still declining, over the last two weeks the declines have been statistically insignificant, with a reduction in new claims of 26,000 in the week of June 13 and just 60,000 in the week of June 20 bringing the number to 1.48 million new applications for assistance filed. This figure is still 2.5 times the pre-pandemic record for initial claims. As well, ongoing benefits are being paid to some 19.5 million folks in the latest data week for that series (thru June 13) and this figure continues to decline as businesses open up again, if slowly. Expanded unemployment benefits that run until at least the end of July may or may not be creating a deterrent to a faster return to work. Certainly, a slow sales environment and social-distancing protocols are likely keeping the worker recall rate damped, too.
After two very lean months, manufacturers no doubt welcomed the 15.8% increase in orders for durable goods in May. The 15.8% increase for the month took back only a portion of March and April declines and orders also remain well below year-ago comparisons, but the gains were solid. Automotive and aircraft orders powered the top-line gain, but even the measure of sales that is a proxy for wide-ranging spending by businesses posted a smart 2.3% increase for the month and orders were generally up for all classes of durable goods for the month.
Two more looks at regional manufacturing for June both told similar tales. Local reports from the Federal Reserve Banks of Richmond and Kansas City both staged rebounds for the month that were good enough to bring them up to a par level, if nothing else. The Richmond Fed’s barometer rose by 27 points in June, landing at 0 for the month, not far from where it was pre-pandemic. Over the last two months, the headline figure here has gained 53 points, and the measure of new orders move to +5.0, its first positive value since January. The rise in orders wasn’t enough to stanch the decline in employment, which dipped for a fourth consecutive month, but the -5.0 was the smallest decline of the bunch. Meanwhile, in the 10th Federal Reserve district, the Kansas City Fed saw a 20-point rise in their gauge, a move good enough to make it to a +1 for the June. The measure of new orders here rose 32 points to +7, the best figure since February, but like the Richmond region, that gain wasn’t enough to move employment to the positive side of the ledger, but the -6 for June was also the smallest decline of the last four months.
The Federal Reserve Bank of Chicago’s National Activity Index sported a record high reading for May of 2.61, the highest single monthly value ever recorded in a series that dates to 1967. Using a par value of 0, this amalgam of some 85 economic indicators seeks to show whether the economy is performing above or below its “potential”, or natural ability to grow without becoming imbalanced. This is thought to be a GDP rate of perhaps 2.4% or so, and the record-high value means that the economy performed at an robust pace for May. Taken as a part of a trend, though, the picture isn’t quite as rosy, as a moving three-month reference improved but only to -6.65, so while progress is being made, there remains a long run just to get back to par for a quarter at this point.
Personal income growth has been distorted over the last couple of months from government stimulus payments and varying fiscal supports. For May, overall incomes declines by 4.2%, but the report was mostly positive, believe it or not. A drop in “transfer payments” (stimulus checks and more) from a 90% increase in April to a -17.2% decline dragged the headline number down, but items like wages and business-owner incomes both turns positive after a couple of months in the red, but investment returns remained damped. Also kicking higher after a couple of subdued months was personal consumption expenditures, which gained 8.2% for the month. Less income and more outgo for the period meant that the nation’s rate of savings eased from 32.2% for April to 23.2% for May, so folks are still banking funds at an elevated clip. These cash hordes should help power at least some spending as we move deeper into summer, and that should in turn provide at least some lift to a wide range of beleaguered businesses.
Consumer moods continue to gradually improve after the coronavirus pandemic shock of earlier this year. The University of Michigan survey covering Consumer Sentiment saw a 5.8-point gain in June, moving the gauge to a value of 78.1 for the month. Assessments of both present and expected conditions moved up, rising 4.8 points and 6.4 points, respectively and all three references moved to their best levels since March. Still, there’s a long way to go to get sentiment readings back to pre-pandemic levels — some 20 to 30 points, depending on which measure you choose to review.
The good news we’re seeing really is good news, even if it falls short of completing any alphabet letter you might choose. Although you may find yourself or friends or colleagues in one camp or the other, we’re trying not to be too pessimistic nor optimistic but rather realistic about the economic situation in which we all find ourselves. As far as the alphabet goes, as long as we don’t find ourselves operating in an “L” shaped economy — the plummet in activity followed by a long, flat line — we will eventually return to an economy where we don’t care about letters and shapes. Hope for “V”, expect “U” and probably “W”, too, as we move into the third quarter.
A quiet start to the week is followed by a big first-of-the-month blast of data and then a holiday to end it. A flat-to-slightly downward trajectory for interest rates for this week will likely give us slightly lower mortgage rates for next week, with perhaps a decline of a couple of basis points in the averaged offered rate for a conforming 30-year FRM as reported by Freddie Mac next Thursday. If we’re right, Americans will ring in the Independence Day holiday with new record low rates.
BY: MATTHEW GRAHAM
Mortgage rates held their ground today, with the average lender in roughly the same shape as they were on Friday. Incidentally, that’s great shape! When it comes to the best-case scenario conventional 30yr fixed quote, rates are still very close to the all-time lows seen two weeks ago. Scenarios with additional risk factors (jumbo balances, lower credit, lower equity or investment properties), the landscape is far more varied. For those scenarios, rates are much farther away from all-time lows.
Will rates be able to remain at these levels or perhaps even set new all-time lows? More and more, this depends entirely on the course of a potential “2nd wave” of coronavirus impacts. This seems to be far more of an issue for some states than others right now. If we see resurgences in states that had already clearly turned the proverbial corner, the reaction in financial markets would be more pronounced.
Simply put, if too many people end up dead or in the hospital due to COVID-19, interest rates would likely stay low or even improve. The opposite logic doesn’t perfectly apply. Rates can avoid a massive spike even if coronavirus numbers gradually improve.
Fannie Mae is adding requirements to qualify self-employed borrowers, potentially widening the pool of prospective buyers who will need to turn to non-QM loans to finance a home.
As the COVID-19 outbreak impacts businesses, Fannie Mae has announced that it will require additional documentation to qualify self-employed borrowers. While lenders are “encouraged” to apply the new requirements to loans currently in process, they must be applied to loans with applications dates on or after June 11. The additional requirements will be in force “until further notice,” Fannie Mae said in a letter to lenders.
“Income from a business that has been negatively impacted by changing conditions is not necessarily ineligible for use in qualifying the borrower,” Fannie Mae said in the letter. “However, the lender is required to determine if the borrower’s income is stable and has a reasonable expectation of continuance.”
Lenders will be required to obtain the following additional documentation for self-employed borrowers:
- An audited year-to-date profit-and-loss statement reporting business revenue, expenses, and net income up to and including the most recent month preceding the loan application, or
- An unaudited year-to-date profit-and-loss statement signed by the borrower reporting business revenue, expenses, and net income up to and including the most recent month preceding the loan application, and two business depository account statements no older than the latest two months represented on the profit-and-loss statement
“Lenders must review the profit and loss statement, and business depository accounts if required, and other relevant factors to determine the extent to which a business has been impacted by COVID-19,” Fannie Mae said in the letter.
Coronavirus hit markets with unprecedented force in March. Stock prices and bond yields sank. When the outlook grew less dire, markets began moving back in the other direction. As quarantine measures ease, fear surrounding a second wave of COVID-19 is pushing back on the recovery in markets.
Let’s quantify the fear using daily COVID-19 case counts in several key states.
There’s no question that these trends are alarming at face value, but the implications can vary quite a bit due to increased testing. We can get a clearer sense of the risks by looking at hospitalization data.
For example, the seemingly dire situation in California looks quite different based on LA County hospitalizations. Numbers remain elevated, but they’re not rising nearly as fast as case counts.
In Texas and Arizona, however, hospitalizations confirm the negative trends.
This data raises more questions than it answers, and it’s at the heart of why markets are entering a highly uncertain time. Simply put, panic and defensiveness were absolutely the right calls in March. And some level of optimism was clearly warranted after that. In other words, it made sense to see stocks and bond yields tank in March and then move higher.
But now what? After attempting to run higher in early June, both stocks and bonds fell abruptly 2 weeks ago. This coincided with a ramp up in concerns about a second wave of COVID-19 impacts. Are we standing on the brink of a market reversal or merely trying to find the right balance between economic reopenings and public health risk?
To whatever extent markets trade the “2nd wave” narrative, we could see stocks and bonds try to move below the dotted lines in the chart above. No matter where they go, they’re increasingly likely to take cues from each other (i.e. stock prices and bond yields moving in the same direction). This is easiest to see over shorter periods of time.
And no reference to stock/bond correlation would be complete without a reminder that one should neverexpect this relationship to play out in the longer term:
Financial markets are one thing, but how about the housing and mortgage markets? This week brought data on new home construction as well as builder confidence. The numbers speak to optimism about the future while still conveying the ill effects of the present.
Specifically, “Housing Starts” which measure the actual ground-breaking phase of construction, are still noticeably depressed relative to previous levels. Meanwhile, Building Permits bounced back in grand fashion (up 14.4% in May and April’s 21% loss was revised to only a 5.7% loss). Neither are back to pre-covid levels, but permits are close.
It’s no surprise, then, to find that builder confidence soared in the National Association of Home Builder’s latest survey. Notably, this survey data was collected well after the Housing Starts data in the chart above. As such, it may suggest a stronger bounce in construction next month.
Are builders participating in reality or is this false hope? If the weekly mortgage application data from the Mortgage Bankers Association is any indication, optimism is justified. Purchase applications were as high as they’ve been since late 2008!
The chart above brings another question into focus: how much of the strength in the housing market is due to mortgage rates holding near all-time lows? Unequivocally, rates are helping housing numbers reach higher than they otherwise would be, but keep in mind, mortgages are much harder to get for certain scenarios right now. Beyond that, the home shopping process has challenges of its own that are keeping some would-be buyers sidelined for a bit longer.
The takeaway is that the bounce back in housing numbers is just like the bounce back in many other sectors of the economy. Things got bad enough that there was simply plenty of room for improvement.
No one is saying “everything’s fine now… back to business as usual!” Rather, many things are just quite a bit better than they were–so much so that we’re now in a position to debate whether the recovery narrative continues or cools off. That’s a debate that will remain open as long as COVID-19 numbers are pushing back on states’ lifting of quarantine measures.
HSH MARKET TREND
June 19, 2020 –As we wend our way out of perhaps the strangest and most difficult spring in memory into what will likely be an odd summer, at least two significant issues will keep things from settling into the usual doldrums: The shape, strength and durability of the rebound in economic activity, and whether or not the spread of coronavirus can be managed, and if so, to what degree.
There are other issues that continue to drive things, too, not the least of which is politics, as it is an election year, but also social tensions that threaten to again boil over at any time.
This time of year is supposed to be full of events and celebrations; in May, it’s typically Moms and proms (long since canceled due to COVID-19) and in June it’s Dads and grads (also coronavirus distorted into drive-in or even remote functions). Weddings and parties and more, all kicked down the road at the very least, so this period feels rather quieter than usual.
As might have been expected, the reopening of state economies in May has resulted in an upsurge in new cases of coronavirus in a number of states, particularly those where enforcement of even basic protective measures such as wearing a mask in a closed space has been lax. Some would say “told you so!”, and new concerns about a “second wave” for the outbreak have appeared. Truth be told, it’s not a second wave, but more like a component of the first; a second wave may come in the fall. Regardless, concerns about the respread of disease have damped investor moods anew in recent days, tempering the level of enthusiasm that might have been seen given signs of a rebounding economy.
What’s happening with home prices? Which markets have recovered… and which still lag behind? Check out the fresh update to HSH’s Home Price Recovery Index, covering price changes in 100 metropolitan areas — and see our Home Value Estimator tool to reckon changes in your market during your ownership period!
Among data pointing to a recovery was a stout increase in retail sales for May. After posting the largest monthly decline on record in April of 14.7%, sales reversed course hard last month, rising 17.7%, the largest gain on record. Even so-called “core” retail sales (which leave out high-ticket items like autos and erratic sales at gasoline stations) sported a 12.4% lift, so it is clear that as things open that people are looking to spend. Some of this boost is “catch up”, of sorts; for example, sales at apparel retailers rose by 188% as folks ventured out to buy summer clothing en masse. Such a spurt also likely reflects increases in disposable income from expanded unemployment benefits and CARES-Act stimulus checks and savings from both. While such a strong gain is not likely to be repeated, retailers are no doubt tying to attract as many shoppers as they can and welcome the chance to try to fill in the revenue hole of the last few months. There remains a ways to go, too, since even with the improvement, sales this May were still some 6.1% below year-ago levels (and “core” -3.9% year-over-year).
A couple of looks at regional manufacturing activity also found rapid improvement on a month-to-month basis. The Federal Reserve Banks of Philadelphia and New York chimed in with their local reports for June this week, and the resumption in activity for both the third and second Fed districts was quite clear. In the New York region, the Fed’s headline indicator rose 29.4 points to land at just -0.2 for June; although activity is still declining, it is only barely declining, and the figure is within shouting distance of where it was when we turned the year. Sub-indexes covering new orders (-0.6) and employment (-3.5) are also greatly improved over where they were in April and May and have a chance to turn positive as New York continues its phased reopening.
Just next door, the Philadelphia Fed’s report was not only improved, but even impressive. In a stunning shift, the headline indicator stormed higher by 70.6 points to land at a positive 27.5, with new orders rising by 42.4 points from -25.7 to +16.7, and while employment didn’t make it out of the red, it did rise smartly, gaining 11 points but landing at -4.3 for the month. Other regional reports come next week, and we’ll get a better sense if the June pickup in activity was only localized or perhaps more widespread.
As manufacturing started to pick up a bit in May, it helped lift overall Industrial Production out of the doldrums. Significant declines in March and especially April gave way to a 1.4% increase for May, pushed higher by a 3.8% increase in manufacturing output, which should take back a bit of the previous two month’s declines. Production would have been stronger but was dragged backward by sagging mining production, which fell by 6.1%; this was a fourth consecutive fall, largely caused by depressed oil prices (which have since rebounded) and slack utility output (-2.3%) from so many places being closed during the month. Utility output should pick up again quickly as things re-open. With the increase, the percentage of industrial shop floors in active use edged up by 0.8% to just 64.8%, so there is plenty of unused capacity available to ramp up production if or when demand returns in force.
By all indications, the housing market weathered the COVID-19 shutdowns fairly well. If not for the hard economic stop and now continuing disruption, we were probably looking at the best spring housing market in a while, as mortgage rates were already near historic lows and the record-long string of job and income gains were helping to create plenty of demand. That said, with the disruption to incomes and more, a number of folks will not be participating in the housing market for a while at least. However, there seems to be plenty of pent-up and delayed demand for homes to buy, as even with still-rising home prices, the repeated call of “record low mortgage rates” continues to bring potential buyers into the market. What’s less clear is if that demand will be met by supply, as inventories of existing homes for sale remain razor thin.
This means improving opportunities for the new construction market, and reflective of this was an improvement in moods of home builders in June. The National Association of Home Builders Housing Market Index (HMI) moved back onto the positive side of the ledger, climbing 21 points to a value of 58 for the month. Sales of single-family homes also rose 21 points to 63, a value considered to be very strong, if not robust; the measure covering expected demand in the coming six-month period flared 22 points higher to 68, also fairly robust, but traffic at model homes and showrooms remained sub-par even with a 22-point leap. At 43, is it seven points below the breakeven level of 50, but it may be that social distancing is still keeping some potential buyers away from physical locations at the moment.
Still, builders will likely be cautious for a time, and at last blush, they had more than an ample supply of already-built stock to sell before they might need to start a faster pace of construction. Housing starts did rise in May, by a reasonable 4.3% to a 974,000 annualized rate of home construction, but this was rather below consensus expectations. Single family starts edged higher by just 0.1% to 675,000 units, but multifamily starts managed a 15% jump. Optimism about tomorrow’s new home market was evident, too, as permits for future construction leapt by 14.4% to 1.220 million (annualized) units. Although all these figures remain far below where they were pre-pandemic, they are moving in the right direction again, and that’s a positive thing.
Of course, building and permitting are one thing; selling is another. We’ll find out about sales of both new and existing homes in May next week; given the builder’s demeanor, it’s likely that new construction sales picked up to a greater degree than will existing sales. Part of that is due to the way the data are gathered; existing homes are tallied as sold when the deed changes hands, while new home sales are based on the date the contract is signed, so one reflects demand conditions 45-60 days prior (March-April, during the worst of the crisis so far) versus actual demand for new houses in the month of May (when things had begun to re-open in a number of locales).
Demand for purchase-money mortgages continues to rise, though, and that can’t all be attributed to new-house purchases. The Mortgage Bankers Association reported that in the week ending June 12, mortgage applications overall rose by 8%, powered by a 3.5% increase in applications for purchase mortgages. This continued a nine-week string of gains that has now moved the purchase index to an 11-year high, according to the trade group. Homeowners have begun to notice that mortgage rates have touched record lows again and again in recent weeks, and applications for refinances popped up by another 10.3% in the latest week.
Rising mortgage applications certainly indicate plenty of demand, but what’s not clear is the success rate of applicants — that is, how many actually make it through to an actual closing. Given somewhat more rigid underwriting standards in place in recent weeks due to mortgage market disruption, economic turmoil and lenders looking to meter inbound demand, this number is likely considerably higher than it had been just a few months ago. As well, we don’t know how many of these applicants that are turned down at one outlet are reapplying at another lender in hopes of finding a greater level of accommodation, so applications for mortgage credit might also appear somewhat higher than they actually are. One borrower, multiple applications.
That economic activity resumed in May after an awful April was reflected in the latest measure of Leading Economic Indicators from the Conference Board. At a value of 2.8, the May reading was 0.5 points higher than forecast and pretty strong, but the top-line figure may be masking underlying weakness since the biggest component was May’s unexpected and significant increase in hiring. Other inputs into the indicator remained pretty subdued. Still, improvement is improvement, regardless of the source, and the stronger-than-expected bump may actually provide a little economic momentum into June if not beyond. Certainly, the economy needs all the boost it can get; even with improved data for May supporting GDP growth, the current estimated run rate for second quarter GDP is a truly bleak -45.5%, according to the Atlanta Fed’s GDPNow tracking tool. While that’s better than the -54 and change of just a few weeks ago, it’s only marginally improved at best.
With varying support programs in place and yet-ongoing issues managing the number of claims in many states it’s a little difficult to know what’s actually happening with the labor market at the moment. In the week ending June 13, initial claims edged downward to 1.508 million new applications processed, a figure that is the lowest of the pandemic period to date, but one that remains very high by any historical reference. Continuing claims being paid also barely edged downward, from 20.6 million to 20.5 in the latest available data week (June 6). Has the once-rapid improvement in the labor market stalled? Is the still-elevated initial claims figure indicative of truly new claims, or are these folks who tried to apply weeks or even months ago finally getting in the systems? The answer isn’t really clear. What is clear is that we will need to see a faster rate of improvement in the weeks ahead for both initial and ongoing claims if the economy is to get on its feet for the third quarter.
Mortgage rates set a new record low this week, something we wrote about expecting just a few weeks ago. Time was when new record lows would have seen 40-point headlines and lots of discussion in the media and beyond, but we have set new records a number of times in just the last 10 years, so that story is a bit old, as it were. As well, most consumers also know that a new record doesn’t necessarily mean a meaningful change in rates; after all, it’s not as though rates were 4% yesterday and 3% today. While of course a milestone, the difference between the record of a few weeks ago and the one set this week is measured in hundredths of a percentage point — two, in fact — a technical record, but not a meaningful one.
In addition, the record applies to just one facet of the mortgage market — a conforming fixed-rate loan made to an excellent credit quality borrower with a significant downpayment, full income and asset documentation and more. For other borrowers with lesser or differing credentials, rates may or may not be at record lows, and for some, credit simply isn’t available regardless of price. For these borrowers, 40-point headlines of “record low mortgage rates” can be pretty meaningless. Still, benchmarks are what they are and what we have to go by, so the reference still has value, even if in reality such new records are being set because the economic climate is quite awful and inflation benign.
The downdraft in mortgage rates from last week to this appears to have paused, at least for the moment. After barely catching up from a refinance blast pre-shutdown, activity in mortgages has been steady to now increasing again, and the economic picture is mixed to a bit better of late. That suggests a flat mortgage rate environment as we head into next week, and we think that the average offered rate for a conforming 30-year FRM as reported by Freddie Mac next Thursday morning will be mostly steady, perhaps increasing by a basis point or two if there is any movement.