February 7, 2020 — If not for the current and expected effects of the still-spreading coronavirus, odds favor that we would be talking about rising rather than falling interest rates. Consider where the economic and political climate is compared to just a couple of months ago; new trade deals are in place, at least putting us at a state of detente with China and getting a working playing field in place for trade flows with Mexico and Canada. The presidential impeachment process and theater show has come to completion. Brexit has actually happened. The Federal Reserve has put monetary policy on a stationary platform for the foreseeable future. Prospects for global growth are said to be improving.
However, all has taken a back seat to concerns about the personal and economic impacts of trying to contain coronavirus. Quarantines, travel bans, store closures, trade-route interruptions and more do seem certain to have some impact on growth in the not-too-distant future, and that even with China injecting billions of new liquidity into financial markets and banks this week to help offset the drag from prevention measures.
Without this dark cloud hanging over the global economy, investors would more likely be focused on the fresh emerging economic data. Frankly, the latest news is actually pretty good, at least good enough to help reverse the hard sell-off in stocks last week to return to mostly gains this week. So far, that reversal has seen bond yields also reverse course, bouncing smartly off lows, but there’s not yet been much follow-through to mortgage rates.
So what’s the good news? To start with, for the first month since last July, the factory sector is no longer contracting. While one month is by no means a trend, the Institute for Supply Management’s barometer that tracks manufacturing moved up by 3.1 points to 50.9 for January, a move good enough to move the needle from contraction to expansion. In the report, measures of new orders bumped 4.4 points to a modest (but positive) 52, but employment remained pretty soft at 46.6, and that included a 1.4-point gain. In the ISM series, 50 is considered a breakeven value, with figures above this level denoting growth. If at least for a month, factories are back online and contributing a bit toward growth; however, given headwinds, readings of barely-to-mildly positive are about all that should be expected for a time yet.
The ISM’s twin survey covering non-manufacturing (service) business activity also had good things to say. The January reading moved up by 0.6 points, pushing the headline value to a moderate 55.5 for the month, the highest figure since last August. The sub-measure covering new orders for services rose by 0.9 points to lift to 56.2, while the employment tracker settled back with a 1.7-point decline to 53.1 for the month. The moderately-expanding economy is already near what is considered to be full employment, so it’s not unreasonable to see business adding workers at a more measured pace.
Meanwhile, the employment report for January was nothing short of stellar. Although some hiring was probably “borrowed” for future months due to unusually warm weather, the 225,000 new hires that took place last month would still have been very solid even if jobs in weather-affected industries were only normal. Not only did more people get jobs last month but they did so at higher wages, as average hourly earnings rose by 7 cents an hour, good enough to push the year-over-year gain to 3.1%, a level solidly above the rate of inflation. As such, “real” wages are improving, and that in turn is good news for consumer spending (and, if sustained, could have some effect on helping inflation get closer to the Fed’s 2 percent target). While the “official” unemployment rate ticked up a tenth of percentage point to 3.6%, just above a 50-year low, this was due to more people being pulled into the workforce, and at the moment, the labor force participation rate is 63.4%, the highest reading for the expansion to date.
Not only are more people working, they are also actually increasing their productivity a bit. Output per worker rose by a more-than-expected 1.4% in the fourth quarter and the overall yearlong rise in productivity for 2019 was the best since 2010, if still only a historically moderate level. Still, the increase helped push down the cost of labor per unit produced to just 1.4% from 2.5% in the third quarter, and higher productivity could allow businesses to pay workers a little bit more without undue effect on final prices or eating into profit margins. That’s both important for improving the nation’s standard of living and for stock prices, so regular gains in productivity are something we’d like to see continue even if business investment in new tools and technology has been soft for a time now.
A rise in the nation’s imbalance of trade also suggests some economic pickup in the U.S. and perhaps a bit elsewhere, too. The difference in value of inbound and outbound trade flows rose by $5.2 billion in December, with the gap between the two expanding to $48.9 billion. Exports rose by $1.5 billion to the highest nominal level since last May, and so it looks as though trading partners are starting again to pick up some goods from us. Imports, though, bounced $6.7 billion higher, and as we are a nation of net imports this is signaling at least a little pick up in economic activity here. Depending upon your leanings, the fact that the U.S. was a net exporter of petroleum products for a fourth straight month (best string since the 1970s) may be a good thing or a bad thing, but it was a positive for trade and contributes to GDP growth.
With more people working and incomes rising, consumer spending should continue to move higher. Some of the benefits of sustained employment and income gains can be seen in sales of new cars and trucks; AutoData reported that an annualized 17 million units were sold in January, up about 100K from December and part of a string of solid sales that have been expected to peter out for about the last year or two now. Although down from peak levels seen in 2016, sales of new cars and trucks are still very solid, especially given the fairly strong sales levels over a stretch of years helping to sate pent-up demand and tighter financing conditions for marginal borrowers over the last year or two. That sales haven’t tailed off is a good thing, as it helps to keep wide-ranging supply chains busy while other facets of manufacturing look to recover from a long soft patch.
Factory orders in December reflect this mix of strength and softness. Overall, orders placed to factories rose a nice 1.8% for the month, the largest monthly gain since August of 2018. However, the details weren’t as encouraging; while orders for durable goods rose by 2.4% (rebounding from a November dip) and those for non-durable goods moved 1.1% higher for the month, the measure which serves as a proxy for wide-ranging outlays by businesses (no defense spending or aircraft included) showed a decline of 0.8% for the month, so the increase in factory orders was likely concentrated to a very narrow slice of the economy. Still, more factories working more does carry beneficial effects, even if they would be better spread out on a wider basis for the best economic effect.
Inventory levels at the nation’s wholesaling firms were depleted by 0.2% in December, and that may ultimately help factories see more orders. Wholesalers reported that holdings of durable goods declined by 0.3% and those of non-durables held steady during the period. However, the decline in holdings would have been stronger except that sales also declined by 0.7% for the month, so the level of goods on hand relative to sales failed to move. At a current 1.36 months, this ratio has been holding nearly steady since last May, so there will of course still only be cautious replenishment of stockpiles.
Spending on new construction projects eased by 0.2% in December, dragged down a bit by softness in the commercial/industrial/retail and public-works sectors. Spending on new residential projects powered forward by 1.4%, a sixth consecutive month of increases, while commercial outlays declined by 1.8% in December after a -0.5% fall in November and public-project spending fell by 0.4%, erasing some of the 1% gain month prior. Despite routine ups and downs, construction spending was 5% higher this December than in December 2018, so the trend is at least moving in the right direction.
Although the outplacement firm of Challenger, Gray and Christmas recorded 67,735 announced job reductions in January — the most since February 2019 — the solid job market likely means that folks affected by layoffs should be able to locate other positions fairly quickly. Some may not even apply for unemployment assistance; even if they do, the number of people placing initial applications for unemployment benefits would probably only tick higher. As we are currently very close to cyclical (and 50+ year) lows with just 202,000 new requests placed in the week ending February 1 it would take a sustained surge of benefit-seekers to significantly change the trend here and cause alarm.
Current Adjustable Rate Mortgage (ARM) Indexes
|Index||For The Week Ending||Year Ago|
|Jan 31||Jan 03||Feb 01|
|Federal Cost of Funds||1.955%||1.998%||0.968%|
|FHLB 11th District COF||1.036%||1.035%||0.639%|
|Freddie Mac 30-yr FRM||3.51%||3.64%||4.41%|
|Historical ARM Index Data|
With mortgage rates declining since the turn of the year, interest in both buying and refinancing homes has been solid. However, as we’ve discussed on a number of occasions, low and still-declining mortgage rates are fostering demand that is not being met by new supply of homes available to buy. In turn, not only are home sales tempered and will struggle to grow but prices of homes for sale are pressed higher… which in turn erases some of the improvement in affordability that lower rates bring. It’s not a fortuitous cycle at the moment, at least for existing home sales, but new home sales (where supply is more elastic) should benefit. Folks looking to refinance already have homes and so are of course unaffected, and have been coming out replace older mortgages with new in solid numbers since the holidays faded into the rearview mirror. In the week ending January 31, the Mortgage Bankers Association of America reported that applications for mortgages rose by 5%, driven there by a 15.3% in applications for refinancing but pulled back to earth by a 9.5% decline in those to purchase homes.
While fixed mortgage rates are just a stone’s throw from historic (65+ year) lows, borrowers or regulators looking to see if highly-regulated banks are loosening underwriting criteria won’t find much by way of that. The latest Senior Loan Officer Opinion Survey from the Federal Reserve covering the fourth quarter of 2019 saw more than 90 percent of respondents reporting unchanged underwriting criteria for conventional, government, QM, non-QM and other loan designations. At best, there was a slight easing overall for GSE-eligible, government-backed and QM products. Overall, while the price of money may be getting easier, accessing that cheaper funding is still a traditionally-rigorous process.
With concerns about the coronavirus causing markets to wax and wane, it’s hard to get a good read on where mortgage rates will head next week. The influential 10-year Treasury yield moved from a panic-level 1.51% about a week ago to as high as 1.65% this week and closed Friday right in the middle of those two levels. That said, mortgage yields haven’t (yet) bounced much up from the levels they dropped to in the last week of January and are holding pretty stable over the last few days, so there seems to be a bit of a mixed bag in the market at the moment. With this in mind, we’ll hedge a bit, and think that the average offered rate for a conforming 30-year FRM as reported by Freddie Mac next Thursday will be steady around present levels with perhaps a slight upward bias.