Market Reality Check


June 12, 2020 — Aside from actual figures, facts and data, optimism and pessimism, ebullience and fear are key drivers of how investors place their bets. Of course, in a time of programmatic trading, a cynic might note that its how machines are placing their bets, even though they should have no emotional component to their decision-making.

In recent weeks, stock values have reflected views from both sides of the camp; first, as the coronavirus pandemic took hold, the view was that the end of the apocalypse was nigh, and selling everything and stuffing dollars in mattresses was all the rage. A few short weeks later (and after unprecedented Fed intervention and trillions of fiscal support from the federal government) markets seemed to be acting as though there was no health or economic calamity to be seen.

A dose of reality hit the market this week, as rising concerns about new incidence of infection in places where social restrictions has been eased began to seep in, exacerbated perhaps by widespread protests in the wake of the killing of George Floyd, and with renewed concern about the prospects for another widespread outbreak in the coming fall. To this resurgent worry came a fairly dour outlook from the Federal Reserve, who completed a two-day meeting this week.

Without any reference to some of the “green shoots” that investors have been focused on (and are a contributing factor in the stock rally in recent weeks), in the statement that closed the meeting the Fed said that “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” 

Unlike the March meeting, where the practice was skipped, this meeting featured a new release of the Summary of Economic Projections from Fed members. Before the outbreak there was discussion that this means of displaying member thinking about the prospects for growth, unemployment, inflation and the likely path of monetary policy over time would be discontinued, as it had arguably outlived its usefulness as a communication tool. It appears that with the pandemic distorting markets gain that the release may continue to have value in helping convey the central bank’s collective thinking and its implication on future policy moves.

The SEP revealed a set of member thoughts that, at a minimum, could be described as concerned. As to be expected, the near-term outlook for this year was quite dark, with a projected 6.5% decline in GDP growth, an unemployment rate expected to average 9.3% and inflation retreating smartly. With this set of beliefs, the federal funds rate would unsurprisingly remain pegged near zero.

However, in the member’s views, the future appeared quite dim as well, as least from their expectation to continue and emergency-level interest rate stance for at least two and a half more years, if not beyond. This view was held despite expecting a relatively robust 5% increase in GDP in 2021, and another 3.5% gain in 20202. Over that time, the median rate for unemployment next year was expected to be a still-high 6.5% and 5.5% in 2022, with no long-run expectation to return to the 50-year-best 3.5% the U.S. enjoyed as recently as February. Inflation would of course be this year but expected to close in on the Fed’s preferred 2 percent rate for core PCE over the next two years. As such, even as overall conditions were expected to improve measurably from today’s terrible levels, Fed members didn’t feel confident enough in their outlooks to expect to be lifting interest rates at all. Of the three-year period comprising 51 separate data points, there were only two — in 2022 — that expected any change to short-term rates at all.

From this, the Fed does not appear to be expecting any kind of “V” shaped recovery. In a comment in his post-meeting press conference, Fed Chair Jay Powell was clear: “We have to be honest that it’s a long road.” 

Adding a dim Fed outlook to a series of increasing worries took the wind out of the stock market, which dropped a bit on Wednesday after the meeting closed but fell precipitously on Thursday before finding its feet again on Friday. As far as bond yields were concerned, the more pessimistic outlook chopped off the spike in yields that had accompanied some better news last week, including a surprisingly-strong hiring report and diminishing unemployment claims. Already trending down, the influential yield for the 10-year U.S. Treasury shed another 10 basis points or so, closing the week nearly a 20 basis points below where it began. The early-week drift down helped curtail our expected increase in mortgage rates for the week, and the late-week decline should help set the stage for next week’s move.

Aside from the Fed meeting, which was the big market-moving event of the week, there was a little bit of economic data for investors to consider, including several pieces of inflation data. The twin reports covering Producer and Consumer Price Indexes for May were released, and although inflation was soft for the month, it certainly still exists. The overall headline figure for Producer prices rose by 0.4%, breaking a three-month string of declines. Propping up costs were often transient items such as food and energy, and so the core measure which excludes them was unchanged for the month. Over the last year, overall producer prices are declining at a 0.8% clip, while “core” PPI managed to hold onto a meager 0.2% increase.

As measured by the CPI, consumer prices told much the same tale. Helped by a fifth consecutive monthly decline in energy costs (likely ending soon), the overall Consumer Price Index declined by 0.1%, it’s third straight fall. That modest fall belies surging prices for food, which popped 1.5% in April (an 18% annual clip) and rose another 0.7% in May. Supply-chain issues for foods still persist and sales are few and far between at grocers at the moment, but the situation is likely to continue to gradually improve, and as it does, price pressures may ease a bit. That said, upstream costs for personal safety and such at manufacturing plants and in factories and fields don’t just disappear, and these will likely keep upward pressure on prices for some time. That’s the bad news; the good news is that CPI-measured inflation is just 0.2% over the last year, and prices as measured at the “core” declined by 0.1% in May and are in a cooling pattern too, running at just an 1.2% annual rate in May (down from as high as 2.4% as recently as February). 

Prices of imported goods broke a three-month string of declines in May, rising a full 1%. That bump came due to a resurgence in oil prices, which not only recovered from a mid-April spike to below zero but have climbed back to about pre-pandemic levels. Outside of that influence, import costs rose a meager 0.1% for the month. The aggregate cost of goods leaving the U.S. for other shores also kicked higher, rising 0.5% and also ending a trifecta of declines. Even with a the upturn, there’s no inflation to be found in either inbound or outbound goods, though, as import prices in May were some 6% lower than at this time a year ago, a decline matched by export costs, too.

Inventory levels at the nation’s wholesaling firms expanded by 0.3% in April. Even with upstream production and delivery issues that were rampant during the month, new goods continued to trickle in. However, with retail establishments everywhere shut down by choice or government mandate, orders for goods cratered for a second month, dropping 16.9% overall. That slump in demand saw the ratio of inventory on hand relative to sales balloon to 1.65 months, the highest-ever reading in the series. With lots of goods available and slack demand from retailers continuing, this suggests that new orders to manufacturers will likely to be slow to improve, and that in turn will contribute to what is expected to be an already slow recovery.

The news on the labor front continues its very gradual improvement. In the week ending June 6, 1.542 million new claims for unemployment assistance were filed across the U.S., the lowest number since mid-March and less than 25% of the peak. That’s good news, but with the slow rate of decline it may be a month or more before we get back to a level that matches the pre-pandemic weekly record in the mid-600,000 range. Declining initial claims means that fewer folks are still losing jobs; as well, some of the current elevation may be from backlogs still being worked through for folks who lost employment months ago. Encouraging, too, is the slow fall of folks receiving continuing support, a sign that at least some formerly laid-off are returning to work.

While people looking to buy houses have been in the market for much of the spring despite challenges, homeowners really haven’t much paid attention to opportunities to refinance. That was, at least until the week ending June 5; overall applications for new mortgages rose 9.3%, according to the Mortgage Bankers Association, where a two-month string of rising applications for purchase-money mortgages (+5.3% in the latest week) was finally joined by an pick up in applications for refinancing, which posted an 11.4% jump. Mortgage rates haven’t really moved around much of late, and certainly underwriting standards haven’t loosened appreciably, but perhaps the news that rates were again holding near all-time lows finally got some notice by homeowners.

Consumer moods continued a modest rebound in early June. According to the University of Michigan survey, Consumer Sentiment gained 6.6 points from its final May value, landing at 78.9 in the preliminary review. Current conditions were gauged a bit more favorably and rose by 5.5 points to 87.8, while expectations for the future improved a bit more with a 7.2-point rise leaving the outlook component at 73.1 for the interim period. All measures were near record highs just a few months back, and we’ll need months and months of steady improvement to get us back there. Still, it’s a start. 

While there’s no scheduled market-moving event for next week, we will get some clues as to how manufacturing is doing in a couple regions of the country, and will also get some sense of what’s happening in the new home market. We’ll also see if consumer spent some of their stimulus funds in May as things began re-opening; it would be hard for retail sales not to rebound at least a little after April’s unprecedented decline. We’ll also get a look at a couple of other items, too, and it would be hard not to consider any improvement anywhere to be relative “green shoots”, but even those only start to fill in the economic hole caused by the pandemic. 

With investors a bit more chastened this week, and influential yields re-settling, mortgage rates are poised to settle back, too. We think that by the time next Thursday morning rolls around, the average offered rate for a conforming 30-year FRM as reported by Freddie Mac will retreat by six basis points, or perhaps even a tick more. Anything more than six would set a new record low. Refinance, anyone?

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