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.