Economic Tightrope HSH MARKET TREND

July 10, 2020 — Although a fair bit of the economic data have been fair to even solid of late — the rebound from the full economic shutdown in April and May is quite evident — we can’t help the feeling that the upturn has little support to it, or a least soft underpinnings at best. In some ways, it feels to us a little like a tightrope looks; solid at the left end, a valley in the middle, where there is going to be some swinging back and forth and a real chance at falling off, and then some distant future right end that is hopefully anchored to something solid enough to hold the other end in place and taut. 

Having climbed out of an unprecedented chasm only recently, right now we’re still pretty close to the solid left end or the rope and optimistic and confident enough, but have no choice but to move forward to a less-steady location, where swooning, swinging and swaying is a distinct possibility.

The fast re-opening rebound of May and especially June doesn’t seem as though it will be repeated as we move though July and into August. A resurgence of the coronavirus outbreak that began a few weeks ago seems certain to temper economic activity for July and into next month, but the open question is “to what degree?”

With little fresh data to review and in the start of what is usually the beginning of the summer dullness for markets, it looks as though the rush to cash this spring continues to be cautiously unwound, in that stock prices continue to be well supported by investors despite significant headwinds and bonds continue to find willing buyers despite very low yields (the Fed is helping provide support here). As far as mortgages go, there appears to be a gentle-but-steady easing in risks that helped widen yield spreads to Great Recession-era levels. Spreads were fairly normal a year ago at this time, and were just slightly wider six months ago; they then ballooned, as the effects of the pandemic on jobs became clearer and confusion about who would pay for mandated mortgage forbearance programs injected quite a bit of risk into the pricing equation. 

But things have settled somewhat since the worst of that. We closed the books on a difficult quarter and fiscal year (for some), the number of homeowners in forbearance programs has started to ebb (for now, at least) and many technically in such programs are making regular payments, regardless. As well, back in April, the FHFA noted that for GSE-backed mortgages “Once a servicer has advanced four months of missed payments on a loan, it will have no further obligation to advance scheduled payments [to MBS investors].” For some servicers and for some loans, this obligation is ending or will be soon, and that helps to remove at least some potential cost and risk elements from the mortgage making and managing process. 

Important, too is that home values don’t appear to be declining anywhere, and while unemployment remains at terrible levels, it has retreated a fair bit, and folks with jobs are likely to continue to make mortgage payments. Collectively, and with the Fed providing a backstop, it seems enough to allow a little relaxation of risk premia, and so mortgage rates have trended slowly lower even though underlying Treasury yields have largely been flat. Still, risks remain appreciable, are likely persistent and may even intensify at times until the economy gets to a place of running on all cylinders again. With tens of millions still out of work and no vaccine or wholly effective treatment in sight, it will be hard for growth to get out of first gear for a while, so risks and rates may only slowly recede. 

We learned last week that the manufacturing side of the economy revived in June, with the ISM’s gauge rising more than expected and landing in positive territory. This week, we also got a signal that the larger service side of the economy came back to life in June, too. The Institute for Supply Management’s index of non-manufacturing activity posted a record leap of 11.7 points from May to June, a jump high enough to see the barometer land at 57.1, a value nearly as high as pre-pandemic February. The submeasure covering new orders rose 19.7 points to a pretty robust 61.6, and although the employment tracking component did rise by 11.3 points, that was only good enough to raise it to 43.1, still well short of the breakeven level of 50, let alone one that would suggest that hiring is expanding. As well, although the supply-chain issue that has been reflected here in recent months did improve, it still signals that there are issues that aren’t due to surging demand, but rather to the effects of COVID-19.

With the hiring component of the ISM services report improved but still weak, we can’t help think that the recent stall in the improvement in initial claims for new unemployment benefits is one that will also be continuing. After weeks and weeks of rapid improvement measured in the hundreds of thousands in declines in new claims each week, the improvement came to an abrupt halt four weeks ago. In Since June 13, the cumulative decline in new claims has been just 252,000 — a four-week sum that doesn’t even come close to the 331,000 decline in new claims that started June. Only mild declines means that the level of initial claims remains extraordinarily high; at 1.314 million new requests for assistance in the week ending July 4, we’re still more than two times the previous weekly pre-pandemic record. It is very clear that many folks are still losing their jobs despite significant re-opening in recent weeks. 

The reopening also isn’t quickly drawing folks from the ranks of the unemployed, either. The number of those receiving benefits (“continuing claims”) is drifting lower, but is still 19.1 million in the week ending July 4. This is a measurable improvement from the nearly 25 million getting help in early May, but discouraging when you consider that the figure was just 1.7 million when March began. 

Consumers mostly continued to curtail their borrowing in May. New consumer credit balances contracted by $18.3 billion, a third consecutive decline. As has been the case, revolving credit balances declined appreciably, following up a $21.5 billion paydown in March, a $58.2 billion drop in balances in April with another $24.3 billion reduction in May. The use of non-revolving credit managed a little gain of $6 billion, most likely the effect of automobile sales ticking a little higher for the month from April’s hard stop. With stimulus checks still wending their way to households, potentially more on the way, on-going concerns about in-person shopping and such and with the April 15 tax filing deadline in July this year it may be that we won’t see an expansion in the use of revolving credit for a time yet, and with an unclear picture for education borrowing this year, installment credit usage might be positive but probably will remain soft.

Homebuyers and homeowners don’t seem to be reacting much to record low mortgage rates. According to the Mortgage Bankers Association, new applications for mortgages rose by 2.2% in the week of July 3. Applications for purchase-money mortgages led the gain, rising by 2.2%, picking up again after a two-week pause that followed a nine week string of increases. Apps for refinancing did manage a slight gain of 0.4%, but there have been more declines in recent weeks than gains despite rates setting new lows on a number of occasions. To be fair, it’s not much more compelling to refinance at a rate of 3.03% rather than 3.07%, but if we crack the 3% mark it may generate some new enthusiasm among homeowners who have the qualifications to grab a new mortgage at a historically-low rate. 

Although there’s no inflation to worry about at the moment, it will be useful to see if price pressures reemerge was we come out of the shutdowns from supply issues or if still-slack demand keeps them retreating. At least at the producer price level and at least for June, producer prices eased by 0.2% overall, taking back April’s unexpected 0.4% pop. Services were a drag on prices, damping the headline, but goods prices firmed across all stages of production and so-called “core” PPI inflation was actually 0.1% firmer for the month. Still, with top-line PPI running 0.8% below last year and core PPI managing just a 0.3% annual rate of increase there’s little reason to think costs will be rising anytime soon. Next week, we’ll get a fresh look at consumer prices. 

In fact, next week’s got considerably more data to chew on than did this one; CPI and import prices are due, as is industrial production, retail sales, housing starts and a couple of local manufacturing looks, among other things. Most of the data is from June, and so should be reasonably rosy; some if from July, and we’ll be reviewing that carefully to see if there is follow-through or faltering after some solid rebounds in a number of data series. 

While we’re still near the left anchor of the rope, things feel relatively solid. Here’s hoping the tautness continues to remain underfoot. Still, given the uncertain nature of the virus and its new surge and a difficult economic climate despite improvement, it’s hard to fell all that confident about taking the next steps. We are going to, regardless. 

The yields which underlie mortgage rates and influence their changes continue to mostly edge downward, with shorter-term mortgages sliding more quickly than longer-term ones. Friday’s markets saw yields firm up a little, but at the moment there is a good possibility that we could crack the 3% threshold for the conforming 30-year FRM as reported by Freddie Mac next Thursday. A decline of four more basis points would do it, and those looking for 15-year deals may find rates improved by a bit more than that. 

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