Beware of Falling GDP

June 26, 2020
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Economists project that the second quarter, which ends next week, will see the biggest quarterly economic contraction on record, dating back to 1947.

Some forecasts call for a GDP loss of greater than 40% at an annualized rate. GDP, which tallies the sum of goods and services across the economy, is on track to crater 46.6% in the April-to-June period, according to a running measure kept by the Atlanta Federal Reserve on Thursday.

This Atlanta Fed tracker, a forecasting model called GDPNow, had been indicating a drop of 45.5% a week ago on June 17th, but poor economic conditions since then caused the central bank district to take down the figure slightly more. Such a drop would easily be the worst in the post-World War II era.

Federal Reserve Chairman Jerome Powell told the Senate Banking Committee last week that, assuming the virus remained under control, the economy could move through three phases.

The first phase, a sharp contraction, could then lead to the second phase – a bounce back marked by large increases in re-employment. Powell said it was possible the economy was in the beginning of that second phase, but he warned that the third phase of recovery would require Americans to regain their confidence engaging in activity that requires close indoor contact and large outdoor gatherings.

The latest numbers of increased COVID-19 cases, infection rates, and hospitalization rates are not cooperating with the Chairman’s third phase. Texas paused reopening, Houston’s intensive-care wards reached capacity, and surgeries were suspended as coronavirus cases climbed 4.8%. Infections rose in other Sun Belt states and California, adding concern for a resurgence of the outbreak.

The attempted reopening in the middle of the second quarter proved premature. States are being forced to attempt to again limit economic activity. The lack of either treatment options or an effective vaccine means that the cycle of restart attempts and subsequent reclosing continues. This significantly limits the initiation of Powell’s third phase of recovery.

The flattening yield curve is providing lower rates, better hedging opportunities

With all the mitigating actions and programs put in place by the Federal Reserve as a result of the dire economic consequences of the coronavirus shutdown, interest rates, both long-term and short-term borrowing base rates, have set record lows or have come close to doing so.

The Fed’s actions, along with the market’s outlook on the economy, has also led to a flattening of the yield curve, meaning that long-term rates, which are normally higher than short-term rates, are nearly flat to short-term rates, especially in the front five years. Flat, and sometimes inverted, yield curves are standard economic events heading into and during recessions, as the U.S. will officially be in once second quarter GDP is released.

Two to five-year interest rate swaps, which represent locked in LIBOR rates, are only a few basis points (1 basis point = 0.01%) above most of their short-term LIBOR setting partners. While 1-month to 6-month LIBOR rates currently range from 0.18% to 0.36%, two to five-year swap rates range from 0.24% to 0.34% “mid-market”, meaning inter-dealer levels.

This graph shows that current 3-month LIBOR was set today at 0.31%, whereas an interest rate swap that locks in 3-month LIBOR for the full three years is at 0.25% (mid-market), or 6 basis points lower.

In the spirit of full disclosure, a borrower will not be able to lock in a swap rate at this mid-market level, or any of the mid-market levels shown. In reality, swap dealers will mark the swap up with credit and profit margin. But even with these markups included, actual traded swap rates provided by dealers are still on top of, or near, their counterpart short-term borrowing base LIBOR rates.

What this means, in this example, is that a borrower can lock in 3-month LIBOR for three years, covering what would otherwise entail 12 LIBOR resets, at a rate that is near the current three-month LIBOR setting. This would eliminate the risk of rising short-term borrowing base rates for the next 11 resets. This opportunity exists with two-year and five-year interest rate swaps, as well, which are currently at approximate rates of 0.23% and 0.34%, respectively (mid-market).

Weekly jobless claims data disappoints

The Labor Department reported that an additional 1.48 million Americans filed for unemployment benefits last week. This was a disappointing release, as the median forecast called for only 1.35 million in new claims. The positive take-away is this was the 12th straight week that this number has declined. It fell by 600,000 from last week’s level of 1.54 million. Nevertheless, the substantial overriding problem is that jobless claims are not declining nearly enough, registering at well over 1 million new claims a week.

Even though many people are being rehired, the people being laid off is offsetting that positive effect. What we are now seeing is a second leg of layoffs. It’s not just the service sector being shut down. Now, it’s businesses saying that they do not need as many people. Many of the recent job losses are emerging from the largest U.S. companies as they adjust to an economy and consumers reshaped by the pandemic.

The number of people continuing to receive benefits, an indicator for overall layoffs, totaled 19.5 million for the week ended June 13th, down slightly from previous weeks. This significant amount of new and total unemployment claims is a strong signal of a slow recovery for the U.S. economy, especially as several states face record infection and hospitalization rates that will impede hiring and consumer spending – the public is not psychologically immune to COVID-19 and has retrenched as the virus has started spreading.

The Labor Department will publish data on June hiring next week, Thursday, July 2nd, with the release of the Nonfarm Payroll and Unemployment report. Employers surprisingly shocked the markets by adding 2.5 million to payrolls in May while all forecasts called for continued declines. Still, overall employment is down by about 20 million compared with February, close to the reported 19.5 million in overall layoffs. The median forecasts are predicting that 3 million people will be added to the nonfarm payrolls in this upcoming report, with the unemployment rate falling from 13.3% to 12.5%.

The $600 in extra weekly unemployment benefits, which comes in addition to the standard benefits provided by the states and was included in the federal stimulus package to help laid-off workers weather the crisis, is set to expire at the end of July. This, unless the Senate moves on extending this benefit. The House has already approved an extension.

 Existing home sales tumble 9.7% in May while new home sales surge 16.6%

Sales of existing homes in May fell 9.7%, compared with April, to a seasonally adjusted annualized rate of 3.91 million units, according to the National Association of Realtors. Sales were down 26.6% annually. That is the largest annual decline since 1982, when interest rates hovered around 18%. It is also the slowest sales pace since October 2010.

These numbers are based on closed sales, representing contracts signed in March and April. These results are not surprising given that they occurred during the strictest periods of the pandemic lockdown.

The meager supply of homes for sale did not help, as potential sellers decided to wait, while some other sellers already on the market pulled their listings. Inventories nationally fell 18.8% compared with May 2019. At the current sales pace, it would take 4.8 months to exhaust the inventory. Supply was lower across all price points. Tight supply kept pressure on home prices, though. The median price of an existing home sold in May was $284,600, which was up 2.3% from a year ago.

Nevertheless, the chief economist for the National Association of Realtors remains optimistic for existing home sales in the coming months, with economies reopening and mortgage rates remaining low.

The nation’s new homebuilders, on the other hand, appear to be benefiting from the lack of existing homes for sale and low mortgage rates. New home sales in the U.S. rose more than expected in May, with purchases of new single-family houses climbing 16.6%, the second-largest monthly advance since 1992, to a 676,000 annualized pace. The inventory of new houses for sale was the lowest since July 2018.

Although new home sales represent only 15% of the total home sales market versus 85% for existing home sales, if we have seen the bottom in existing home sales, combined with the strength of new home sales already observed, this could signify a significant positive factor in the economy. New home sales, in general, regardless of whether they are existing or new, spur significant additional economic activity in several areas such as retail sales, labor, and eventually in homeowner wealth. This is why the federal government supports housing and the mortgage industry in some of the strongest fashions possible.

Although mortgage rates are some of the lowest on record, we have already written about why there is a fracture in the residential mortgage markets (see AEGIS’s Markets Summary RATES blog from June 5, 2020) that are flooring mortgage rates roughly 1.00% higher than they should be, and imposing strict credit guidelines, such as on cash out loans, home equity lines, and jumbo loans. Lowering residential mortgage rates to where they should be trading, and easing credit approval restrictions, would help support new home sales even further and allow this to be an even stronger vehicle for economic growth and support for a much needed rebound.

We continue to monitor oil, gas, NGLs, and regional markets for hedging opportunities. To learn more and see AEGIS opinion and recommendations, go to AEGIS View publications, or contact Like what you see? Share this article with the button on the bottom right of your desktop. Market questions or comments? Contact us at

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