Price and yield action across almost all markets are being driven by COVID-19 effects and are expected to do so until there is evidence the pandemic can be controlled.
Since the pandemic began dominating both the news and public policy, most asset classes have been driven by the vagaries of virus developments. Stocks initially collapsed, and then recovered as the fiscal and monetary policy taps gushed stimulus. Bond yields have remained low (although longer-term yields have begun to rise, see below) as economic data remains overall weak, albeit off their worst levels.
There has been one primary driver of price action in most markets – the pandemic, and this will continue until there is a widely available vaccine. It will continue to drive public policy and will also drive market price action.
June employment data stronger than expected
The U.S. jobs report was unexpectedly strong in June, with nonfarm payrolls up 4.8 million, above median expectations of 2.9 million. And, although the unemployment rate fell to a crisis low of 11.1% (better than the 12.4% consensus expectation), unemployment remains at historically high levels and it’s lingering effects are still being felt. The report reflects the pay period that contains the 12th of the month, so the most recent reclosures across several states will filter into next month’s numbers.
Initial jobless claims for the week of July 4th were also less than expected, coming in at 1.314 million, the 13th consecutive week of declining claims since the record high of almost 7 million during the last full week of March. Continuing claims, which lags the initial claims report by a week, fell for its fifth consecutive week to 18.06 million for the week ending June 27th.
Stubborn unemployment levels and jobless claims data, as well as paused/reversed openings, suggest that while fiscal policy has patched the income gap over the past several months, more is undoubtedly necessary. There remains the lingering effect of high unemployment which is unstable economically and politically. So, the expected plateau in economic growth still needs to be digested.
We anticipate that Congress will pass its next round of fiscal stimulus by the end of July, if not by August 8th. The positive June jobs report led some congressional rank-and-file Republicans to believe another package is not needed, but most of the data weakened in the second half of June. In addition, Trump may push for a large stimulus package in light of his weak polling numbers. The critically supportive $600/week bonus unemployment insurance benefit expires July 31st unless Congress acts to extend it.
Passage could slip to August 8th, when the Paycheck Protection Program loans expire, without creating major problems. A political compromise still needs to happen as the incomes of the unemployed need to be buoyed, House Speaker Pelosi needs to deliver state and local government aid to prevent widespread public sector layoffs, and Senate Majority Leader McConnell needs to deliver liability protections so businesses can reopen.
Labor market spurs consumer confidence
The Conference Board survey of consumer confidence index rose more than expected to 98.1 in June, higher than economists’ polls that forecasted a rise to only 91.0 from May’s reading of 85.9. June’s index showed monthly increases in both the present situation and the expectations components. The present situation survey primarily reflected recent improvements in the U.S. labor market.
Confidence correlates inversely with the U.S. saving rate, which has risen dramatically as services spending (especially person-to-person services) has been restrained due to COVID-19 concerns. Income has been patched primarily by fiscal policy. The continuation of any spending rebound into 2H 2020 and 2021 likely requires continued increases in consumer confidence and a decline in the saving rate. The economy is moving in the right direction on confidence, though there is much more room to grow from current levels.
The return of market volatility?
Many pundits are jumping on the bandwagon that there is no way stocks are fairly valued with the S&P 500 Index back near January levels with an economy significantly worse off than it was then. With coronavirus cases climbing, fiscal stimulus in question, and political risks rising, negative catalysts abound.
After a run that hit +45% for the S&P 500, turning the benchmark’s returns positive in 2020 for a moment, the S&P 500 has largely been stuck trading sideways in a 200-point band amid rising cases of COVID-19 in hot spots around the country.
Timing any market is an undeniably impossible task and few attempt to do so, especially after countless equity strategists were burned just a few months ago when the quickest ever bear equity market morphed into an unrelenting rally.
Many who are still optimistic because of an extremely accommodative Federal Reserve are starting to turn less optimistic over further steps the Fed can, or will, take.
A dive back into a bear equity market will certainly create additional volatility and risks that will likely bleed into other asset classes, potentially interest rates.
The VIX index, discussed in previous weekly commentaries, is a real-time market index that represents the market’s expectation of 30-day, forward-looking volatility. Although the VIX is derived from price inputs of equity options on the S&P 500 Index, it provides a measure of general market risk and various investors’ sentiments. That is why it is often referred to as the “Fear Gauge” or the “Fear Index.” Investors, research analysts, and economists look to the VIX to measure overall market risk, fear, and stress.
A VIX level below 12 is considered to be “low”, a level between 12 and 20 to be “normal”, and a level above 20 to be “high”.
The current VIX level is under 30, so at slightly above normal levels. A VIX return to the 80 level, as was seen in March, will be a clear sign of increased volatility across other markets, including the Treasury and interest rate swap markets. For most, increased volatility is a cause for concern and a reason to hedge risks, especially when the opportunity to do so is at attractive levels.
This is especially so in the interest rate hedging market if you are a floating rate payer. Interest rate swaps, with which you can lock in interest expense for a longer term than one or three months via LIBOR, are near record lows, with two to five-year swaps sitting right on top of current LIBOR settings:
Commercial paper jump increases LIBOR
The number of issues in AA-rated financial paper increased this week, which helps to support LIBOR rates.
Three-month LIBOR moved up to 0.273% on Wednesday after falling to a five-month low. The rise follows a climb in commercial paper issues maturing in more than 80-days that rose to their highest levels in over a month, putting pressure on various short-term borrowing rates and indices.
Treasury yield curve will steepen without key long-term buyers
A steeper Treasury yield curve could be on the near horizon due to the disappearance of a significant buyer of long-dated debt, just as supply will start to climb in the months ahead.
Pension funds and insurance companies, commonly known as liability-driven investors, or “LDIs”, are beginning to retreat from the market given that yields are too low to fulfill their goal of matching long-term assets with future long-term liabilities.
Due to a lack of demand, a push higher in the yield on 30-year Treasuries – up over 30 basis points, or 0.30%, since their lows in March – could further steepen the curve. The commonly watched spread between five and 30-year bond yields has climbed to over 100 basis points from just over 50 basis points in March:
U.S. Supreme Court will review the long-disputed Fannie-Freddie profit sweep
Fannie Mae and Freddie Mac keep the U.S. housing market humming by buying mortgages from lenders and packaging them into bonds (mortgage-backed securities, or “MBS”) that are sold to investors with guarantees of interest and principal.
After the housing market cratered in 2008, these companies were put into federal conservatorship and sustained by taxpayer aid. They have since returned to profitability and paid $115 billion more in dividends to the Treasury than they received in bailout funds. Since 2013, most of their profits have been sent to the Treasury under the so called “net-worth sweep”.
The U.S. Supreme Court has agreed to decide whether investors can challenge the 2012 agreements that let the federal government collect hundreds of billions of dollars of Fannie Mae and Freddie Mac’s profits.
A ruling in the investors’ favor would give them a chance to collect a massive settlement. Fannie and Freddie have paid more than $300 billion in dividends to the Treasury under the net-worth sweep.