This week saw the undoing of the impressive economic momentum from the previous week.
Just last week, we were commenting on the hugely unexpected increase in nonfarm payrolls of 2.5 million and drop in unemployment (which actually may have been a slight increase once the 3% calculation anomaly is included), a 2.7% to 7.2% rise in the major equity indices, rising interest rates, and a steepening of the yield curve.
Even as early as this Monday, the S&P 500 capped its fastest 50-day rally since the Great Depression to wipe out all it’s losses in 2020. At one point, there was not a single stock in the benchmark that was lower since the rebound began. The NASDAQ 100 surpassed 10,000 for the first time ever and was up 16% for the year.
What a difference a week, three days in fact, can make.
Nearly everything took a turn this Wednesday and into Thursday and Friday primarily off continued weekly jobless claims, the FOMC meeting and the Fed Chairman’s comments, along with evidence of a rebound of the coronavirus.
Initial Weekly Unemployment Claims Ease Slightly
Continuing jobless claims have been choppy, but have overall eased, sending a signal that reduced slack in the labor market is forming. That’s the good news.
The reality nevertheless is that initial claims for unemployment pay are lessening from extraordinarily high levels. For the week ending June 6th, initial weekly unemployment claims came in at 1.542 million:
Though claims decelerated for the 10th straight week, it still represents a stunningly sharp exodus of workers to the unemployment line over the past three months.
Since the pandemic began, more than 44 million workers have filed claims, with the government extending the duration of unemployment insurance and offering many workers what they would normally collect plus $600. Those benefits are set to expire July 31, though Congress has been considering proposals aimed at extending the measures.
Federal Reserve Chairman Jerome Powell Sets a Somber Tone
The Federal Reserve held it’s two-day Federal Open Market Committee (“FOMC”) meeting Tuesday-Wednesday. The FOMC’s written statement released at the conclusion of the meeting did not cause much surprise or concern. The federal funds target range will remain at 0.00% – 0.25%. Although the Fed recognized slight improvements in the economy, particularly from the previous week’s jobs report and the rebound in the stock market, they will continue to support economic growth via continued debt monetization and purchasing Treasuries and mortgage-backed securities at its current pace, restoring orderly market conditions, and adjusting the plan as needed.
In other words, the Fed will continue to use their full range of tools and will keep doing it until they reach maximum employment and price stability, their two legally mandated roles. It was revealed that a final decision on yield curve targeting was not finalized but will continue to be discussed while the Fed will continue providing forward guidance.
Things took a turn for the worse during the live comment and Q&A session that followed by the Federal Reserve Chairman Jerome Powell.
Throughout Powell’s comments and subsequent answers, it became abundantly clear that the previous week’s good news was felt to be but a single data point, and one data point does not make a trend. Furthermore, several times over, the Chairman reiterated the concerns over the massive amount of unemployment, the ability to re-establish over 20 million jobs, the amount of permanent unemployment that may result, and the worry that many of the unemployed will drop out of the work force entirely. This, he believed, would all cause longer-term damage to the economy.
Powell stated that the path for the economy was highly uncertain and dependent on the path of the pandemic. He added that any further outbreaks, let alone a full second wave of the spread of the coronavirus, would cause a loss of public confidence that would reverse and undermine the slow recovery. He questioned the degree of willingness of laborers to return to work and consumers to pick up consumption given the continued health risks.
Although he did his best to remain politically neutral, he also hinted many times that the Fed has done, and will continue to do, all it can by acting swiftly and dramatically to support the economy, but ultimately economic recovery cannot fully occur without continued fiscal support. Right now, the next round of fiscal support is languishing in the Senate.
Powell’s somber messaging underscored to investors that the U.S. was in this for a longer haul than previously anticipated.
Yeah, We May Have Jumped the Gun
Following the Fed’s clear warning that the economy’s recovery from the pandemic-fueled recession will be slow and uneven on Wednesday, U.S. stocks tumbled the most in almost six weeks Thursday with the additional news of the mounting evidence of a second wave of coronavirus cases.
On the day, the Dow Jones Industrial Index fell 6.9%, the S&P 500 fell 5.9%, the NASDAQ Composite Index fell 5.3%, and the Russell 2000 took the biggest hit, falling 7.6%.
Also on Thursday, short-term Treasury yields and interest rate swap rates fell slightly while longer-term yields fell by as much as 17 bps, flattening out the yield curve.
Essentially, all the gains in equities and rise in rates from the previous week were undone.
Currently, 20 out of the 50 states are reporting increased cases of COVID-19. The U.S. continues to see around 20,000 new cases and 1,000 deaths per day from the virus. More than two million people in the U.S. have been infected so far. The localized surges are raising significant concerns.
Testing and case confirmation are two gauges important to the measurement of the spread of the pandemic. However, these two dimensions can be misconstrued as, unless the coronavirus is eradicated, the more you test, inevitably the more cases will be found. This is not to say that neither is worthwhile, as it is imperative to identify those who are infected so they can be treated, traced, and quarantined. The more telling result of these numbers is their ratio, or the percentage of those tested who are found to be sick. The rising percentages seen indicate an increasing spread of the virus.
Two other measures are hospitalization and mortality rates. Not only do these represent confirmed cases, but they obviously present considerably more personal concern as they rise. So, while testing unto itself merely displays but does not contribute to increased infection rates, hospitalization rates can itself add to mortality rates, superfluously, if the health system becomes overwhelmed.
This was the exact concern early on in this coronavirus crisis in states such as Washington, California, Illinois, Michigan, and especially the tri-state area of New York, New Jersey, and Connecticut. These fears have now shifted to states such as Georgia, South Carolina, Florida, and particularly Arizona and Texas. On Thursday, Houston’s highest-ranking county official claimed that the city “may be approaching the precipice of a disaster”. Anecdotal evidence suggested that warmer weather was supposed to provide a degree of reprieve from the spread of the virus, placing the focus for any second wave on late fall and early winter, combined with flu season. However, these are all warm weather states and it is mid-June, so this warm weather hope is turning out to be hollow. Coincidentally, these are also some of the earliest states to reopen and with relatively more lax requirements.
The biggest risk for a second wave of coronavirus infections is that people get tired of doing the right thing. Social distancing, mask wearing, quarantining, and shutdowns are mentally fatiguing and financially draining for individuals and families, as well as for the overall economy. But as we have seen, the tradeoff is continued, if not increased, sickness and death, which may lead to a circular cycle of additional social distancing, mask wearing, quarantining, and shutdowns. This is not a very appealing set of choices.
Germany, so far, has shown that it is possible to contain the virus without clamping down too harshly. This is an important lesson if the recent spread in the U.S. turns into a full blown second wave of coronavirus infections. Germany’s experience has demonstrated that it is far better to respond quickly and smartly, with the right technology and mass testing and tracing, which the U.S. lacks, rather than only relying on the crudest of shutdowns. This shows that there is a possible path that avoids much of the hardships the U.S. has endured.
One extremely important aspect in being prepared for potential additional waves of the virus is access to the right technology. Although several vaccinations and trials are underway in various stages by a record number of potential providers, one recent study suggested that COVID-19 might remain a force to worry about through 2024. That means some forms of physical distancing will persist, making Americans more dependent on information technology.
Fragile and Fickle Conditions Demand Action
If nothing else, the past two weeks should serve notice to the powerful tradeoff between fundamentals and sentiment. Markets have always been, and will continue to be, volatile. Probably the most predominantly referenced measure of volatility is the Chicago Board Options Exchange’s Volatility Index, or the “VIX”.
The VIX is a real-time market index that represents the market’s expectation of 30-day, forward-looking (or “implied”, as opposed to historical) 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 VIX this week rose to over 44:
Volatility serves many well, especially investment banks and certain traders. But for most individuals and companies, it is a cause for concern and a reason to hedge risks, especially when the opportunity to do so at attractive levels arise.
In regard to interest rate hedging, we are seeing more attractive swap rates as they have followed Treasury yields this week in falling across the board by 5 bps, or 0.05%, for two years, to 13 bps, or 0.13%, for ten years. Combined with the potential of increased volatility across markets for the foreseeable future, taking advantage of these lower rates and hedging future volatility (like we have seen over the past two weeks and as implied in the current VIX) is a recommended interest rate management strategy.