The U.S. labor market unexpectedly rebounded in May, signaling the economy is picking up faster than forecasted from the depths of the damage caused by the coronavirus shutdown
Nonfarm payrolls rose by 2.5 million in May after a 20.7 million decline the prior month, both record changes going back to 1939, according to U.S. Department of Labor data Friday. The unemployment rate fell to 13.3% from 14.7%. These ultra-surprising results came against median forecasts that called for continued payroll losses of 7-8 million for the month and an unemployment rate increase to 20% or more. No one in any survey had forecasted improvement in either measure.
This data shows a U.S. economy pulling back from the brink, and quite possibly from it’s bottom, as states relax restrictions and businesses bring back staff, while supporting the ongoing rebound in the stock markets. Immediately after this release, the overall markets saw textbook risk rotation out of bonds (raising Treasury and interest rate swap yields, discussed below) and into equities. The Dow Jones Industrial Index was up over 1,000 points intraday Friday, only to close lower on some slight profit taking (+829 points, or +3.15%).
One caveat noted by Labor Department was that the unemployment rate would have been about 3% higher than reported if data were reported “correctly”. This comment refers to workers who were recorded as employed but absent from work due to other reasons, rather than unemployed on temporary layoff. Much of the strength in this report likely came down to timing. Workers did not have to work the whole reference period to be counted on company payrolls or to be counted as employed, they just had to have done any work at all during the respective reference period. Many of the payroll increases came in just at the computation deadline.
Data on permanent job losses continued to climb higher by 295,000 over the month, to a total of 2.3 million. Furloughed workers have been brought back but the last three months have seen over one million total jobs lost permanently. Also to note, forecasters are waiting to see the employment effect when the Paycheck Protection Program expires and when certain fiscal aid bailouts, such as that to the airlines, allows for layoffs.
One surprise in the report was the 1% drop in average hourly earnings from the previous month while the workweek rose to 34.7 hours. That likely reflects the large return of lower-wage jobs versus this same figure that was skewed significantly upward last month as millions of lower-paying jobs dropped out of the workforce. Given the strength of this labor report, another surprise was the sharp continued increase in government related unemployment, which correlates to the fiscally weak conditions of states and municipalities, especially as most approach fiscal year-end budget deadlines June 30th.
The rebound in employment is particularly surprising given signs of deterioration across the full suite of claims figures previously released. A quicker than anticipated rebound in May from April does not on its own suggest the overall economic recovery’s profile will be V-shaped, as the economy still suffers from a 13.3% unemployment rate and is still in recession. But, this jobs report will lower the expectations for second quarter contraction which, prior to this report, called for GDP to fall in the second quarter by as much as 50%.
As stated several times previously, this is not a normal economic cycle brought on by a breakdown in a certain business sector (or sectors) of the economy, but rather by a global pandemic health crisis. As a result of this being a unique economic cycle, a new recovery shape reference has been growing in the forecasting community — that is the shape of a square root symbol, or a sharp initial rebound followed by a slower and longer-term recovery.
In summary, this jobs report was a complete positive surprise and indicates that the near-term condition of the economy is becoming clearer. Nevertheless, the longer-term condition is still uncertain as the economy still sustains historically high unemployment and is anticipated to display a record fall in GDP for the second quarter. One must also remember the health threat lingering in the background of a potential second wave of the pandemic that led us into economic crisis in the first place. To fully recover to pre-coronavirus economic levels, more monetary and fiscal relief is going to be required.
Congress not seeing eye-to-eye on next rounds of relief, Wall Street leaders are concerned
Senator Majority Leader Mitch McConnell has told White House officials that another round of fiscal stimulus from Congress could be just under $1 trillion, a figure with which the Trump administration is comfortable. This amount falls far short of the $3.5 trillion relief measure passed last month by the House of Representatives that included $1 trillion alone in aid for states and local governments facing revenue shortfalls, along with a new round of direct stimulus payments to individuals along with money for COVID-19 testing and tracing, among other relief items.
Furthermore, McConnell said that there are no plans to do a stimulus bill before the July 3rd two-week recess, leaving action on any such measure after July 20th. This misses the House’s target of completing the next round of relief by June 30th, the fiscal year end for most states and municipalities.
The Senate announced late Wednesday that it will hold a hearing next week on currently increased unemployment benefits that are set to expire at the end of July. Any plan that emerges will have to meet the concern, mostly voiced by Republicans, that the extra benefits payments ($600 per week) have become a disincentive to work. Any additional relief package will have to win votes from Democrats who control the House and are pushing to keep such safety nets in place for the tens of millions of Americans who have lost their jobs during the pandemic.
There are some indications of a compromise on these unemployment payments. One plan winning support from the Trump administration would redirect stimulus into topping up wages for the re-employed — a so-called “back-to-work bonus.” A separate Democratic proposal would gradually whittle the jobless benefits back to pre-crisis levels as unemployment rates fall. Both ideas have potential to win across-the-aisle support, perhaps even combined with each other.
Doing nothing, and simply allowing the additional unemployment payments to expire without a substitute, is an option that has little support and would risk further sinking the economy that has left households relying on government benefits for income and would risk choking off initial signs of recovery. While another round of fiscal stimulus is anticipated to be enacted, it would be a negative economic catalyst should negotiations fall apart.
Meanwhile, Wall Street leaders, including JPMorgan Chase CEO Jamie Dimon and Goldman Sachs President John Waldron, have voiced concerns about the potential for an economic rebound. Lazard CEO Ken Jacobs, whose firm is working on some of the largest restructurings in the world, sees more trouble ahead even as economies begin to reopen. “The second wave likely starts sometime this summer for the companies that don’t have enough money to make it through,” Jacobs said this week in an interview. Lazard also warned that there could be cascading bankruptcies if the U.S. government did not step up with a more stimulus.
In the meantime, Wall Street is in the midst of one of the strongest quarters for debt underwriting ever, thanks to record bond issuance by corporate clients trying to bolster their balance sheets given current economic conditions, historically low yields, and the Federal Reserve’s policy of buying corporate debt to prop up companies economically damaged by the global pandemic. The combined amount of new investment grade and high yield issuance in March, April, and May will be the largest on record for any three-month period.
Shorter-term Treasury yields have been unusually stable in the last month but yield curves are steepening as longer-term yields rise
Yields out to three years continue to remain within the tight channel set by the effective Fed Funds rate of about 5 bps, or 0.05%, and the Fed’s upper target of 25 bps, or 0.25%.
Yields in the ten to 30-year sector continue to display a steepening trend, especially following Friday’s labor report.
Ten-year Treasuries at 0.65%, where we started the week, may become a distant memory. This benchmark yield rose roughly 25 basis points, or 0.25%, throughout the week, jumping from 0.86% to 0.95% alone intraday in the few minutes following the jobs data release Friday morning.
The 30-year Treasury bond has seen significant selling since mid-April, rising roughly 50 basis points, or 0.50%, from about 1.15% to 1.65%. This all the while shorter-term rates continue to hover near their May 8th record lows. This has led to a steepening of the Treasury yield curve, which similarly affects the interest rate swap curve. The spread between the five-year and the 30-year Treasury yield has reached its steepest level in three and a half years, currently at over 120 bps, or 1.20%. A steepening yield curve is typically a strong sign of expected economic growth from current conditions.
This continued steepening is expected to continue for the foreseeable future. The steepening is a result of the market conveying optimism that the worst-case scenarios for both public health and reopenings have not been realized, and in fact, is initially bouncing back faster than expected with Friday’s jobs report. Also, the market expects yield curve control and forward guidance to come from the Federal Reserve in June, keeping shorter maturities suppressed as reopening progresses, while allowing the ten, 20 and 30-year yields to float freely in the face of growing long bond supply.
Market purists should enjoy this move in longer-term bonds as an example of legitimate supply and demand being reflected in price. Also, by targeting shorter-term yields and allowing longer-term yields to freely trade, the Fed is avoiding the fear that a peg on long-term yields would provoke an upward jump in inflation expectations as they would be seen as capping these inflation telling rates artificially low.
The major threat posed by a large rise in long-term rates would be on future corporate debt issuance and mortgage demand. But so far this has not been a problem in the corporate market, as already discussed. It has not been a problem for the demand for new mortgages and refinancings, either. In fact, in the mortgage market the problem is the supply of mortgages and the credit standards imposed by banks that are bottlenecking mortgage lending, not the level of long-term bond yields.
Strains in the residential home mortgage market
Mortgage availability has tightened sharply as lenders impose tougher income, credit-score, and down-payment conditions and drop some loan types altogether, such as home-equity lines of credit.
As part of its March relief bill, Congress let homeowners suspend mortgage payments for up to a year but provided no way to pay for this, potentially saddling lenders with the burden.
The Cares Act, passed by Congress in late March, allows homeowners whose loans are backed by Fannie Mae, Freddie Mac, the Federal Housing Administration, and the Veterans Administration to suspend payments for up to a year, even without giving proof of hardship. So far, 4.75 million people have done so, representing about $1.04 trillion of unpaid principal.
What Congress did not address is that Fannie and Freddie would not guarantee a new loan made to anyone who sought forbearance, effectively barring them from refinancing.
One indicator of the credit crunch is that the volume of mortgages being refinanced, which normally rises sharply when rates drop, is up only modestly since before the pandemic.
Another indicator is mortgage rates themselves — they are roughly a percentage point higher than they ordinarily would be given current Treasury bond yields.
Historically, 30-year fixed mortgage rates hover around 1.70% above the ten-year Treasury yield. That spread is now 2.70%. Hence, mortgage rates should be closer to 2.50% than their 3.50% level now.
A weak economy puts borrowers at greater risk of losing a job and defaulting, and typically leads to tighter credit, but not this tight. Markets are frozen for so-called jumbo loans, usually those that exceed $510,400 in most localities, which are too large for government backing,
A strained mortgage market threatens to make the economic recovery more difficult. Housing is often the most immediate way the Federal Reserve transmits lower interest rates to the economy, as homeowners refinance to free up cash and as home buying spurs construction and spending.