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Bill Roller
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Summary
Markets were down last week. The Dow Jones Industrial Average fell 1.05% to 26,935.07. The S&P500 ended down 0.51% to 2,992.07 while the Nasdaq Composite finished down 0.72% to 8,117.67. The annual yield on the 30-year Treasury fell 17.9 basis points to 2.199%.
Economic data for the week was highlighted by the Federal Reserve lowering short-term interest rates by another quarter-point, in line with financial market expectations. Otherwise, industrial production and housing sales came in stronger than expected, several regional manufacturing indexes declined but remained expansionary, while the index of leading economic indicators was little changed.
Equity markets lost ground last week moderately, both in the U.S. and abroad. Bonds fared better, with positive returns in keeping with the Fed’s lowering of interest rates. Commodities rose due to a spike in crude oil prices on the heels of an attack on Saudi oil facilities, threatening near-term supplies.
Economic Notes
(0) The FOMC decided to lower the fed funds rate range by -0.25%, as mentioned earlier in the week. The market reaction to the move was largely as expected, with the dissents by several committee members (in opposite directions) being one of the more unusual aspects of this meeting. The Powell-led press conference appeared to focus on business ‘uncertainty’ and slower global growth as the primary catalysts for the move—neither of which is based on current U.S. data. While it appeared previous Fed chairs took considerable time and effort to reach consensus prior to meetings, the Powell Fed seems less focused on such a result, allowing a wider breadth of views. The downside, of course, is that the Fed appears a bit more disjointed, with the perception of confusion as to whether the economy needs stimulus or not.
By the looks of the forward-looking economic projections, the path of future rates was little changed from current levels. Predictions for economic growth (small upgrade, but still around 2%), inflation (recovering from below to near the 2% target), and unemployment (3.5-4.0% area) were little changed in keeping with broader consensus views.
(+) Industrial production for August rose by 0.6%, which beat the median forecast, which called for a 0.2% gain. The manufacturing component rose by 0.5%, led by business equipment (up 1%) and other groups outside of autos, which declined by -1%. Utilities rose by 0.6% in addition to a strong prior month, due to weather factors, while mining production rose 1.4%. Capacity utilization rose by 0.4% to 77.9%. Overall, while only representing about a tenth of overall GDP, manufacturing remains solid despite signs of weaker sentiment and tariff/trade impacts.
(-) The New York Fed Empire manufacturing survey fell by -2.8 points to a level of 2.0 for September, remaining expansionary but below the 4.8 level expected by consensus. Employment improved further into growth, while new orders and shipments weakened by several points—but remained in expansion. Prices paid also rose several points, into further inflationary territory. Assessments for business conditions over the next six months fell by double-digits but also continued to provide a signal of expansion.
(-/0) The Philadelphia Fed manufacturing index fell by -4.8 points in September, to a level of 12.0—but surpassed the 10.5 expected. Under the hood, shipments and employment actually gained sharply to move further into the expansionary zone, while new orders declined a bit, but remained sharply in expansion. Prices paid moved sharply higher, further into expansion, as well. The six-month-ahead business condition indicator declined by nearly -12 points, but remained close to a positive 21 level.
(+) Existing home sales for August rose 1.3% to a seasonally-adjusted annualized rate of 5.49 mil. units, which outperformed the median forecast calling for a -0.7% decline, and represented the strongest monthly number in over a year. Single-family units rose by just over 1%, while condos/co-ops came in rising just under 2%. Sales rose in three of the U.S. regions, led by a 8% increase in the Northeast, while sales in the West fell by -3%. Sales are now back to pre-crisis peak levels, after more than a decade, although low levels of housing inventory (with an average listing period of just over 30 days) have weighed on sales numbers more than expected, particularly in the single-family home segment. The median sales price declined a bit to $278,200, which remains up 5% from a year ago at this time. The influence of lower interest rates appear to be a tailwind, while labor shortages continue to weigh on building activity.
(+) Housing starts rose 12.3% in the month of August to a seasonally-adjusted annualized rate of 1.364 mil., beating the median forecast calling for a 5.0% rise. Single-family starts rose 4% (to 919k units), while the sporadic multi-family group rose by 33%. Regionally, the Northeast, South and Midwest experienced gains well into the double-digits for the month, while those in the west were flat. Overall, starts are up 7% from levels a year ago. Building permits rose 7.7% for the month, also outperforming, relative to the -1.3% decline anticipated. A near-mirror image to starts arose with permits, with single-family permits rising 5%, while multi-family increased 13%. By region, all areas gained but the West, with the Northeast rising by nearly 30%.
(+) The NAHB homebuilder sentiment index rose 1 point to 68 for September, which exceeded the expected decline by a point to 66. By composition, current sales rose 2 points, future sales fell -1 point, while prospective buyer traffic was unchanged. Regionally, the Northeast and South gained decently for the month, while the Midwest segment lagged with a flat reading. While the summer high season is now past, this reading continues to point to an expansion of autumn activity.
(0) The Conference Board’s Index of Leading Economic Indicators for August was unchanged from the prior month. Underlying statistics of housing permits and credit, which performed positively, offset weakness in manufacturing and the interest rate spread. Over the past six months, the leading indicator rose at a 1.1% annualized rate, which is on par with the general growth rate over the prior six-month period. The coincident indicator rose by 0.3% from the previous month (while the six-month rate of change slowed by a few tenths of a percent), while the index of lagging indicators declined by -0.3% in August. Recent signs from these indicators have been mixed, which is no surprise to those watching the individual economic signals. At the same time, no near-term recession ‘red flags’ have been triggered, either.
(0) Initial jobless claims for the Sep. 14 ending week ticked up by 2k to 208k, but below expectations for a higher rise to 213k. Continuing claims for the Sep. 7 week, on the other hand, fell by -13k to 1.661 mil., below the 1.672 level forecasted. Once again, no anomalies were reported, with claims levels continuing to point to low layoff activity and strong employment markets.
Question(s) of the Week
How will the recent attack on Saudi oil facilities affect energy and financial markets?
Due to experiences in the past, especially in the 1970s, many investors have been conditioned to expect the worst when oil supplies are threatened. While trends in oil demand tend to be far more persistent, and are largely affected by slower-moving events such as the demographics or recessions, oil supply can be disrupted instantaneously, so acts as a faster market price catalyst.
Over the prior weekend, it was confirmed that Yemini rebels (possibly backed or encouraged by Iran) used drones to attack two key Saudi oil extraction and refining facilities, which took nearly 6 million barrels offline—or about 5% of the world’s production volume. This is just one of several infrastructure attacks on Saudi soil this year, but by far the most damaging. The largest one-day oil price spike in 20 years ensued (over 15% at one point to back over $60/barrel). Later, prices tempered, following ramp-ups from other oil producers and the U.S. administration that crude could be released from the Strategic Petroleum Reserve as needed to shore up supply/demand in the interim. Again, as in decades prior, the U.S. government has been put in a tricky position regarding possible retaliations, and if so, towards whom and for how long.
The ultimate question always comes down to ensuring that there is enough oil getting to where it needs to go. There has always been a historical ‘risk premium’ baked into the price of crude oil, due to the geopolitical hotspots where it’s found—such as the Middle East, parts of Latin America, etc. The amount of this premium varies, but we were told years ago by an industry expert, and later government official, that it could be anywhere from $5-20/barrel at any given time. Of course, premiums only matter when they matter.
There are several differences here that separate this from reactions in prior eras. As a whole, despite the growth of emerging markets, populations use less oil per capita than they used to, due to modernized manufacturing and industrial efficiencies. The emergence of green technologies has also taken a further bite into petroleum consumption to some degree. As a result of the shale revolution, the U.S. has overtaken Saudi Arabia as the world’s ‘swing producer,’ meaning that disruptions in more volatile geographies should be less disruptive than they have been in the past. In fact, U.S. sanctions placed on Iran and Venezuela, as well as geopolitical unrest in areas such as Nigeria, have threatened far more in global inventories.
Financial markets also seem to have reflected the tempered concern. The risks, of course, are an escalation, and further attacks, which could begin to add up in terms of supply disruptions. The worst case would be a significant rise in petroleum prices, which has been a wildcard often associated with tipping economies into recession—if they’ve been on the precipice already. The positive side, of course, is higher revenues for energy-oriented assets, such as commodities and energy sector revenues, which have lagged the broader market due to oil prices being stuck in a lower trading range this year. Perhaps surprisingly, a small pickup in prices and drilling activity could also help U.S. GDP growth slightly.
What happened in short-term financing markets last week that caused rates to spike temporarily?
While falling under the radar for the most part, perhaps the most dynamic lubricants of the financial system are markets for short-term funding. These include the Fed-regulated market for ‘excess reserves,’ where banking institutions with excess cash held above their required reserve ratios can lend it to banks needing to fill their reserve bucket—governed by the FOMC-based fed funds rate used as a key tool in monetary policy. (Excess reserves are not a small part of the financial economy, totaling $1.4 trillion as of August.) Other short-term funding markets include the repurchase (or ‘repo’) market, in which firms can borrow cash for very short-term periods (a day in some cases, or longer), in return for posting a certain type of collateral (usually U.S. treasuries). Money market mutual funds are large participants in this market, which is the reason money market yields tend to be fairly close to the fed funds rate. This market is large and typically extremely liquid, considering the high quality of collateral and short maturities, but historically, the Fed has been close at hand to inject liquidity when needed to keep the ‘plumbing’ running smoothly.
Last week, however, those rates spiked when not enough funds were available to satisfy demand. In keeping with demand for an asset and limited supply, the cost (interest rate) of the good (money) rose sharply for a brief time until the Fed stepped into provide liquidity.
This has generally occurred during periods of extreme demand for cash, such as the financial crisis, which is why it was seen as a problem at first glance. However, it appears a confluence of factors created a perfect storm for such an event, which may have been brewing for some time. One of these is the Fed’s paying of interest on excess reserves (‘IOER,’ a new policy after the financial crisis) which kept more funds in the Federal Reserve system. It also adjusted the size of the repo market, depending on where lending banks can earn a slightly higher rate, even by a few basis points. Other factors may include the slow drain of liquidity by the Fed as quantitative easing was unwound, and a sharp increase in treasury issuance—which creates a mismatch between long-term maturities and short-term funding needs. More immediately, significant treasury bill settlements, adjustment of bank balance sheets for quarter-end, and quarterly corporate tax payments potentially added fuel to the fire, causing a cash crunch.
Many bond market professionals don’t see this is a watershed crisis event of any kind. The Fed didn’t address this in depth during last week’s press conference, but they may need to adjust the operations of this market a bit, such as providing more funding buffers to preserve repo market stability, in addition to lowering the IOER as they did last week from 2.1% to 1.8%, to incent banks to move more funds out into lending markets. Or, systematic changes may be required longer-term to prevent such ‘clogs,’ such as a standing overnight repo facility, like a credit line, which it has considered instigating in recent years.
Market Notes
| Period ending 9/20/2019 | 1 Week (%) | YTD (%) |
| DJIA | -1.05 | 17.58 |
| S&P 500 | -0.49 | 21.13 |
| Russell 2000 | -1.14 | 16.81 |
| MSCI-EAFE | -0.35 | 13.94 |
| MSCI-EM | -0.52 | 5.75 |
| BBgBarc U.S. Aggregate | 0.88 | 8.07 |
| U.S. Treasury Yields | 3 Mo. | 2 Yr. | 5 Yr. | 10 Yr. | 30 Yr. |
| 12/31/2018 | 2.45 | 2.48 | 2.51 | 2.69 | 3.02 |
| 9/13/2019 | 1.96 | 1.79 | 1.75 | 1.90 | 2.37 |
| 9/20/2019 | 1.91 | 1.69 | 1.61 | 1.74 | 2.17 |
U.S. stocks ended lower last week, although with an absence of volatility in geopolitics (other than the Saudi oil attack, which was largely ignored by markets) and markedly little news on the U.S.-China trade front, which has been driving sentiment in both directions for months. By sector, defensive groups utilities and healthcare outperformed, along with energy due to higher oil prices; conversely, consumer discretionary and industrial stocks lagged for the week, with the latter presumably more affected by higher energy prices.
Foreign stocks performed generally in line with domestic equities, with the exception of emerging markets, which lagged other groups slightly. Hopes for a UK-EU Brexit deal continue to persist, although odds of a deal or ‘no deal’ outcome in coming weeks continue to appear as even odds, with the Irish backstop remaining a sticking point. The Bank of England left interest rates on hold, regardless, with offsetting risks from the economy and weaker currency factors. EM results were led by weakness in China, Turkey and South Africa. In China, several economic indicators, such as industrial production and retail sales, pointed to damage from the current trade spat, which has undermined sentiment. While oil importers generally suffered, this was offset by positivity in oil-exporting nations Russia and Mexico, which would benefit from price spikes.
U.S. bonds gained ground on the week as interest rates dipped back to lower levels across the curve, in keeping with both sentiment away from risky assets and the Fed’s quarter-percent rate cut. Investment-grade corporates fared best for the week, with long-term treasuries faring best, while high yield and senior loans lagged. A stronger dollar held foreign developed bonds back, with minimal gains, while emerging market bonds were again mixed—USD-denominated gaining nearly 2%, while local debt was flat.
Real estate bucked general equity trends, but kept pace with defensive sectors, by gaining over a percent on the week. Foreign real estate positions provided similar returns to those in the U.S., with gains in Europe offset by losses in Asia.
Commodity indexes rose broadly, due to the overwhelmingly positive influence of energy, as agriculture was little changed, industrial metals lost a bit, and precious metals gained slightly. As discussed earlier, the price of crude oil spiked early in the week, following the Saudi attack, while optimistic expectations for getting facilities back on online (by possibly month-end) resulted in a price reversal downward. On net, the price of crude oil rose by 6% to just over $58/barrel.
Mortgage Rates
Sam Khater, Freddie Mac’s Chief Economist says, “Despite the rise in mortgage rates, economic data improved this week – particularly housing activity, which gained momentum with a noticeable rise in purchase demand and new construction. Homebuyers flocked to lenders with purchase applications, which were up fifteen% from a year ago and residential construction permits increased twelve% from a year ago to 1.4 million, the highest level in twelve years. While there was initially a slow response to the overall lower mortgage rate environment this year, it is clear that the housing market is finally improving due to the strong labor market and low mortgage rates.”
The 30-year fixed-rate mortgage averaged 3.73% with an average 0.5 point for the week ending September 19, 2019, up from last week when it averaged 3.56%. A year ago at this time, the 30-year FRM averaged 4.65%.
The 15-year fixed-rate mortgage averaged 3.21% with an average 0.5 point, up from last week when it averaged 3.09%. A year ago at this time, the 15-year FRM averaged 4.11%.
The 5-year Treasury-indexed hybrid adjustable-rate mortgage (ARM) averaged 3.49% with an average 0.4 point, up from last week when it averaged 3.36%. A year ago at this time, the 5-year ARM averaged 3.92%.
Average commitment rates should be reported along with average fees and points to reflect the total upfront cost of obtaining the mortgage. Visit the following link for the Definitions. Borrowers may still pay closing costs which are not included in the survey.
Through our relationship with Prestige Home Mortgage in Vancouver, Washington we originate residential and reverse mortgages. Check us out at https://beaconrrwa.com and our affiliated websites at https://reverse-mortgages.us and https://socialsecurityquestionsanswered4u.com.
Sources: Ryan Long, CFA, FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, PIMCO, Standard & Poor’s, StockCharts.com, The Conference Board, Thomson Reuters, T. Rowe Price, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.
Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.