From Bull to Bear, Stock Market Gets Pounded as Fed Intervenes
The 11-year bull market run on Wall Street came to a dismal end this week as the Dow Jones Industrial Average sank to 20% below its peak reached last month en route to the Dow’s worst day since the infamous ‘Black Monday’ in 1987. The uncertainty about the spread of the coronavirus (COVID-19) has been the main driver behind the extreme volatility.
It’s not just the virus itself that concerns investors, rather it’s the effect investors are seeing on businesses across the country and around the world. Consumers have been the main drivers of the market. When consumers stay home they stop spending money which causes businesses, and consequently, the economy, to suffer.
The Federal Reserve took drastic measures this week in order to stop the bleeding on Wall Street. Thursday afternoon the Fed announced it would inject more than $1 trillion in its market intervention efforts to calm market fear and provide liquidity.
According to this new plan of attack, the Fed will extend its purchases “across a range of maturities” to include bills, notes and Treasury Inflation-Protected Securities among others. The central bank says it will also begin purchasing coupon-bearing securities. That part of the plan started Thursday afternoon and is expected to continue through April 13.
In addition, the New York Fed desk is offering $500 billion in a three-month repo operation and a one-month operation, occurring on a weekly basis.
Lastly, the Fed will continue to offer at least $175 billion in overnight repos and $45 billion in two-week operations. The repo market is short for repurchase market. This is a situation where institutions, like banks, sell collateral in exchange for cash with the promise to repurchases that collateral at a later date. This provides those institutions with enough cash reserves to operate.
This announcement was initially cheered on Wall Street as the Dow quickly started to pare its massive one-day losses. This move to increase liquidity came nine days after the Fed eased the federal funds rate by 50 basis points, to a range of 1% to 1.25%. Investors were already expecting another rate cut by the Fed at next week’s Federal Open Market Committee meeting.
That excitement was short-lived, however, as the Dow promptly tumbled back down 1,600 points down as the selloff continued. The S&P 500 ended Thursday with a 9.5% drop, its worst performance in three decades, joining the Dow in bear territory. The CBOE EarlVolatility Index (VIX) jumped to more than 66 and hit its highest level since 2008. This index is widely seen as the best gauge of fear on Wall Street.
This is all relative, however, as you look at where the drop is coming. This marked the end of an epic 11-year economic expansion. The chart below gives you a good idea of where we are now compared to 2008.
The Effect on Business
Early Friday morning was a welcome respite from the lackluster Dow this week with all major equity indices trading at limit up (5% cap) in order to create more stable trading at the opening bell. While this is a good sign, we won’t know the full extent of the economic effect of the virus for some as we wait to see the losses businesses will take due to the cancellation of major events worldwide.
Dramatic measures are being taken by businesses and governments in an effort to contain the spread of the virus. The NBA suspended its season after one player tested positive while the NCAA officially cancelled the entirety of March Madness. Washington State’s governor banned any gatherings of more than 250 people. Boeing’s stock faltered by the largest margin since 1974 after the company announced it would halt hiring and limit overtime in order to preserve cash. The major airline supplier is affected by fewer people traveling and many airlines cutting back on flight schedules.
President Trump’s speech on Wednesday night did not ease fears on Wall Street. The travel ban on flights from Europe caused a 5% drop in the oil market which has been in bear territory for some time already. This ban only complicated the issue of increased supply as OPEC and Russia battle for market control. Crude prices continued to be mired in a bear market with the industry seeing its worst day since 1991.
The most impressive example of just how steep the drop was this week can be seen in the trajectory of the 10-year Treasury note yield. The significant decline happened Sunday night and continued its volatility into Monday. The 10-year yield dropped below 0.5% and dipped all the way down to 0.314% before rebounding back above .85% in early morning trading on Friday. The intraweek 10-year Treasury yield has more than doubled in just a few days. All of this volatility shows just how confusing all of this is for investors trying to make sense of what is really going on and what does it all mean. It should be noted that the yield curve has steepened substantially in the last few trading sessions with the 2- and 10-year Treasurys now at a 40 bps spread. It wasn’t too long ago that we were talking about the potential for another yield curve inversion.
The extreme volatility in the stock market will continue until there is a more certain expectation of what will happen with the spread of COVID-19. Typically, the true effect a global pandemic has on the economy will not be seen until enough data can be gathered. For example, weekly jobless claims fell last week, meaning fewer people are applying for unemployment. That will likely change after the next reading considering current reaction, such as Boeing halting hiring. Producer prices also fell sharply, spurred mainly by the stark drop in the price of gasoline.
One place we have yet to see the virus impact is employment data. Weekly unemployment claims dropped, according to the report from the Labor Department. This data was accumulated over last week so it will likely not reflect any claims that show the effect of the virus’ impact until two weeks from now.
Producer prices saw a steep decline of 0.6%, the largest drop for this data point in five years according to the Labor Department. This is largely because of the drop in gasoline prices. Annually, the producer price index (PPI) rose by 1.8% in February, against expectations for a slight loss. The core PPI, which excludes the more volatile components like gas, saw its first drop since June 2019, dipping by 0.1% month-over-month.
The Labor Department’s data also showed a surprising jump in consumer prices in February. There was a 0.1% gain month-over-month, while the core consumer price index (CPI) showed a 2.3% annual gain. That went against economist’s predictions for no monthly change and a year-over-year increase of 2.2%.
Housing Hitting Unprecedented Highs
The silver lining in the severe drop in markets is historically low interest rates. Freddie Mac’s 30-year fixed-rate mortgage average actually went up this week to 3.36%. This is potentially because some lenders are raising rates in order to slow down demand because volume has been so incredible.
Despite it going up, that kept the floodgates open for refinances that were already red-lining lenders the week prior. Data from the Mortgage Bankers Association shows refis were up 79% week-over-week from Feb. 28 to March 6 with annual refi volume up 479%. Purchases were up 12% year-over-year. The number of mortgage applications is at its highest level since 2009.
This data caused the MBA to take another look at its 2020 predictions. Now, the group is predicting $1.2 trillion in refinance volume this year, a 37% increase from 2019. The group also expects total overall mortgage volume to hit $2.61 trillion in 2020.
Contributed by Greg Richardson, MAXEX Managing Director
Greg Richardson is Managing Director at MAXEX, LLC, based in Atlanta, GA. He has 30 years of experience in capital markets, including trading, banking asset and portfolio management, mortgage banking secondary marketing and accounting. MAXEX is the only platform in the mortgage industry to offer a centralized clearinghouse that enables buyers and sellers to trade anonymously with multiple counterparties using a single standardized contract.