Friday Wrap: October Effect, Labor Buoys Economy, GSE Shift

Equities Take a Hit, Increased Chance for Another Fed Rate Cut

The “October effect” came in full force this week as the Dow Jones Industrial average dropped more than 800 points over the first two days of the month. The S&P 500 also had a poor performance, falling below its 50-day moving average due to the lowest manufacturing data numbers in a decade.

The “October effect” is mainly a psychological phenomenon in the trading world as many of the United States’ worst financial disasters happened during the month (Black Tuesday in 1929, Black Monday in 1987 and the beginning of the financial crisis in 2008). Recently, October has actually been one of the best performing months of the year with regard to equities. As one analyst put it, “even the slightest bit of volatility can cause overreaction in the market.”

The initial drop was a response to the Institute of Supply Management’s U.S. manufacturing survey showing its worst reading in a decade. The data for the purchasing managers’ index showed just 47.8% in September, which is the second consecutive month of contraction. You can see the drop relative to 2009 in the chart below. 

Another bad sign was that only three of the 18 U.S. manufacturing industries that are tracked by the ISM showed any growth. Essentially, manufacturers everywhere are feeling the pressure of a global economic slowdown and the ongoing tariff battle between the U.S. and China.

After that sharp drop across the Dow and S&P 500, Thursday’s numbers rebounded on the news that the Federal Reserve is expected to ease rates at the October meeting. Right now the market is pricing in a 95% chance that the Fed will ease rates at the Federal Open Market Committee meeting at the end of this month. 

Again, that volatility was caused by reaction to another piece of data. This time, it was the ISM’s non-manufacturing data reading at its lowest point since August 2016. This index measures services in the U.S., like healthcare, retailers and computer services. Roughly two-thirds of all U.S. output is directly related to the service sector. Economists had expected a reading of 55.3, but the reading came in at 52.6 in September. August’s reading was at 56.4. That initially sent the Dow plunging for a third straight day until the news of a potential cut by the Fed helped rally the markets. 

All this volatility in the markets has pushed bond yields back down, close to the year-to-date low seen Sept. 3 where the 10-year Treasury note closed at 1.47%. The 10-year note is currently trading at 1.53% as of Friday morning. Understand that we also saw the 10-year Treasury note hit a month-high of 1.90% on Sept 13. Most of this volatility has occurred in the last several days and was not reflected in the Freddie Mac mortgage averages this week. The 30-year fixed rate average is holding steady around 3.65% but you can expect next week’s survey to be several basis points lower.

Labor Market Continues to Buoy Economy

Despite all the trade volatility and global economic slowdowns, the U.S. labor market continues to buoy the economy and drive the 11-year growth of the economy. The ISM non-manufacturing index, while showing a steep drop from August to September, is still reading above 50%. Any reading above 50% is seen as a sign of an expanding services sector.

The Labor Department’s unemployment numbers show that there was an increase in initial state claims for unemployment benefits, but it’s possible that increase is due to an ongoing strike by General Motors workers. 

An interesting twist is that layoffs in the United States have dropped. A report from the firm Challenger, Gray & Christmas shows job cuts announced by U.S. companies hit a five-month low in September. 

The jobs released by the Labor Department Friday morning shows nonfarm payrolls rose by just 136,000 against expectations of a rise of 146,000. The unemployment rate hit a 50-year low once again, hitting the 3.5% last seen in December 1969, which again was lower than expected. August and July were both revised up showing a net gain of 45,000 jobs not previously reported. 

Hourly earnings did not change much and are up just 2.9% for the year which is the lowest increase for wages since July 2018. The Fed watches wages closely and factors the data into the committee members’ decision on whether to raise or ease rates. The Bureau of Labor Statistics did report that retail jobs continue to falter, losing another 11,000 jobs in September. The retail sector has now lost nearly 200,000 jobs since Jan. 2017. 

Fannie, Freddie Start Slow Move to Privatization

Government-sponsored enterprises, Freddie Mac and Fannie Mae, are starting the slow move out of government conservatorship and into the private sector. This week the Treasury Department, along with the Federal Housing Finance Authority, came to an agreement that Fannie and Freddie would be allowed to keep $25B and $20B in capital, respectively. These are the beginning stages of a plane that will hopefully put an end to the decade-long conservatorships and have both companies return to the private market.

 

Fannie and Freddie entered into government conservatorship during the financial crisis of 2008. This was meant to be a temporary solution until the economy reached a point where both entities could move back into the private sector. The government bailed out the companies by purchasing stock and then enacting a profit sweep via executive order that pushed any profits from the companies directly to the U.S. Treasury. 

 

In a statement, Treasury Secretary Steve Mnuchin said, “These modifications are an important step toward implementing Treasury’s recommended reforms that will define a limited role for the federal government in the housing finance system and protect taxpayers against future bailouts.”

Contributed by Greg Richardson, MAXEX Managing Director

Greg Richardson

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.