Virus Fallout Stokes Uncertainty as Markets Remain Volatile
The rapid spread of coronavirus COVID-19 has created a tidal wave of volatility in the markets, both domestic and global, as the world’s economies are expected to slow down dramatically. It is tough to make sense of a market that is so extremely volatile like we are seeing now. Every day brings a new extreme, high and low, that is making it tough to predict exactly where this economy and markets are headed. So here’s a look at what some of what happened this week and what that’s telling us about the near future.
- Sunday, March 15: Federal Reserve cuts federal funds rate to 0%-0.25% and launches extensive quantitative easing. The $1.5 trillion QE initiative included purchase of $200 billion worth of mortgage-backed securities.
- Monday, March 16: Dow Jones futures hit limit down. All major indices drop, Dow loses nearly 3,000 points in worst day since 1987s infamous “Black Monday.”
- Tuesday, March 17: Dow drops below 20,000 points for the first time in three years. President Trump announced a $1 trillion stimulus package including direct cash payments to Americans. IRS announces 90-day delay for paying Federal income taxes for those making less than $1 million.
- Wednesday, March 18: European Central Bank announced $819 billion stimulus plan, 10-year Treasury note yield climbs back above 1% in response to US and European stimulus plans. All three indices down 25% from February highs. Fed announces it will make loans to financial institutions that buy shares in “prime” money market mutual funds.
- Thursday, March 19: Dow shows positive gains as tech stocks rise. Oil also jumped up by 20% after seeing record lows earlier in the week. Senate Majority Leader Mitch McConnell releases relief plan for Americans.
By Thursday evening, the Dow had rebounded above 20,000 points and the 10-year Treasury note yield settled at 1.158%. The volatility continues early Friday morning with stocks set to soar and the 10-year Treasury note falling to 1.0%.
Below are charts showing the trajectories of the Dow Jones, the S&P 500 and the 10-year Treasury note.
Let’s start with the Dow. We have seen the worst trading days since 1987’s infamous “Black Monday” with the Dow slipping below 20,000 points earlier this week.
The S&P 500 chart goes back to October 2019. You can see the steep plunge starting at the end of February and into the beginning of March. That is right when events and travel started to be cancelled due to heightened concern about the spread of the coronavirus.
Finally, this chart shows the 10-year Treasury note yield’s progression over the last month. We see the extreme peaks and valleys the Fed is trying to balance with injecting liquidity into markets and purchasing MBS.
The Fed’s move on Wednesday night was an interesting one as it announced any financial institution that purchases shares in “prime” money market mutual funds would be eligible for a loan. These mutual funds are low risk and encouraging institutions to purchase shares would keep the value of cash high which would in turn help investors. This is an effort by the Fed to make sure the everyday transactions that help ensure stability are still flowing as usual.
Data Starting to Show Breakdown
New data this week is starting to reflect what’s happening in the economy. Weekly jobless claims jumped up significantly to 281,000, according to the Labor Department’s survey. That’s the highest total since September 2017. That number is expected to keep increasing as companies continue to furlough employees and governments mandate shutdowns.
Bank of America is already calling this a recession and expect to see the unemployment rate to nearly double this year as the economy “collapses” by 12% in Q2. BOA’s analysts predict that a total of 3.5 million jobs will be lost overall in Q2.
Mortgage Rates See Volatile Peaks and Valleys
So what is up (literally) with mortgage rates? Although the headline rate in the chart below from Freddie has the rate at 3.65%, actual rates are dramatically higher. After seeing lows of close to 3% just over a week ago, mortgage rates are now posted north of 4%. That is a pretty dramatic move in a short period of time. The easy answer is the 10-year Treasury note climbed from a low of .35% to 1.25%. The real answer is a bit deeper and broader than that. Liquidity has been compromised a bit as the normal buyers are out. Those are banks, REITS, money managers, etc. To make matters worse, they are now sellers. The only buyer is the Fed and quite frankly their purchases are not enough to absorb the supply. When this happens, mortgage-backed securities spreads widen out and prices get much worse relative to Treasuries. To further complicate things, mortgage originators are experiencing much higher hedge costs to manage their loan pipeline interest rate risk. These additional risks are part of how a mortgage company comes up with the posted rate. I would not be surprised to see the Fed step up its buying to help calm the markets.
The chart below from Freddie Mac shows the trajectory of mortgage rates and you can see the low on Sunday-Monday followed by the spike Wednesday into Thursday. Thursday’s average from Freddie Mac for a 30-year fixed-rate mortgage was 3.65%.
Sam Khater, Freddie Mac’s chief economist, doesn’t expect this rate increase to be a long-term thing, saying “Mortgage rates rose again this week as lenders increased prices to help manage skyrocketing refinance demand. This is expected to be a short-term phenomenon as lenders work through their backlog.”
As you might expect, the Mortgage Bankers Association’s data showed that mortgage applications were down 8.4% from the week prior. The refinance market was also down 10% week-over-week, but was up a whopping 402% year-over-year. The MBA’s chief economist Joel Kan pointed to the obvious culprit for the volatile swings in mortgage applications.
“The ongoing situation around the coronavirus led to further stress in the financial markets late last week, with unprecedented volatility and widening spreads,” said Kan. “This drove mortgage rates back up to their highest levels since mid-February and led to a 10% decrease in refinance applications. However, refinance activity remains very high. Excluding the spike two weeks ago, the index remained at its highest level since October 2012, and refinancing accounted for almost 75 percent of all applications.”
Kan continued, saying “Amidst these challenging times, the savings that households can gain from refinancing will help bolster their own financial circumstances and support the broader economy.”
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.