Rates to Follow Narrow Path as Congress Dithers

Last Week: Interest rates traded slightly higher and equities added to existing gains. The US 10-year Treasury note yield added a mere two basis points to wrap the week at 0.63%, as 1-month LIBOR also drifted higher to 0.18% as optimism in a near-term virus vaccine evaporated in the harsh glare of a continued rise in virus infections. The price of a barrel of West Texas Intermediate crude oil rose nearly $2 to $40.90, as the US Dollar weakened, and Gold strengthened. Treasury yield volatility, a key driver in the cost of rate caps and swaptions, ground lower throughout the week.

Rates jerked higher by coronavirus vaccine progress. Two vaccines to protect against the COVID-19 virus, one being developed in the US and one in Great Britain, showed strong promise in early trials and are progressing toward more advanced testing. It is hoped that inoculations will be approved for use later this year. The vaccine being developed by a team at Oxford University is set to go into production even before trials are complete to produce as many as two billion doses by Q1 2021. The news help offset growing evidence of the virus’s resurgence in the US, Japan, and Australia in recent weeks, necessitating the rollback of some reopening plans. Our take: Do not get too excited that the pandemic’s days are numbered. We are guessing that a viable vaccine won’t show up for months, and when it does, won’t quickly cure the economic ills left in Covid-19’s wake.

Positive data lost its oomph amid the fast-evolving pandemic. US data collected in June remained quite upbeat, with retail sales rising 5.4%, beating expectations following an 18.2% rise in May, while industrial production gained 5.4%. The US housing sector remained strong as interest rates dipped below 3% for a 30-year mortgage – a 50-year low. New home sales rose 55% in June. Despite the seemingly good news, financial markets view the data as backward looking, and not a reflection of the state of the economy today. For some borrowers, seeking relief by refinancing at these ultra-low levels may prove difficult if they’ve lost their job or had to take a pay-cut.  Even though home values remain firm for now, the ability to service the loan over the long term is becoming an increasingly common question.

Our take: With more and more communities shuttering businesses that recently reopened, such as bars, movie theaters and restaurants, it is just a matter of time before the monthly economic gauges we all rely on show signs of faltering. It is unavoidable; states comprising 75% of the US population have paused or reversed reopening plans, significantly impacting consumer behavior.  Looking further out, once lock-downs ease anew, the traditional retail space will remain under tremendous strain. The Fed’s latest Beige Book report, which provided a sneak-peek at July retail sales, demonstrated the recent rebound in retail demand likely won’t be enough to keep many retailers afloat. On the demand side of the coin, a crash in consumer incomes will become more evident as the initial round of Federal stimulus measures wanes in the coming weeks. Bottom line: An argument could be made for the impact of a second wave of infections to be less pronounced than the first.  This is due to a better understanding of the virus and lower mortality rates.  Nevertheless, rising infection rates should still dampen the recovery as it could lead to a more long lasting, secondary impacts on consumer and business behavior that stunts both the US and global growth. All told, the robustness of recent economic data by no means indicates that the economy can recover on its own. Instead, it is testament to the timeliness of the unprecedented policy response early in the crisis by the Fed and Congress; it also highlights the urgency for more. The trillion dollar question now – will congress get it done and what will it look like?

Pressure on Congress ramping as month-end looms. The income and support cliff is right around the corner. The $600 top-up to unemployment benefits expires at the end of the month, and the Payroll Protection Program (PPP) stops accepting new applications on August 8th. At the same time, mortgage forbearance plans are expiring. The freeze on student-debt repayments is set to end in September. While the political debate will be cantankerous, our trusted politicians will get more aid in the hands of the unemployed and businesses, it will just be less generous this time around. Read on for detail.

Low rates – forever? The Bank of Japan and European Central Bank each met last week, and neither changed policy, as their respective short-term rates stand near record lows. Calmer markets have seen central bank balance sheets rise slower than previously forecast. For example, the US Federal Reserve’s balance sheet is now seen ending the year at $8.5 trillion, $1 trillion less than May estimates, as only 4% of the Fed’s $2.6 trillion in emergency lending capacity has been deployed. Bank of England (BOE) Governor Andrew Bailey told lawmakers this week that he sees low rates for a long time and that the UK’s central bank will do everything it can to support the economy.With the central banks of the world all going on in on stimulus, there’s a scant chance rates, at any point ion the curve, will rise by any meaningful amount anytime soon.

What to Watch This Week: Congress’s work on a new relief package begins today, and while we won’t get to see the contents of the sausage until late next week, we expect a smaller (~$1 trillion) and more targeted aid package this time around, including more frugal jobless benefits, another round of targeted stimulus checks and small business aid. Help to states and local governments will likely fall well short of what is hoped for. While Congress’s small-ish aid package will not derail the nascent economic recovery, it will keep growth firmly in the slow lane into year-end.

The data docket in the days ahead is a light one, but contains useful information for select industries, like real estate, via the most recent reads on new and existing home sales (on Friday and Wednesday respectively).  Record low mortgage rates are currently fueling demand and seasonality disruptions are making housing statistics look robust. While relieving on the surface, the current signs of strength will probably wane in the months ahead as the knock-on effects of the pandemic drive more bankruptcies and job losses that will never return.

Elevated forbearance rates point to a sharp increase in delinquencies and foreclosures once extensions expire. More than 4 million homeowners, or roughly 8% of loans, remained in forbearance at the beginning of July, according to the Mortgage Bankers Association. A spike in foreclosures could hinder the initial robust recovery in the housing market by impacting borrowers’ credit scores and weighing on property values.

There won’t be any fresh insights available on the Fed this week, as officials enter their blackout period for public speeches ahead of the July 29th monetary policy meeting.

Big Picture: Nominal Treasury yields have traded in tight ranges in recent weeks with the 10-year Treasury swinging between 0.57% and 0.76% over the past month. Real yields, nominal yields adjusted for inflation, are and have been deeply negative for some time. The Treasury market is charting its narrow path forward based on the newly-resurgent coronavirus, and the slow recovery dynamic that comes with it, and expectations that the Fed will keep the stimulus flowing for months to come.

While the ultra-low rates we’re all enjoying are prompting many to refinance commercial real estate at fixed rates, for some borrowers, fixing now may be the worst thing to do. Why? With infections on the rise and a second wave of lock-down looming, having flexibility is key, and one could say that borrowing at a fixed interest rate eliminates flexibility. While every borrower and every project are different, often there’s a smarter way to secure a low rate without locking oneself into a financial straight jacket: fixing the rate via an interest rate swap. Want to learn why? See our latest DL Report, Swaps are Back.

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Source: Bloomberg Professional

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Source: Bloomberg Professional