As rate cuts aren’t free, it’s important to assess the cost and benefits. Just as we saw with the destruction of profitability with European and Japanese banks, I’m afraid of what a disappearing yield curve will do to US bank profits. While the Fed’s idea of ‘financial conditions’ really only includes the S&P 500 and high yield credit spreads, almost all small and medium sized businesses rely on bank loans and if bank loan margins are on the cusp of getting squeezed, ‘financial conditions’ for this sector of the economy will be tightening. As of last week’s data, there are $2.36 Trillion of commercial and industrial loans outstanding and this number includes to all sized businesses.
The other pain point from lower rates is what it does to people’s retirement funds with baby boomers still a huge population cohort of about 70mm, just below the number of millenials. We are 11 years into this economic expansion and many pension funds are still badly underfunded. Good luck reaching that 7% required rate of return now so the Fed will have blood on its hands for bankrupting many of the country’s financial retirement systems. As for those individuals living on 401k’s, IRA’s and other fixed income, the Fed is now forcing you to take even more risk. Each day 10,000 people turn 65.
In the haste to ‘do something’ and to save us from a 10% stock market correction off a record high of just a few weeks ago and a virus that will go away, you can be sure these things were not discussed in the FOMC conference call deciding to cut rates by 50 bps two weeks before a regularly scheduled meeting.
I’ll stop with this because you’ve heard enough of me on the Fed the past two days. In an editorial in yesterday’s FT, thus before the surprise cut, Karen Petrou at Federal Financial Analytics talking about the possibility of an ’emergency rate cut’ wrote “Too big to fail banks will be succeeded by equity prices that are too high to fall. That is a sure-fire way to create crisis yet unknown.”
We’ll hear from St. Louis Fed President Bullard today and he can explain his reasoning for what they did yesterday.
The sharp w/o/w drop in mortgage rates to just 3.57% on average saw the immediate impact on refi’s as they jumped by 26% w/o/w and are now up 224% y/o/y. Likely due to the paralyzing impact of the stock market drop, purchases fell by 2.7% w/o/w but are still up 10.3% y/o/y (but on still easy comparisons). For those looking to buy, it sure is nice to see the plunge in mortgage rates but you still need confidence in your job and wage outlook in order to pull the trigger. And you have to hope that home prices don’t jump to an extent that dilutes the impact of lower mortgage rates.
Investors Intelligence reflected what you think it would after the damage done over the past week. Bulls fell to 41.7 from 49.1 and vs 54.7 in the week prior. Everyone though is still self confident that it’s a buy the dip as Bears only rose by 1.2 pts to a small low level of 20.4. Those expecting a Correction made up the balance rising to 37.9 from 31.7.
Ahead of the US services indices today, here are some data points overseas. China’s private sector Caixin services index for February collapsed to 26.5 from 51.8. I’m not sure why the estimate was only 48 with so much of their country shut down. Japan’s services PMI fell to 46.8 from 51. Hong Kong’s was a disaster, dropping to 33.1 from 46.8. Singapore’s fell to 47 from 51.4. Singapore has done an extraordinary job in controlling the outbreak but of course is not immune to what’s going on around them. Australia’s services PMI fell just 1.6 pts to 49. India, who has a very domestically oriented economy and hasn’t seem to have been impacted by this virus, saw its services PMI rise to 57.6 from 56.3. For all the challenges in India and Modi controversies, I remain bullish on India.
CHINA’s CAIXIN services PMI
The Eurozone services PMI was revised to 52.6 from 52.8 initially. That is still up .1 pt from January. This was all about domestic growth “as export sales declined at the greatest rate for 5 months.” And for both goods and services the region is seeing “increasingly widespread delivery delays threaten future production. In the service sector, growing numbers of companies are reporting lost business due to the virus spread, notably in sectors such as hotels, travel, transport and tourism but also even in areas such as financial services.” Bottom line, we’re certainly all flying blind here as to how long this lasts and the impact in the meantime. After 4 straight days of gains, the euro is down slightly while bond yields continue to fall.
The UK services February PMI was 53.2 vs 53.9 in January but up from 50 in December. Markit said “The post-election rebound in service sector growth lost some of its bounce in February, in part due to coronavirus related disruptions to sectors such as travel and tourism, but continued to expand at an encouragingly robust pace.” The pounds little changed with gilt yields slightly lower. Pound denominated stocs are still attractive with a dividend yield of 5.2% for the FTSE 100 and a still depressed pound.