Powell Freeze

Fed chair Powell stated, “There have been market reactions when we try to shrink the size of the balance sheet.” Powell is looking to freeze the size of the balance sheet after QE ends. We’ve seen this with other central banks where they decide that the balance sheet staying stable is hawkish because as a percentage of the economy it shrinks. Of course, with Europe’s economy growing at a glacial speed, that rate of decline is very small.

It makes sense for the Fed to keep its balance sheet large. This unwind signaled to the market that the Fed would no longer support it. Technically, the unwind had little direct impact on markets. That being said, the most powerful Fed policy tool is guidance, so this isn’t unique. 

Another aspect is the Fed unwound QE last time when the cycle was mature. If the Fed waits until the economy is ‘perfect’ it will inevitably lead to a weaker economy because the economy is cyclical. Also, keep in mind this Powell statement is guidance in itself. This is guidance inception. 

It’s similar to the Fed saying it won’t raise rates for years. Most wouldn’t have expected the Fed to unwind QE for at least 3 years anyway, so this statement has little near term impact. Powell only said it to calm markets. Why else would you talk about policy 3-5 years from now?

Recovery In All Aspects Of The Economy

As you can see from the chart below, Oxford Economics has come up with a signal for 6 aspects of the economy called the recovery index. It’s no surprise the financial category is doing the best because the stock market has been on a rampage and corporate bond spreads have been tightening. This is partially due to the extremely dovish Fed. 

It’s ironic that health is lagging this index. The catalyst of this recession has improved the least, yet markets and demand have improved. We know demand is up because of government support. If it wasn’t for the Fed and the fiscal stimulus, we may have seen the economy start to recover after the virus went away.

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Some predicted that the Atlanta Fed Nowcast would improve dramatically after it fully included all the April data. That was right because we understood how it actually works instead of using it to make bearish forecasts. Obviously, if you annualize the worst part of the quarter when the improved data comes out, it will project higher growth. On June 17th, the Nowcast was revised down 1 tenth to -45.5%, but of course, it’s way above its bottom of -58.6% on June 4th.

In this latest reading, the housing starts report caused the nowcast for real residential investment growth to fall from -23.3% to -25.9%. Housing starts report showed starts improved from 934,000 to 974,000. That’s a very modest improvement compared to most other data points. It missed estimates for 1.1 million. 

With the housing market on a tear, price increases will come quickly if supply doesn’t spike. A spike in housing starts in Q3 would be a big boost for the economy. Permits were a little better as they increased from 1.066 million to 1.22 million. Permits are an early indicator of starts.

Amazing MBA Applications Again

The housing market is in spectacular shape. It’s a perfect V-shaped recovery as the chart below shows. The purchase index has almost fully recovered its losses. It will likely make a new high soon because there was pent up demand from people who couldn’t buy homes in March and some of April. Many thought that demand would be gone for good. It was just pushed back a few weeks.

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MBA composite index was up 8% weekly which was on top of 9.3% growth. The refinance index was up 10% after increasing 11%. Low rates are spurring demand for houses and refinances. The purchase index was up 4% after it increased 5% the prior week. Yearly growth was 8%. 

Dow Jones's home construction ETF is up 88.03% since the bottom. Surprisingly, even though the housing market has fully recovered, the index is still down 9.94% from its high in February. The best explanation for that is the cloud stocks are where the capital is going. Only a certain number of industries can outperform. This hasn’t been one. Maybe it should outperform.

Industrial Production Improves Less Than Expected

Everyone seems to have a handle on the routine when it comes to May's economic data. Monthly growth will be positively impacted by the easy comp. Just when you thought the recovery was going according to plan, we were thrown a curveball as industrial production missed estimates by a lot. 

Monthly production growth was 1.4% which missed estimates for 2.9%. To make matters worse, the April reading was revised down 1.3 points to -12.5%. The global economy is hurting. As you can see from the chart below, almost the entire manufacturing sector is still in a recession. Industrial production is 15.4% below its pre-corona level.

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On the other hand, manufacturing beat estimates very slightly. Growth was 3.8% which beat by 0.2% and improved from -15.5%. Once again there was a big negative revision as the original report showed growth was -13.7% in April. Autos led growth. Mining was down 6.8% and utilities were down 2.3%. Manufacturing is down 16.8% since the recession started. 

Yearly manufacturing growth improved from -19.5% to -16.5%. Last month’s reading was the worst ever. Data goes back to 1973. The worst growth rate before this was in the last recession in which growth bottomed at -18.2%. It’s amazing that a total economic shutdown only slightly surpassed the depths of the last recession. That shows how bad it was.

Each day that goes by brings us closer to understanding this recession. At the current pace, this will be the quickest recession ever, but one of the deepest. It’s tough to fully compare the total loss in activity until all the data is out. We can be sure there will be plenty of analysis on this. We still don’t know if there will be a double-dip recession because of a 2nd wave of COVID-19.