I’m still standing — If Federal Reserve Chair Jerome Powell isn’t already a fan of Sir Elton John, he might at least want to learn the lyrics to this classic tune, which celebrates fortitude.
Last week’s headlines were focused on President Trump’s shift to a conciliatory tone with his two frequent punching bags: Powell and China. Finally, a sigh of relief was felt among the investment community following Trump’s admission that he has no intention of firing the Fed Chair, legalities of the decision aside. Trump also stated that he believed a deal with Beijing would be possible—and with it, a significant reduction in the sweeping tariffs imposed by both sides. The bond and stock markets rallied after these comments, while repo rates dropped significantly, thereby creating a confluence of market signals that were commensurate with tacit approval of the cooling tensions.
Recent bouts of volatility have been eye-watering, making any decisions in these markets more akin to a feeling of paralysis than a show of valor. Remember: Trading volumes are currently tied to tweets and headlines from Washington, D.C., not to economic fundamentals. Though there are potential cracks in the economy, it seems there is still life left in this economic expansion. There is also reason to believe that calmer heads have been elevated on the fiscal side. Thus, what has felt like a tsunami crashing directly on us may, instead, ultimately end as a cannonball falling into the opposite end of an Olympic-sized pool. We explain below.
Economic cycles die not of old age, but disease. The disease typically is the slowing of economic production, due to the vicious feedback loops following a rate-hike cycle. There is reason to believe that we have been in a mild recession, or at least the beginnings of one, for at least a year; the unemployment rate bottomed out at 3.4% in April 2023 and has slowly climbed to its current two-year high at 4.2%.
The approximate 80 basis points (bps) increase over a two-year period lies within historical norms for job separations within the first third of recessionary periods (Figure 1). We concede that today’s market may be marred by changes to immigration, technology, and/or fiscal policy. But the data in the analyses extends to the 1970s, so the previous eight recessions had at least some of today’s dynamics.
Moreover, none of the previous recessions had an unemployment rate that was declining—and this indicator tends to trend. Stated differently, once firings commence or cease, they tend to maintain momentum until something stops them, like a change in monetary policy or an exogenous shock, such as Covid. Yet even in a highly unusual shock like Covid, the associated recession followed a cessation of rate hikes and arrived after the Federal Open Market Committee began to lower rates (Figure 2). The economic “disease” was therefore still aligned with historical trends; Covid merely magnified and expedited the outcome.
Housing remains one of the key pillars of the U.S. economy, but monthly real estate reports are often overlooked. For example, shelter accounts for about one third of the Consumer Price Index (CPI), while economic incentives for real estate are a far-reaching barometer on the health of the economy.
In fact, there has never been a U.S. recession at a time when the housing sector stood strong. Similarly, the housing market tends to decline ahead of recessions. Permits for construction tend to be a leading/coincident indicator of an economic cycle. Figure 3 illustrates the average decline in permit activity heading into the final third of the previous eight expansions, as well as the first two thirds of the corresponding recessions.
Last week, the U.S. Census Bureau released the building permits report for March, which was mostly flat, month over month, though the longer-term trend has been weakening marginally (Figure 4); the average decline of the last 12 months (-4%) jives with the aforementioned rise in unemployment and likely accompaniment to the early stages of recession.
It isn’t all bad news, however. The Federal Reserve has shown a willingness to become more accommodative, combined with the resolve to not unduly react to external forces. We also have an executive branch who, as of this week, has been more open to market feedback and now seems willing to ease global tensions after repeatedly stoking them. Finally, we have an economy that has remained resilient in the face of it all.
We are certainly not out of the recessionary woods. If anything, we are likely closer to beginning our walk through it. But so far, the main guides have shown a willingness and ability to take their cues from the stimulus around them and react within reason. One could argue that decisions are being made “too late,” whether from monetary policy or from reduction in global tensions. Nonetheless, this sailboat still seems to be tacking in the right direction.
FROM THE DESK
Agency CMBS — Our markets found some footing last week, even if the mood was subdued. Larger FTIO DUS continued to trade well, while smaller ones (under $5 million) required a heavy concession of around 10 bps. Generically, DUS loans were several bps wider, week over week. Ginnie perm loans stabilized somewhat, after widening the previous two weeks.
Municipals — AAA tax-exempt yields were lower throughout the yield curve, week over week. The municipal bond market continues to have a firmer tone and saw several housing, cash-collateralized deals price—some deals even priced with spreads to the AAA benchmark differing by over 20 bps. The healthcare sector has been extremely quiet, with only two deals pricing in recent weeks. Meanwhile, municipal bond funds saw their seventh straight week of outflows, with $397 million leaving (year-to-date inflows of $125 million), while high-yield funds saw a fourth-straight week of outflows, with $142 million leaving. While bond funds continue to see outflows, they appear to be trending lower.
