Why Market's Sudden Gyrations Just Might Prompt Dealmakers to Put 'Pens Down'
“Truth is confirmed by inspection and delay; falsehood by haste and uncertainty.” - Tacitus “Panic is part of the process.” - Matt Powers
No, that quote wasn’t a reference to markets…we were talking with each other about trying to write CoStar Economy each week. Panic is, indeed, part of the process. Especially during weeks like the last one.
Where to start? After a 9% drop last week, the stock market is “officially” in a bear market, falling over 20% from its peak. Selloffs in corporate and securitized debt, and pretty much any risky asset, have pushed broad financial conditions to levels not seen since the investment bank Lehman Brothers filed for bankruptcy in 2008. Equity market volatility, as measured by the VIX Index, and interest rate volatility, which we have represented here with VXTYN Index, nearly reached the peaks of that financial crisis.
Simply put, markets were in a full meltdown this past week. The worst of the week was Thursday’s 9% sell-off in stocks, the largest decline since 1987’s Black Monday. Notably, the bond market also sold off during the week. Monday can only be described as pure panic buying in Treasuries, with the 10-year yield reaching below 0.40% several times throughout the day. By Friday, that rate had more than doubled as some semblance of normalcy returned to the rates market.
This past week, including the weekend, felt like 2008 in many ways. So it is no surprise that the monetary policy response was similar. During the week the New York Fed offered liquidity to primary dealers through $1.5 trillion in repurchase agreements. However, this did little to ease a further fall in the stock markets, and dealers took up only a small fraction of the Fed's offering.
Over the weekend, the Federal Open Market Committee was bolder. Late Sunday afternoon, the committee announced a range of actions. . First, it cut rates a full percentage point, all the way back down the zero lower bound of 0-25 basis points. This cut follows close on the heels of the 50 basis point emergency rate cut, rare on its own, from two weeks ago. The announcement was combined with forward guidance, with the committee indicating the Fed Funds rate would remain at zero “until it is confident that the economy has weathered recent events.”
Second, the Fed has re-started Quantitative Easing (QE), pledging to boost its bond holdings by $700 billion ($500 billion in Treasuries, $200 billion in Agency Mortgage-Backed Securities). This follows a similar balance sheet expansion brought forward last week, but formalizes balance sheet growth as explicitly stimulative, not just a technical tool. The Fed isn’t trying to be cute anymore; this is QE just like we saw during the financial crisis.
The Fed didn’t stop there. Additionally they coordinated with global central banks to open dollar swap lines for foreign-bank funding needs, letting banks borrow at the discount window for 90 days, and cutting reserve requirements to zero. This should go a long way to ease stress in the funding markets.
We know this is anecdotal at best, but this weekend felt eerily like “the weekend that changed Wall Street forever,” the Fed meeting that happened in an attempt to save Lehman Brothers from bankruptcy. The market reaction hasn’t been positive so far.
Equity and bond markets are the first to show stress in the economy. But where will the cracks begin to show in the commercial real estate market? A good rule of thumb is this: the shorter the lease, the more quickly you’re affected. And it’s harder to find a shorter lease than in the hotel space, where rooms are leased overnight.
We looked at an indicator called Revenue Per Available Room (RevPAR) for hotels in the top 25 markets, using data from Costar’s recently acquired hospitality research firm STR. Transient RevPAR comes from rooms rented to individuals or small groups, while Group RevPAR represents rooms sold to large groups with a signed agreement (think conferences).
Reader, the graph is not pretty.
Note this graph is for the week of March 7. We are certain to see further declines the next week. The problem is not just the sharpness of the drops, but also the indefinite nature of the slowdown, where containment results have varied widely by country. We don’t yet know how long this will last. Conferences and meetings that were originally postponed could eventually be canceled, or they may just be delayed. We just don’t know.
We expect the effects of the virus to begin showing up in the economic data soon enough. The typical macro data this note tracks remained useless last week. Instead of dissecting updates from the small business-minded National Federal Independent Business and Consumer Price Index for February (both of which beat expectations), we look to higher frequency data for clues on the sharpness of the decline.
Most stunning was initial jobless claims for that same March 7 week as the graphs above. One would expect a rise in layoffs, right? Guess again – claims dropped by 4,000! There is little explanation to this, though it is unlikely to be continued.
But that wasn’t the only surprisingly healthy data point last week. Weekly same-store retail sales also looked great, which likely reflects consumers rushing to stock up on supplies ahead of potential quarantines. That shouldn’t be a surprise to anyone who has tried to go out and buy anything this week among the hordes filling their carts with food and toilet paper.
The University of Michigan gave us our first print for March monthly data with their preliminary estimate of consumer sentiment. At 95.9, this was a drop from 101.0 in February, but was better than expected and only in the middle of its range since 2017.
We’re not so optimistic. A more reliable data print is likely found in the Morning Consult’s daily consumer confidence report. It reported the worst single-day drop in two years occurred on Thursday, suggesting further declines in the University of Michigan report. A quick drop in wealth, in addition to the "social distancing" shutdowns in activity, are surely to cause a sharp drop in spending once the panic buying of supplies comes to an end.
With the scope of the virus so wide, there are endless ways to monitor impact. Let’s take another cross-section here. If, for example, we’re looking at where in the U.S. commercial real estate will be hit the hardest, let’s look at who relies on the industries likely hit the most, and who is facing the worst quarantines. Vulnerable industries include goods-producing firms likely to be hit by shutdowns in the global supply chain and the fall in exports, as well as leisure and hospitality jobs, which could see severe drop-offs in demand.
Of those in states with high reported coronavirus cases so far, Seattle and San Diego appear most at risk. Houston is already suffering from the dramatic drop in oil prices, and should a rise in COVID-19 cases cause added disruption, this market appears vulnerable. While densely-populated New York City has seen a meaningful flare-up of cases, primarily in the suburbs to the north, the market is helped by having a large share of office workers who can work from home.
From a commercial real estate perspective, it seems like the response to financial market volatility and quarantines is to go “pens down.” Anecdotal evidence points to a stagnation of deal and loan activity, stopping work every deal that isn’t very close to closing, given how little clarity on how long it will take conditions to return to normal.
It is as unsatisfying to write as we are sure it is to read: we just don’t have enough information to know what the world will look like in another month, or two, or six.
The Week Ahead…
Policymaker response to the virus remains the most important factor to watch for this week, although we received a lot of clarity over the weekend. Markets already got the rate cut they were expecting on Sunday, which will replace the anticipated meeting this coming week. The Fed will also not publish their regular quarterly economic projections, but who could do that right now?
Congress is expected to agree upon a stimulus bill to provide free testing and paid sick leave for some after a late-Friday agreement between Pelosi and President Trump.
Meanwhile, regional manufacturing data for March begins to come in, with the New York Fed's Empire State Manufacturing Index and similar report from the Philadelphia Fed released on Monday and Thursday, respectively. We will continue to monitor daily, weekly, and whatever possible alternative measures of activity are out there.
CoStar Economy is produced weekly by Robert Calhoun, managing director and senior economist, and Matt Powers, associate director of CoStar Market Analytics in New York City.