How Epidemics Impact Lending
It is important for STRATMOR clients, and lenders in general to remember how a large-scale disease, in this instance the coronavirus, can affect the U.S. housing market and mortgage rates. Events like this, even though the detailed impact is yet to be fully realized, drive volatility in global stock and bond markets. And although loan originators everywhere are cheering the low rates, they come with a price.
China, where the coronavirus originated, represents a little over one-fifth of the world’s GDP, and all forms of travel, manufacturing and trade with China have slowed. Supply chains have already been disrupted and Chinese growth will accordingly be impacted negatively this year. Quarantines and fear in China will have a significant negative impact on China’s gross domestic product in 2020, with some estimates lopping two percent off their near six percent official real GDP growth rate. Other Asian economies that are tightly linked to China through global supply chains will also feel the drag, even if their absolute or relative numbers of coronavirus cases are much smaller than China’s.
Many U.S. firms have extensive supply chain networks in China that may be disrupted by closures and quarantines, delaying shipments of key parts and slowing output just as business was gaining momentum following the Phase One China trade agreement. The U.S. could certainly see further economic disruption and consumer confidence should wane if the virus continues to spread.
Supply chain disruptions stand to be the biggest factor potentially impacting U.S. economic growth, though the effects would be unevenly distributed across the country. The impact will likely play out over the next few months, as extended shutdowns in China following the Lunar New Year lead to parts shortages and production cuts. Trade volumes normally slow around the Lunar New Year, so the impact from additional shutdowns tied to the coronavirus may not become apparent until this spring.
Weaker demand in China may pull world crude oil prices lower, triggering some additional belt-tightening in oil-producing states in this country. Downward pressure on oil prices would further reduce oil and gas capital investment (which has pulled back substantially over the past year), leading many operators to slash capital spending. Manufacturers all over the country have links to the energy sector, and some will undoubtedly feel the pain from cutbacks in capital outlays.
Tennessee has the highest percentage of state GDP tied to the value of exports and imports to China, followed by California, Washington, South Carolina, Illinois and Kentucky. But to some extent, producers in every state have a connection to China. There are several exposed sectors, notably the computer and electronics, automotive, and industrial machinery sectors.
The Western region of the U.S. may be most impacted due to its concentration of computer and electronics manufacturers. Additionally, heavy manufacturing industries, which are concentrated in the Midwest and South, utilize a wide range of inputs from China. Manufacturers in the Pacific Northwest, Midwest and Southeast will also likely feel a large impact, while firms that import parts and components from other nations may also be impacted because China has become such a large part of global supply chains.
Chinese tourism to the United States is also likely to slow, and several large trade shows have already seen cancellations of vendors and attendees. China-related tourism generates a significant amount of economic activity in states such as California, Nevada, New York, Massachusetts and Washington, D.C.
Why should lenders care? After all, rates are great! The U.S. Treasury market tends to be a money safe haven as investors sell global stocks and buy U.S. Treasuries. But if enough money floods the U.S. Treasury market, long-term bond rates could sink below short-term bond rates, the condition commonly known as an inverted yield curve. Banks tend to reduce or stop lending when shorter-term money is more expensive than longer-term money, making continued economic expansion harder. If banks have to offer depositors higher short-term deposit rates than they can charge on long-term business loans, they are losing money and carrying the risk that some loans will default. That means the banks might just say no to new business loans, helping spur an economic downturn.
Some people now believe there will be a 25-basis point cut to the Fed Funds rate in June, which would represent a “material” change to the Fed’s outlook. The average 30-year fixed mortgage rate is at the lowest level since August 2016, and the MBA refinance index is at its highest level since 2013. The 10-year Treasury yield, which is the benchmark for 30-year fixed-rate mortgages, fell around .20 percent in early February. Mortgage rates may certainly stabilize or rise once the coronavirus is contained, but nobody knows for sure when that will occur.
In summary, low rates are fine, and keeping many originators busy refinancing their own book of business or trying to refinance the loans their competitors have done recently. But if there truly is an economic drag from any epidemic, the coronavirus or something else, a slower U.S. economy is not something to look forward to.