In chaos theory, the butterfly effect refers to the idea that due to the interconnectedness of all things, a small event can result in large effects on a nonlinear, dynamic system.
The butterfly effect gets its name from the metaphor that even small swirls of air caused by the flapping of a butterfly’s wings can change the path of a tornado, even though the system is far removed in space and time from the initial event.
In many ways, we see this theory manifest in the U.S. bond and stock market – a dynamic system that is prone to the influences of distant perturbations.
Case in point, a virus outbreak among an urban population of a distant country may lead to a lower rate of growth in the economy in 2020. But it could also lead to a lower 10-year yield and thus lower mortgage rates for the housing market.
How can this happen?
As I explained in my 2020 forecast article, negative headline news stories can lead to stock market sell-offs, driving money into bonds and lowering the 10-year yield. Those familiar with my work may recall that I said an inverted yield curve could be bullish for the economy when everyone else was saying it was a harbinger for a recession.
Today, we have a set of different headline issues, and if these factors come together, we can see cycle lows in mortgage rates. The following seven could act as the metaphorical flapping of a butterfly’s wings:
1. The Coronavirus is an unfortunate surprise new addition to our list of headline risks. The virus outbreak could affect economic stability, not only in China but globally. If the headlines regarding the spread of the Coronavirus get worse, look for more money to come out of stocks into the safety of bonds.
2. Boeing delays will impact growth in the first half. If the delays last into the 3rd quarter, this will be a surprise to the market place and will impact growth further into the year.
3. Election headline risks are in play. If Bernie Sanders wins the Democratic primary, expect a reaction from the market. You may recall that both the elections of President Barack Obama and President Donald Trump caused fear of a market reaction. Political figures, whether good or bad from your perspective, will have that effect on the markets one way or another during the election year.
4. Manufacturing data has stabilized but has the potential to get softer. Recently the Philly, Richmond and Texas Manufacturing Data lines all showed growth, so I am not too worried about this risk factor now. Ignore the American bears who focus on the Chicago PMI data alone, because this index is weighted with Boeing. The Chicago PMI data has been negative 16 times during this record-breaking expansion.
5. If Brexit negotiations turn sour, this could create more headline drama and confusion for the markets.
6. The Chinese or European trade war tap dance could create more negative headlines and thus more volatility in the stock and bond markets.
7. Any military conflict in the Middle East or North Korean missile launches could lead to market instability.
Short term economic events can lead to a negative GDP print. Three times during this record expansion, GDP prints were negative for a quarter. This occurred twice in 2011 and once in 2014. A negative GDP, combined with these headlines, could drive rates to recent all-time lows on the 30-year fixed rate.
The silver lining to all the headline drama – and certain factors that can inhibit faster growth rates – is that as long as the 10-year yield is below 2%, we are in play for cycle low mortgage rates. (See more on that in the graph below).
If Coronavirus headlines get better and Boeing gets back online, look for some benefit in GDP growth for the second half of 2020. These changes could also lead to slightly higher yields.
As of today, my six recession flag model indicates that the expansion is still going, so don’t join the cast of characters who overreact to each negative data point. These doomsday people have been wrong about America for decades.
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