Letter from the UK #2
Publicerad: 2 november 2018, 18:41
Regardless of the impact on real estate values the global withdrawal of liquidity by central banks will lead to higher market volatility. Markets will react more sensitively to data and political sentiment. In an environment where politics is often flaky this could lead to material market movements that have an impact on the financial position of otherwise stable investments.
Ämnen i artikeln:Jonathan Lye
LONDON, Oct 31st The global bull market is over, central banks measured withdrawal from bond markets is having an impact and liquidity is being reduced. Currently the 3M USD LIBOR is 2.54%, with 5-year swap rate at 3.07% which is up from 64Bps and 84Bps respectively this time last year. 3M STIBOR is 0.54% and the 5-year swap is 0.35% which is no change in STIBOR from 1 year ago and a 2Bp fall in the swap rate. The increase in US interest rates is leading to investment managers shifting the way they deploy their funds which is showing in the global equity market however the question is, will this show itself in the real estate market?
The Riksbank has maintained its position of ending new bond purchases under its QE program (announced Dec ’17) however, unlike the Fed it has not raised its base (repo) rate, yet. This has left the Krona in the strange position of having weakened against the Euro in the spot market however in the forward market the Krona is initially strengthening, then as the interest rate differential between the euro and Krona changes again SEK weakens.
The Riksbank policy has been to maintain an interest rate that is lower than the ECB in order to maintain a weak currency so that exports to the euro zone will not be unduly impacted. This policy looks likely to change in the near future as the messaging from the central bank is that they expect to raise the repo rate between December and February ’18 which is likely to be sooner than the ECB. This will be the first raise in over 7 years (last rising period Jul 10-11) and as an illustration of how significant this is the Riksbank has published a paper explaining what usually happens in the event of a rate hike. The Riksbank is no longer making new asset purchases under its QE policy but continues to reinvest so there is an ongoing forecast of growth of the balance sheet. The first forecast fall in the holdings of government bonds is March 2019. The interest rate differential and hence SEK pricing in the forward market also supports the view that the Riksbank will raise rates before the ECB.
Sweden and in particular Stockholm can be observed from the outside as a real estate bubble. The constrained supply and the availability of cheap money has led to a decrease in yield and valuations that are seemingly inflated. However, the economy continues to perform with the Riksbank raising its expectation for inflation in its last report and GDP growth continuing to look positive. Stockholm offices have seen rental increases, which has the impact of increasing the asset yield and will provide a buffer to investors in the event that real estate values do fall. The Swedish market has not seen any material change in the interest rate environment over the last year – unlike the US. The US has seen 8 rate rises since 2015 and still real estate cap rates continue to fall. However; there are signs, according to RCA data, that liquidity in certain US markets is beginning to reduce, despite the headline deal volumes.
There are however headwinds that could cause delay to the rate rise; the dip in recently published market confidence figures, if realised in key data and the lack of a functional government. There is still a possibility that Sweden will return to the polls for a further vote given the stalemate that has existed since 10th September. The global economy continues to be two stories with the US continuing to perform and others, notably the eurozone showing signs of softening. The strength of the USD continues to constrain emerging economies as this has an impact on their cost of debt.
Regardless of the impact on real estate values the global withdrawal of liquidity by central banks will lead to higher market volatility. Markets will react more sensitively to data and political sentiment. In an environment where politics is often flaky this could lead to material market movements that have an impact on the financial position of otherwise stable investments. Currencies are where cross border investors are most likely to feel the impact and as a result should be a key consideration in the investment process.
The outlook for the Swedish economy remains positive. The Riksbank is warming the market up for a rise in the repo rate and combined with the lowering of liquidity as a result of the reduction in the QE program interest rates look set to increase. As market support is removed volatility will increase and investors will be subjected to more material movements in value as data and politics become more influential. It remains to be seen whether this will lead to a fall in real estate value however it does mean a changing investment environment.
Director, Auxilium Financial Risk Management