Eighty years ago, Time publisher Henry Luce purchased Life magazine. Intending to switch the periodical from an illustrated news weekly to a pure-play photo essay, Luce took an extraordinary risk with an already successful model. Amidst the Great Depression and only a few years prior to WWII, Life evolved quickly to an overwhelming success. Whether President-Elect Trump, his administration and a Republican-controlled Congress will be able to convert an existing model of success into an even more impressive outcome remains to be determined; but, the investing public has clearly wagered a change in tactics will not befall the domestic or global economy with a reversal in fortune.
Late last week, the yield on the 10-year UST nearly broke above 2.4 percent for the first time since July 14, 2015, and, with the mark cleared, an approximate 85 basis point increase since Labor Day, with 50 basis points of the rise coming since Election Day. The selloff in the global bond market and multiple record valuations in domestic equities have been well-covered. As a digest, markets have priced in:
As we recently posited, the policy picture remains cloudy and heightened uncertainty is likely to constrain domestic economic activity until President-Elect Trump clarifies his positions and cabinet postings. Stated alternatively, the conviction many investors have in recent market movements, as drastic and in many cases destructive as they have been, will remain weak until domestic economic activity corroborates current valuations in the equity and bond markets.
Or, as the case may be, until investors become distracted with another news headline.
As the below graph conveys, the yield on the 10-year UST rose 64 basis points in the past 30 days, in a maneuver eerily similar to the 73 basis point increase in the 30 days ending July 2013. In that time period, the 10-year UST shot above its 200-day moving average and then see-sawed before cooling down to pre-tantrum levels. As many of you will remember, the sudden increase in yields investors required stemmed from conjecture relating to the “Taper Tantrum.” Across the commercial real estate industry, property prices did not experience a broad setback, though it should be noted transaction volumes expanded by more than 20 percent that year.
The “hockey-stick” effect in interest rates has interrupted conventional lower-for-longer mantras and shifted future expectations of yields across the globe. Below, we map economist expectations for the 10-year UST. The implied forward curve (based on futures) shows a more moderate increase in yields, albeit from current pricing, while a survey of more than 50 economists shows a sharper rise in the bond after it falls back to earth later this quarter. But by year end 2017, everyone seems to agree the 10-year could hit 2.5 percent.
The excitement of bond yields has tempered as investors focus on election results in Italy, Germany and France. Monday marked the eighth consecutive day the 10-year UST has yielded 2.3 percent, arresting the rapid increase. Furthermore, yesterday yields on the 10-year UST declined almost five basis points. Meanwhile, equities are teetering on M&A transaction news, valuation concerns and, as we mentioned earlier, concern over policy for 2017. Meanwhile, the corporate bond market has priced efficiently alongside Treasuries. As the below graph indicates, 10-year A and BBB bond yields have not moved significantly, hopefully allowing for lower pressure on credit spreads in an environment where benchmarks are increasing.
As it relates to the commercial real estate community, it seems appropriate to assume any accommodative fiscal policy will not immediately impact property fundamentals, and a lag will be necessary to feel any lift. But as with prior cycles, the investing public prices in anticipated movement well ahead of actual performance. And for now, at least in the bond market, pricing indeed feels adequate to expectation.
In the meantime, and as we raised two weeks ago, the “Contract of Suspense” still hangs in the balance.
Jimmy Hinton serves as Managing Director of HFF, responsible for the firm’s national research efforts. Mr. Hinton works with the executive management team to assist in investor relations and to inform both HFF staff and firm clients with in-depth analysis of economic, property and capital market trends. He is also responsible for providing extensive market reports, client presentations and deal-specific analysis for debt placement and investment sales assignments. Mr. Hinton’s responsibilities include substantial interaction with pension funds, life insurance companies, regional and CMBS lenders, REITs, foreign investors and private equity funds.
During his tenure at HFF, Mr. Hinton has supported the execution of more than 150 commercial real estate transactions totaling more than $4.5 billion in 20 states. Mr. Hinton has experience in fixed- and adjustable-rate debt, mezzanine debt, construction loans and joint venture executions on behalf of clients engaged in the acquisition, development and recapitalization of property types including multi-housing, industrial, office, retail, medical office and storage properties.