Weekly insights on current research in the commercial real estate industry from HFF Managing Director of Research Jimmy Hinton. View Daily Rates on the HFF website or access the HFF Daily Rates App in iTunes.
In 1609, the Dutch East India Company hired an English-born navigator to find a northeasterly passage to Asia by way of the Arctic Ocean. Commanding his vessel, Henry Hudson encountered too much ice to make the northern passage so he turned his ship back to the west. But he didn’t return to port, instead opting to investigate a rumor he’d heard while stocking in Amsterdam – a waterborne passage to Asia through North America.
Hudson wished to survey the entire eastern coastline. Either impatient or supply-strapped, he only made it to Virginia before turning back north. Opting not to enter Chesapeake Bay, Hudson passed Hog Island, Delaware Bay and the New Jersey Shore before choosing to explore the “North River.” The river carried great lore among sailors having been originally explored by Giovanni da Verrazzano nearly a century prior. The waters were controlled by aggressive Native Americans who killed one of Hudson’s crew with a well-placed arrow to the neck. Beginning on this day in 1609, Hudson spent nearly two weeks on the river before reaching another impasse; instead of ice, it was a narrowing of the river in what is now Albany, New York.
Failing to reach Asia, Henry Hudson helped settle New Amsterdam at the mouth of the river that now carries his name. In the Age of Sail, navigators seldom reached their desired destinations, but their missions frequently led to other important discoveries; in the modern era, the same rule applies.
Friday’s market conditions left me with an unease that carried the entire weekend. Knowing overseas markets were closed when Friday’s domestic selloff began, I was hopeful (perhaps wishfully) the weekend would provide a cooling period. It did not. Late last night Asian markets opened sharply lower. The same fate befell European markets. Domestic equity markets suffered consecutive losses on Wednesday, Thursday and Friday. As of this writing, the trend may be reversed, with the DJI, SPX and NASDAQ all green. That is important: if the negative trajectory continued, I believe Asian and European markets would have very probably opened lower again tonight/tomorrow morning. But what is more relevant to me are the bond markets.
At 1.68 percent, the 10-year UST is currently at a two-month high. Let’s take another moment to enjoy the relatively docile oasis the summer of 2016 provided to our clients. Now let’s brace for a more volatile road ahead.
On-the-run 10-year UST yield since issuance.
As we discussed on Friday, central banks around the world are messaging their intent to wean monetary stimulus. A primary goal of the shock and awe campaign has been to promote growth, in this case measured by inflation. It is abundantly clear our navigators have failed to reach that destination.
Another primary goal of monetary stimulus has been reducing volatility. With one breath of doubt, volatility creeps back in. Goldman Sachs believes that volatility will manifest itself in higher bond yields – and sooner than later.
“Both the Bank of Japan and the European Central Bank have now put their QE operations under review in order to assess how to improve the transmission of expansionary monetary policy. There are various reasons why such an assessment is necessary at this juncture. One of them is that the sharp fall in ultra-long dated yields has resulted in costs and distortions counterbalancing the economic benefits of lower real rates. Consider that pension and life insurance companies in Europe and Japan have large stocks of defined liabilities and asset allocations skewed towards fixed income products. When long-term rates decline, these financial institutions tend to manage down their risk exposure, rather than increase it.” – Goldman Sachs
They say further:
“Central bank interventions aimed at depressing yields along the term structure have enabled governments to lower their interest bill and reduce roll-over risk. This has been accompanied by an increase of primary fiscal deficits in both Europe and Japan. In the U.S., discussions on the possibility of an easier fiscal policy are linked to the outcome of the Presidential election. But the market appears increasingly responsive to such moves, as it considers them more effective in supporting final domestic demand when interest rates are close to their effective lower nominal bound.” – Goldman Sachs
They conclude therefore:
“We expect the increase in long-dated yields to extend into Q4, with U.S. Treasuries reaching two percent by year-end.” – Goldman Sachs
Let’s shift our focus to Chicago, where the Federal Reserve’s Lael Brainard will speak in less than two hours at the time of this writing. Her commentary will be hawked for hints to the FOMC’s interest rate to-hike-or-not-to-hike decision later this month for two reasons. First, she is generally dovish, so any hint of a hike significantly increases the probability of one. Additionally, she is thought to be a close ally of Janet Yellen. Finally, hers is the last planned speech by a Fed official prior to the vote on September 21.
I found the commentary of Mohamed El-Erian, Chief Economic Advisor at Allianz, to be particularly pertinent:
“We have experienced sudden air pockets in the last year. These events have been rather infrequent given the context of unusually low market volatility, and all have proved both temporary and quickly reversible. Some are urging investors to ‘buy the dip.’ Other commentators are more cautious. Some have suggested that investors should sell. Where you end up on this issue has less to do with your assessment of corporate and economic fundamentals than with how you see the prospects for a continuation of the recent exceptional period of both public and private liquidity support for financial markets.” – Mohamed El-Erian
There are pockets of our real estate industry that are flush with debt and equity capital; others are less liquid. Certainly we can expect that periods of volatility will create a disproportionate impact on the latter.
Maintain a watchful eye on the bond market. The 10-year UST is up 17 bps T30 days.
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.