Displaying items by tag: rate hikes

Since the yield on the 10-year inched above 5% in October, we have seen a relentless rally in Treasuries. According to Bank of America, this rally is due to the increasing likelihood of an upcoming Fed rate cut and is just getting started. It eventually forecasts the 10-year yield falling another 200 basis points based on historical precedent of dramatic declines in yield during the interim period between the Fed’s final rate hike and first rate cut. 

There have been five hiking cycles since 1988. Each saw a major rally in Treasuries once the hikes were complete. The largest decline was 163 basis points, while the average decline was 107 basis points. The drop in yields tended to abate once the Fed began cutting rates. This cycle Bank of America sees the 10-year yield dropping to 2.25% by May 2024 which is when the first hikes are expected to take place. 

Such a decline in Treasury yields would have major implications for other asset classes as well. The researchers also warned that this prediction could be impacted by ‘lingering inflationary pressures. Interestingly, the bank’s strategists have a different outlook as they expect the 10-year period to end next year at 4.25%, which indicates minor change from current levels. 

Finsum: Bank of America shared historical research which shows that the 10-year yield tends to experience weakness during the interim between the Fed’s final hike and its first rate cut. 

High rates have severely impacted the real estate market. In terms of commercial real estate (CRE), higher rates mean that financing costs have risen, but more pain will come when they have to roll over debt in the coming years, assuming that rates remain elevated. 

According to Rich Hill, the Head of Real Estate Strategy & Research at Cohen and Steers, Head of Real Estate Strategy & Research, REITs are in a much better position to handle these stresses than the larger CRE market. 

Many REITs have delivered their balance sheets with 86% of debt fixed for around 6 years which means there is much less exposure to interest rates than other CRE operators and investors. Additionally on the aggregate, REITs have a loan to value of 35% which is quite conservative relative to historical standards. 

So far, high rates have had a muted impact on earnings, about 1.4%, making it more of a mild headwind. Thus, valuations for REITs have become quite attractive, while they remain on strong footing fundamentally, especially in relation to the broader CRE market. As a result, Hill notes that valuations for REITs have stabilized, while private valuations continue to move lower. 

Finsum: High rates are leading to significant amounts of stress for parts of the commercial real estate market; however REITs have been less affected so far. 

Many investors are hopeful that inflation will continue moving lower which will provide relief for fixed income and equities as the Fed could start loosening monetary policy. However, KKR does not believe it’s likely. Instead, they believe we are in the midst of a ‘regime change’ in terms of the macroeconomic landscape which will require investors to adopt new portfolio management strategies.

In essence, they see inflation being structurally higher due to factors such as entrenched fiscal deficits, labor shortages, energy transitions, and increased geopolitical risk. With these conditions, stocks and bonds are more correlated as evidenced by the last 2 years. The firm believes that investors need to increase their allocation to real assets with recurring yields as a source of diversification, given the increase in bond market volatility. 

Rather than the traditional real assets such as REITs, TIPs, and precious metals, they find value in real assets that have collateral-based cash flows like private real estate to provide positive returns while dampening portfolio risk. 

Even if their outlook on inflation proves to be incorrect, KKR believes that real assets should outperform given that they remain bullish on economic growth and see Q4 and 2024 GDP coming in above expectations. 

Finsum: KKR is bullish on real assets including private real estate as it believes inflation is going to remain structurally high and that bonds are not providing sufficient diversification.

Nuveen believes that real estate is an integral asset for multi-asset portfolios especially during periods of volatility and the recent tight correlation between stocks and bonds. Within real estate, the firm favors private real estate due to attractive yields, diversification, and uncorrelated returns. 

According to the firm, private real estate outperforms during bear markets because prices are based on real transactions rather than public markets. This dampens volatility especially during periods of market stress when public equities can go haywire. 

In terms of both public and private real estate, Nuveen favors the industrial sector due to expectations of continued growth in e-commerce and investments in logistics near urban locations. Another factor supporting growth is supply chain diversification which is boosting demand for space near ports on the East Coast and the US/Mexico border. 

It’s also constructive on healthcare, residential, and self-storage. Within the public REIT space, the gaming sector is in favor due to high dividends and strong cash flows. Another tailwind has been consolidation in the space which is leading to upward pressure on rents. 

Nuveen also believes that we are in the final innings of the Fed’s hiking cycle due to inflation moderating which could be a major catalyst for the sector going into next year.

Finsum: Nuveen is bullish on real estate particularly for the industrial, healthcare, and residential sectors. Also, it believes that we are close to the end of the Fed’s hiking cycle. 

The rising rate environment has been brutal for REIT stocks with double-digit losses in 2022. In 2023, the sector saw decent gains in the first-half of the year, however these gains have been wiped out amid the breakout in longer-term yields. 

However, this could be setting up a contrarian opportunity especially as the odds of a ‘soft landing’ continue to inch higher. Inflation is moderating, while the economy continues to modestly expand as evidenced by the September jobs report and upwards revisions to the July and August payroll data. In addition, Q2 GDP was better than expected, and consumer sentiment continues to move higher.

In essence, a soft landing scenario would be bullish for residential REITs. It implies no significant spike in defaults, while lower rates would also lead to a generous tailwind for the sector. In contrast, commercial REITs are facing more significant challenges and have more structural issues especially with offices and retail. 

To be clear, the odds of a soft landing have increased, but it’s far from a certainty. Some threats to this outlook include a resurgence of inflation or the economy suddenly deteriorating due to pressure from higher rates. 

Finsum: The odds of a soft landing have moved up higher after a recent spate of positive economic data. Here’s why residential REITs would outperform in such a scenario.