Bond yields climb again, central bank hawkishness causes more market volatility, investors brace themselves for CPI report and the recovery in commercial real estate gains momentum. All these stories and more are covered in this week’s insights update from BlackBee.
Investor sentiment got another jolt last week thanks to the latest murmurings from central bankers in the US and Euro zone. The minutes from the March meeting of the US Federal Reserve revealed that many voters favoured regular rate hikes this year. Furthermore, the minutes also suggested the Fed would begin to reduce the size of its balance sheet (essentially start to ‘sell back’ bonds it had purchased during the COVID crisis) at a quicker pace than it had done in 2017, the last time it did such an exercise. Even the mere mention of selling back these bonds had triggered nervousness in equity and bond markets earlier this year so it appears this is a story which will continue to be a factor for investors over the next few months.
The minutes from the ECB’s March meeting also showed some calls for interest rates to be hiked this year although there is much less of a consensus for this action and justifiably so in our opinion, particularly considering the potential negative impact of the war in Ukraine on the Euro zone economy. Some ECB voters called for a definitive end date for when the Bank would end bond purchases to prepare the groundwork for rate increases later in the year. However, these views were balanced elsewhere in the committee with others wishing to take a “wait and see” approach considering the ongoing conflict.
Overall, the main data releases of note last week were the final Purchasing Manager Indices (PMIs) for March for a number of key economies. Overall, the results still indicated robust growth across the world although the ‘Ukraine factor’ has yet to filter through to many PMI readings. China was something of an exception with the March PMI readings indicating a contracting economy, hindered of late by the government’s zero COVID policy.
Equity markets lost ground again last week with many markets retracting on the back of the hawkish feel to the March Fed and ECB minutes that we noted earlier. In addition to the Fed minutes, a number of prominent Fed voters spoke last week to reiterate the view that interest rate increases and Balance sheet runoff (the technical term for selling back the bonds the Fed purchased during COVID) were warranted. We too feel that both are warranted given the inherent strength in the US economy right now. However, in our view the Fed in particular needs to also remain data dependent to give it some scope to recalibrate the path for US interest rates should it see signs of the economy slowing.
Last week was another difficult week for bonds and for government bonds in particular. Our chart of the week this week shows just how much borrowing costs (as measured by 10 year bond yields) have risen this year – the US for example has seen borrowing costs rise by over 1% in a little over a quarter, something that would have been thought of as very unlikely even early last year. Performances in the credit sector were jittery again last week as sentiment towards the riskier asset classes deteriorated.
Commodities were also weaker last week. Oil prices eased again over the period as further news of emergency releases of oil from a number of countries’ strategic reserves pushed crude lower. The hawkish rhetoric from the Fed also helped push the US dollar higher over the week which put downward pressure more broadly on the commodity space. Even precious metals like gold weren’t immune to falls despite shakier investors sentiment last week but recovered later on as investors braced themselves for Tuesday’s inflation report from the Fed.
Commercial Real Estate – Office transaction activity and another bumper quarter for industrial and logistics indicates recovery in the sector is gaining momentum.
CBRE last week released its quarterly report on the office sector. 45,000sqm of office transactional activity was recorded over the quarter comprising of 42 transactions, but while this is marked increase on the 2,043sqm transacted in Q1 2021 we still have a ways to go before we reach pre-pandemic levels, as activity remains 24% below the ten-year Q1 average and 57% below Q1 2020. Still this is still evidence that recovery in the sector is gaining momentum in part driven by post pandemic clarity as restrictions gradually eased. This is also apparent due to the fall in the vacancy rate across Dublin from 8.5 to 8.2%, with city centre offices the most in demand. City centre transactions accounted for 84% of total office transactions for the quarter and of the 285,000sqm actively required the vast majority seek to be located within the city centre. Dublin 2 and 4 also represented 63% of the 107,500sqm reserved at the end of the quarter.
The city centre is proving the most desirable location as occupier employment rises and with strategic decisions previously stalled, key strategic decisions on real estate portfolios must be made, with those who have leases expiring searching for high quality fit outs in centralized locations to attract workers back to offices. This has seen prime city centre rents increase to €629 from €620 the previous quarter while yields remained stable at 4%. This also suggests there may be pent-up demand within the market, particularly for offices with strong ESG credentials as occupiers seek to protect the future value of their assets, with grade A properties accounting for 9 of the 10 top transactions. Also, while office investment activity only accounted for 10.4% of total commercial real estate investment for the quarter several investments are currently in legal stage of processing, with the proportion of total investment in offices expected to increase throughout the year.
The industrial & logistics sector, the star performer of 2021, had another strong quarter with 96,563sqm transacted, 32% of which were pre-lettings conveying the lack of available standing stock and suggests there will be a steady pipeline of demand throughout the year. This is also apparent by the increase in actively required space, rising to 197,000sqm from 150,000sqm. The lack of existing supply and robust demand has seen prime rents rise to €116.75 per sqm and are expected to break €118 throughout the year. The sector represented 24% of total real estate investment this quarter which is unsurprising when you realise it achieved a net total return of 23% last year, with 16.5% attributable to capital growth. With choppy equity and bond markets expected over the short-term we expect investors may be attracted by the relative safety of real assets and spur the recovery on.