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- Markets falter on hawkish Fed pause
Market index returns
Week to date since September 13, 2023 as of September 20, 2023
Index definitions: Global Real Estate = FTSE EPRA/NAREIT Developed Index; Global Infrastructure = Dow Jones Brookfield Global Infrastructure Index; Natural Resource Equities = S&P Global Natural Resources Index; Commodity Futures = Bloomberg Commodity Index; TIPS = Barclays US TIPS Index; Global Equities = MSCI World Index; Real Assets Index = 30% FTSE EPRA/NAREIT Developed Index, 30% Dow Jones Brookfield Global Infrastructure Index; 15% S&P Global Natural Resources Index; 15% Bloomberg Commodity Index, 10% Barclays TIPS Index. Source: Bloomberg, DWS. Past performance is not indicative of future results. It is not possible to invest directly in an index.
Market commentary:
Broader equity markets turned south this week with their descent accelerating following the Federal Open Market Committee (FOMC) meeting, which saw no rate hike but featured hawkish comments. During our weekly review period ended September 20th, all Real Assets classes bested broader equity markets and (aside from TIPS) ended in positive territory. Natural Resource Equities led the charge with a rebound in Metals & Mining names while Global Infrastructure securities followed on strength from the Asia Pacific region. Global Real Estate securities had milder gains, as did Commodities, which were kept in check by declines within the agriculture complex.
Why it matters: Market participants still appear to be pricing in a soft landing scenario and expect the U.S. Federal Reserve (Fed) to begin trimming rates in early 2024. These views stand in stark contrast to what we just heard from the Fed. Volatility remains tame despite lingering risks to the U.S. and global economy. The largest auto union in the U.S. is on strike, the U.S. government is flirting with a shutdown, and geopolitical tensions are running high as the war in the East escalates and political affectations (particularly ahead of upcoming elections in the U.S. and Poland) may call international support for Ukraine into question. As uncertainty shrouds the path of the U.S. and other global economies, we continue to advocate for a professionally managed, holistic allocation to Liquid Real Assets. Real Assets can offer diversification benefits, defensive posturing, and attractive income yields while also potentially benefiting from secular changes such as aging populations, energy transition, and even artificial intelligence (AI).
Digging deeper: First up, we review perhaps the most important event this week – the FOMC meeting in the U.S. – before covering several other important central bank meetings across the globe. Next, we observe that as the Fed adjusts their economic outlook, so have investors in the treasury market, which has led to higher rates at the long end of the curve. Finally, we peek at updated economic projections from the Organisation for Economic Co-operation and Development (OECD) and consider how those forecasts have changed over the past few months.
Why it matters: Market participants still appear to be pricing in a soft landing scenario and expect the U.S. Federal Reserve (Fed) to begin trimming rates in early 2024. These views stand in stark contrast to what we just heard from the Fed. Volatility remains tame despite lingering risks to the U.S. and global economy. The largest auto union in the U.S. is on strike, the U.S. government is flirting with a shutdown, and geopolitical tensions are running high as the war in the East escalates and political affectations (particularly ahead of upcoming elections in the U.S. and Poland) may call international support for Ukraine into question. As uncertainty shrouds the path of the U.S. and other global economies, we continue to advocate for a professionally managed, holistic allocation to Liquid Real Assets. Real Assets can offer diversification benefits, defensive posturing, and attractive income yields while also potentially benefiting from secular changes such as aging populations, energy transition, and even artificial intelligence (AI).
Digging deeper: First up, we review perhaps the most important event this week – the FOMC meeting in the U.S. – before covering several other important central bank meetings across the globe. Next, we observe that as the Fed adjusts their economic outlook, so have investors in the treasury market, which has led to higher rates at the long end of the curve. Finally, we peek at updated economic projections from the Organisation for Economic Co-operation and Development (OECD) and consider how those forecasts have changed over the past few months.
- Fed pause shows claws: The Fed opted to hold the Fed Funds target rate steady at 5.25-5.50% this week but left the door open for an additional hike this year. With inflation not yet down to the Fed’s 2% target, Fed Chairman Jerome Powell stood firm noting, “The worst thing we can do is fail to restore price stability.” He went on to say that while a soft landing is possible, it is not the Fed’s baseline scenario and that a governmental shutdown would represent an economic headwind that could limit the Fed’s ability to collect and analyze key data. Higher for longer seems to be a continuing mantra, with the latest dot plot showing another hike this year and two fewer cuts in 2024 compared to their prior forecast. In a sign of economic resilience to date, the Fed did lower their unemployment forecast for 2023 by 30 bps to 3.8% before ticking up to 4.1% in 2024 (40 bps lower than previously), while economic growth projections were increased by 110 bps to 2.1% this year and up 40 bps to 1.5% in 2024.
- Treasury yields surge: Leading up to the Fed decision, longer-term U.S. Treasury yields drifted higher, and the ascent accelerated in the wake of Chairman Powell’s press conference. The 10-year bond is sitting just shy of 4.48% as we write, the highest level since 2007 and up 23 bps from September 13th. Shorter tenors have moved less or stood pat, leading to a steepening of the yield curve. Still, the curves remain deeply inverted, with the 2s-to-10s at -67 bps, the 1s-to-10s at -98 bps, and the 3mo-to-10s at -90 bps – if the Fed proceeds with another hike, we expect the short end of the curve to move even higher. While higher rates are a boon for fixed income investors, they can pressure asset values (via higher discount rates on cash flows), corporate earnings (through higher financing costs), and prospective homebuyers (who face higher mortgage rates).
- UK borrowers get a moment to breathe: Given the recent surprise deceleration of inflation in the UK (6.7% headline vs. expected 7.0% and 6.2% core vs. expected 6.8%), the Bank of England (BOE) surprised many investors by narrowly deciding to hold rates steady, with Governor Andrew Bailey casting the determining vote in a 5-4 decision. In its messaging, the BOE said another hike could still be necessary, and the markets seem to agree as overnight index swaps indicate a greater than even chance of another hike occurring. In other central bank action, Sweden’s Riksbank and Norway’s’ Norges Bank both raised rates by 25 bps, while the Swiss National Bank left rates unchanged (ending their five consecutive hike streak), as did the Bank of Japan (BOJ) leaving their benchmark rate at -0.1% continuing their ultra-loose monetary policy.
- Europe wins the “grow-down” showdown: The OECD released an update to their GDP growth projections this week, which showed an increase of 30 bps globally for 2023 at 3.0% from their June estimates, but with 2024 falling by 20 bps to 2.7%. They also noted that a disproportionate amount of growth will come from Asia in both years despite the recent economic weakness in China. Additionally, the Eurozone forecast for 2024 was slashed by 40 bps to 1.1% with the German and Italian (and UK) economies expected to grow by less than 1%. In a sign that inflation might stick around a bit longer, while they did bring down their 2023 G20 headline inflation estimate by 14 bps to 5.98%, 2024 was increased by 10 bps to 4.81%
What we are watching: We are closely monitoring the situation in the U.S. Congress (for both entertainment and research purposes) which has until the end of the month to avert a government shutdown. We are also watching strikes at a limited number of plants that were started by the United Auto Workers (UAW) last week as additional contagion could have a chilling effect on the U.S. economy and certain commodity prices. We also check in on the state of residential construction in the U.S. and how it may affect potential homebuyers, renters, and listed real estate markets. Finally, we shoot a sideways glance at the UK where the prime minister has taken steps to roll back some green energy policies.
- Shut it down?: This week, the world watched as House Speaker Kevin McCarthy tried (unsuccessfully) to wrangle his caucus, returning us to the familiar brink of a U.S. government shutdown. We pride ourselves on being decidedly apolitical, nonetheless calculus related to infighting between Republicans has left the U.S. House of Representatives unable to pass any spending bills as McCarthy has sent members home for the weekend. Members won’t return until Tuesday, leaving little time to pass a continuing resolution or longer-term spending bills. As the days pass, the question may no longer be whether a shutdown will come to pass, but rather how long it will last.
- The UAW is not messing around: Strikes at three auto plants in Ohio, Michigan, and Missouri had been in place for a week with the UAW threatening to expand strikes if there is was no new agreement in place by noon on Friday – as we write, those strikes have expanded to nearly 40 locations. Indications are that the union and manufacturers are still “far apart” in their demands and offers, but it’s not just the 15k striking union members off the clock right now. Many non-union members employed by parts suppliers have either been laid off or had their hours reduced, with more likely to come. We’ve seen one estimate that for every week the strike continues, quarterly GDP could be reduced by 5-10 bps. One might expect this to drag down pricing for metals used in auto-manufacturing such as steel, aluminum, and palladium, but steel-producing equities and the latter two commodities all rose this week, a situation we will be monitoring carefully in the week ahead.
- U.S. housing supply runs dry: Housing starts in the U.S. dropped by 11.3% in August from July to a seasonally adjusted annual rate of 1.28M, the lowest level since June 2020 during the height of the pandemic. The multifamily starts (5+ units) showed an even steeper decline of 26.2% from July. While higher mortgage rates have taken a toll on overall housing affordability, the lack of supply has only exacerbated the situation. With home ownership out of reach for many, numerous individuals are forced to continue renting or even double-up. We would expect the apartment and single-family rental REITs to benefit from the shortage of new supply, though we would note that in this release, permits for future construction of both single family and multifamily increased in August, meaning more development is in the way; it just won’t be delivered for a while.
- The Sunak step-back: This week saw UK Prime Minister Rishi Sunak announce changes to previously announced net zero carbon emission goals. Perhaps the biggest change was the pushback of the deadline to phase out the sale of new gasoline and diesel cars by five years to 2035, while a delay on gas boiler conversion to heat pumps also appears to be in the works. Despite these deadlines being pushed back, Sunak insisted that reaching net zero by 2050 was still achievable but gave no detail as to how. These changes created confusion and rifts not only within his own Conservative party but also presented uncertainty to affected industries, such as auto manufacturers, as well as the investor community, which could deem the UK a relatively less attractive place to invest. We will continue to watch how this dynamic unfolds and what impact it has on real assets like UK utilities and capital flows to the country.
