Markets Weekly podcast – 3 October 2022

Henk Potts (HP): Hello. It’s Monday, 3^rd October and welcome to the Barclays Private Bank Markets Weekly podcast, the recording that will guide you through the turmoil of the global economy and financial markets.

My name is Henk Potts, Market Strategist for Barclays Private Bank. Each week, I’ll be joined by guests to discuss both risks and opportunities for investors.

Firstly, I’ll analyse the events that moved the markets and grabbed the headlines over the course of the past week. We’ll then discuss the outlook for the UK mortgage market and possible impact on house prices, given all the disruption that we’ve been seeing over the past couple of weeks. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

As we know it was yet another turbulent week in global financial markets, particularly for UK assets after the Bank of England was forced to step into avert the melees in government bond markets impacting the stability of their financial system and the broader economy.

Meanwhile, global investment sentiment remained negative, as the spectre of elevated inflation continues to pressure central bankers into hiking rates further into restrictive territory. In terms of equity market performance, well, the S&P 500 fell 2.9% over the course of the week, was down 9.3% in September, that’s the worst monthly performance since the height of the pandemic sell-off in March 2020.

In Europe, the STOXX 600 fell seven-tenths of 1% last week, down 6.6% over the course of the month. Equities have now registered three straight quarters of losses, which is the longest losing streak since the 2008 financial crisis. So, I suppose we should be asking ourselves what can change sentiment?

Well, it’s hard to see how investors will be able to regain their composure till policymakers are able to declare victory in the battle over inflation. We think, in order for that to happen, we need to see at least two things. Firstly, confirmation that we’ve reached a peak in terms of price pressures. And, secondly, clarity over terminal rate levels.

With equity markets, I think there’s also a growing realisation that analysts’ forecasts for earnings are far too optimistic, given the pressure that we’ve been seeing on margins, and, therefore, revisions will need to be made before investors will be able to make a more informed judgement around valuations.

UK assets had a rough ride over the course of the past couple of weeks. Bloomberg data estimates UK stock and bond markets have lost a combined $500 billion in value since Liz Truss took over as Prime Minister, although we should know, of course, other international markets have been falling as well.

Investors appear to be more cautious on the UK’s prospects after sweeping changes in policy were not accompanied by details outlining the accompanying offsetting revenue and spending measures. Traders, I think, are also concerned that the fiscal boost will stoke inflation and increase pressure on the Bank of England to extend the rate-hiking cycle, despite the risk to growth. The unfunded nature of the announcement led to a rare stinging rebuke from the IMF last week.

In reaction to the turmoil, the Bank of England, as we know, was forced to stage a significant intervention on Wednesday, implementing a policy to buy long-dated gilts. In their statement, officials said that markets had become dysfunctional and were worried the sell-off would create margin calls, forcing investors, including the likes of pension funds, to sell more bonds, creating a negative loop.

The Bank of England pledged that purchases would be carried out on whatever scale is necessary. The impact was immediate. Thirty-year yields fell by around about 100 basis points, that’s the biggest drop we’ve seen in a single day, but markets, of course, still remain extreme jittery.

In terms of the outlook for UK assets, we expect UK assets to remain under pressure till the government bridges its perceived credibility gap. To do this, they’ll need to provide clarity on the measures that they intend to implement to return the nation’s finances to a sustainable path.

This morning, we have seen the first crack in the government’s resolve to push ahead with its plan in its entirety, the Chancellor abandoning plans to abolish the 45 pence tax rate, though this measure only accounts for round about £2 billion of the measures that have been outlined.

We will expect, I think, continued pledges from the government around fiscal discipline over the course of the coming weeks, but it looks like we could have to wait until the Chancellor delivers his medium-term fiscal plan, which, despite the protests, is still only scheduled for 23^rd November. Remember, the Chancellor has requested the Office for Budget Responsibility sets out a full forecast alongside the fiscal plan.

However, convincing sceptical investors will likely prove to be a high bar. Meanwhile, the Bank of England have confirmed a looser fiscal policy will require a significant policy response. We don’t expect an intermeeting hike, but we do think the MPC will agree a 75-basis point increase at the 3^rd November meeting, although, of course, it’s worth noting the markets are pricing considerably more than that.

Moving on to the US, where we got another warning signal as data confirmed the post-pandemic boom in the housing market there is cooling down at a rapid rate. The S&P CoreLogic Case-Shiller index showed prices rose 15.8% year on year in July, but that was the smallest gain that we’ve seen since April 2021, down from the 18.1% increase in June, which represents the largest deceleration in the history of the index.

While the annual rate remains positive, home prices month on month registered a contraction of 0.4%, which is the first monthly decline since 2012. The West Coast cities of San Francisco, Seattle and Santiago have registered the largest month-on-month declines. That’s where we’re seeing affordability measures perhaps being pushed the most.

Elevated prices and rising mortgage rates are clearly starting to take their toll. If you look at average 30-year fixed mortgage rates in the United States, they hit 6.7% last week, the highest rate that we’ve seen since 2007, the biggest annual jump since the early 1980s.

The underlying data suggests that slowing house price depreciation will continue at pace. Over the next 12 months, we expect the Case-Shiller index to decelerate to zero growth, or potentially decrease.

In Europe, to finish off, the latest inflation print, of course, registered another record. Price pressures surged into double digits for the first time, hitting 10% in September, which was ahead of analysts’ estimates of 9.7%. We expect inflation to remain elevated in the eurozone through the course of next year, in fact, averaging 6.3% in 2023, which should keep the European Central Bank hiking. We look for a further 75-basis point increase at the meeting on 27^th October.

So, that was the global economy and financial markets last week. In order to discuss the UK housing market, I’m pleased to be joined by Stephen Moroukian, Head of Real Estate Product and Proposition at Barclays Private Bank.

Stephen, great to have you with us today, as always. Let’s start off with an overview. We’ve certainly seen some distressing headlines over the course of the past few days, so what’s been happening in terms of the UK mortgage market?

Stephen Moroukian (SM): Yeah, good morning, Henk. What a week. So, firstly, a number of inter-related causes and consequences acting together is what we’re seeing and it’s important that we make some sense of those headlines.

So, firstly, the wholesale mortgage market for fixed-rate pricing, which had been creeping up since August last year, effectively doubled in the last 30 working days. That’s fairly unprecedented, and was pushed along further and quicker by the mini-budget announcement, and the central bank rates that were baked in really were seen by the market as insufficient.

So, fixed-rate prices in the UK mortgage market have been creeping up. We saw the five-year fixed rate go from 1%-2% to 3%-4%. However, we now have a five-year swap at 5%, and it becomes really just unsustainable for UK lenders to hold these types of rates for a long period.

So, the second thing that’s happening is that the UK’s mortgage book, there’s about eight million mortgages in the UK, I mean mortgage borrowers, and they’ve taken fixed rates, traditionally, very recently. In fact, since 2018, according to UK finances data, around 90% of mortgage borrowers have been fixing to protect themselves, which all sounds, in itself, very prudent and has meant that the Bank of England knew that UK mortgage borrowers would be more insulated from the central bank increases, as they only impact tracker rates and variable rates.

However, of that 8 million, between now and the end of 2023, we’re going to see 1.8 million of those borrowers come off their fixed rates and they will look to refix and find a new deal. That’s nearly a quarter of the borrowers that we saw, and really what we saw last week was that early demand to refix all come at the same time as borrowers started to do the maths on their future payments with the concern of where rates would be, you know, six months, 12 months from now.

This caused a spike in applications and demand across all UK lenders and, therefore, needed them to deal with that demand by doing two things. Number one, trying to increase their capacity to be able to take that demand. And secondly, to increase rates in order to allow other lenders to pick up the slack. So, as you can see, the planets aligned somewhat awkwardly and resulted in, you know, the dramatic headlines of last week. Some would argue that the touchpaper of that was accelerated right after the 23^rd September announcement.

HP: OK, let’s get some more details around some of those key elements. So, how do the base rate increases that we’ve already seen, along with expectations of future rises, of course, translate into the pricing for mortgages?

SM: Yeah, well, look, there’s a difference between fixed rates and tracker rates and it’s important that, you know, I just tell that story. You know, the immediate base rate increases will only impact those mortgage borrowers on variable or tracker rates. And this is a far less told story and needs us to go back to 2008.

At that time, variable rates made up around 40% of mortgages taken and were typically priced at a small margin over base. In fact, a handful of borrowers were even offering these at a margin below base, if you can believe such a thing. And, as the Bank of England base rate dropped to near nil in 2008, and then again in 2020, borrowers who were able to afford mortgages at 5% and 6% saw their payments drop significantly and have enjoyed a really long run of cheap funding. Now, those borrowers have seen their mortgage rates slowly creeping up.

So, the point of explaining all that is that there are now greater pockets of both fixed-rate borrowers out there, and tracker and variable rate borrowers out there, beginning to feel the squeeze as those disposable incomes start to reduce. And, I guess what the impact of that will be to local economies, overlaid with the further cost-of-living increases, remains to be seen.

HP: I think given the turmoil that we have been seeing many of the listeners will also be wondering, of course, what does this mean in terms of UK property prices.

SM: Well, I think that’s the question everybody has, Henk. I’ve said here before, the UK has seen a once-in-a-generation value creation in property prices, especially outside of London, driven by supply shortage, low borrowing rates, the race for space, and the stamp-duty holiday through the pandemic. With two of those falling away, it’s almost certain a degree of correction has to take place. Like me, I’m sure the listeners have read about chains falling through, buyers pulling out. I think home movers will be rethinking their strategy, whilst first-time buyers will absolutely look for the froth to come off a little.

The main commentators haven’t all declared, it’s a bit early, but numbers suggest a fall back to 2020 prices. That’s about 10% to 15% off current prices. But it is complicated. The supply-side challenge in the UK is a 40-year-old problem. There’s simply not enough property in the UK, employment rates remain strong, and various governments keep trying to solve the first-time buyer accessibility problem with a number of different strategies to get people on the ladder, and I suspect that that will continue.

For prime central London, there remains a supply problem and a demand problem as well. So, we will see, I’m sure, US dollar investors coming to the UK seeing opportunity, and if we look at some of the previous moments where sterling has been weak against the dollar, we’ve seen Asia, the Middle East, and US investors come to the market.

HP: Stephen, as we were discussing earlier, we’ve been seeing some real weakness starting to shine through in terms of the US housing market. We’ve certainly been talking about the UK housing market today. So, my question is are we now looking at a global issue when it comes to housing markets?

SM: I think it’s a great question, Henk. I think the simple answer is yes. You know, there’s overheated or fragile markets all over the globe. The US, as you’ve already mentioned, is a really interesting case study. Canada and China are the other ones that really come to mind that are very well documented. We’ve seen extraordinary levels of growth and risk of decline, far less regulated mortgage environments as well, so it’s clear there’s risk to those markets and they’ve got their own upcoming challenges. I think there isn’t a one-size-fits-all approach to solving those or dealing with those and I think for those particular markets to play out as they will accordingly.

So, in mainland Europe, one thing worth noting is that European mortgage rules are somewhat similar to the UK because they were covered by something called the EU mortgage credit directive, which launched in 2016. So, as such, it’s fair to say that these countries that are feeling the inflation pinch, that are feeling the cost of rates increasing, will have a little bit of a buffer in average borrowers who will have been tested at higher interest rates and probably more able to absorb a higher degree of interest rate hikes similar to the UK.

Additionally, of course, we’ve seen some markets do fantastically well, and we’ve spoken about those before, the French Riviera, Monaco, and some of the Crown Dependencies, and some of those other post-pandemic safe havens. So, as ever, I think we’ve got winners and losers to keep an eye on.

HP: Well, thank you, Stephen, for your insight. There’s no doubt, of course, higher rates are creating some stress and some disturbing headlines, but I think it was reassuring to hear, of course, the fact that that supply-and-demand dynamic, particularly in the UK, will continue to underpin the market.

And, we should remember, of course, the UK property market is an international market. We spend a lot of time on the road with clients overseas and we know that the weaker sterling will also help to create some opportunities in terms of transactions, but it’s certainly set to be a little bit more volatile time in the months, and perhaps years, ahead compared to what we’ve seen over the course of the past decade.

Let’s move on to the week ahead, where the focus in the US will be on Friday’s employment report. We expect nonfarm payrolls to continue the trend of modest slowing. We project payroll gains will step down from 315,000 in August to around 250,000 in September. We look to the unemployment rate to hold steady at 3.7%, wage growth pressures holding steady, plus four-tenths of 1% month on month or 5.3% year on year.

Markets will also be monitoring the OPEC+ meeting on Wednesday, where members are expected to discuss a further cut in production levels. This is after crude prices have slumped by around about 20% since August, as the reduction in activity, as the global economy slows, threatens demand expectations. The OPEC+ alliance is reportedly considering a one million barrel-per-day cut in production levels, which would be the largest since the reductions introduced as a result of the pandemic. So, watch out for headlines coming through from that meeting in the middle of the week.

But with that, I’d like to thank you once again for joining us. I hope that you found this update interesting. We will, of course, be back next week with our latest instalment, but for now may I wish you every success in the trading week ahead.