Markets Weekly podcast – 21 February 2022

Julien Lafargue (JL): Welcome to this new edition of Markets Weekly. My name is Julien Lafargue, Chief Market Strategist at Barclays Private Bank, and I will be your host this week. As usual, we will start by looking at last week’s events, before transitioning to our guest segment.

This week I’m very pleased to be joined by Stephen Moroukian. Stephen is Product and Proposition Director for Real Estate Financing here at Barclays Private Bank, and we will be discussing the UK real estate market in a few minutes. But before that, let’s review last week in the markets.

To be fair, last week’s developments weren’t very different from the week prior. The tensions between Ukraine, Russia, and NATO continued to grab the headlines, while investors looked at what central banks, and the Fed in particular, may be able to do next.

So first, when it comes to Ukraine, the situation remains extremely fluid, and an invasion by Russia has been imminent for a couple of weeks now. And as the world impatiently awaited for Russia to potentially move on Ukraine over the weekend, another silver lining saved the day. Presidents Biden and Putin have reportedly agreed to a summit in principle, provided that Russia doesn't invade Ukraine beforehand.

Importantly, both the timing and the format of that summit have yet to be determined. The substance of it might be worked out this week in the meeting between Secretary of State Blinken and Russian Foreign Minister Lavrov, who are supposed to meet on Thursday.

Importantly, according to the latest US intelligence cited by CNN over the weekend, Russia now has 75% of its conventional forces positioned against Ukraine. This is a significant commitment of power, and it’s unlikely that the situation will remain as such for an extended period of time.

As we mentioned last week, this is a very, very binary situation, and an uncomfortable one for investors. And to be fair, the risk/reward isn’t very favourable, as although some risk premium has been factored in, a full-scale invasion and a series of retaliations from the West would likely result in additional downside.

The main question mark here is what would the Fed’s reaction be? On one hand, a military conflict would likely boost energy prices in the short term, keeping inflationary pressures elevated. While, on the other hand, the uncertainty emanating from a possible war could actually push the Fed to wait and see. At this stage, though, we believe the bar for the Fed now to hike in March is very, very high.

And beyond Ukraine, this is probably the key reason behind the volatility we are experiencing at the moment. With the exception of the BoJ in Japan, most major central banks have turned more hawkish in recent weeks.

The Bank of England’s normalisation process is well underway, and after inflation reached 5.5% in January, its highest level in almost 30 years, the case for additional rate hikes in both March and May has strengthened. On the other hand, both the Fed and the ECB have yet to hike interest rates, and to stop buying securities.

The Fed is set to hike in March, and the quantitative tightening process is set to start soon after. The ECB had been dovish until now, but this, too, is changing as the central bank’s rhetoric is growing more and more hawkish. Last week, ECB chief economist Lane suggested the eurozone may be seeing a change in its inflation regime, and odds for one or more interest rate hikes in 2022 are rapidly increasing, with the APP quantitative programme potentially ending as early as this summer.

With all this focus on central banks, we thought it would be great to have Stephen on the podcast today in order to discuss the UK real estate market. Obviously, this is a market that is very tied to what is going on with central banks, and, therefore, with interest rates, so having his perspective we thought would be very valuable.

Stephen, thank you very much for joining us today. Let me start by asking you a pretty simple question. What do central bank action, and the Bank of England action in particular, mean for the mortgage market?

Stephen Moroukian (SM): Hi, Julien, and great to be on today. Thank you. It’s a really important question right at this particular moment. Since the Bank of England base rate rise late last year, we’ve seen a steady increase over a short period of time to mortgage swap rates.

In fact, we saw the five-year view go from just under 1% in November to over 1.8% last week. Now, this pushes up the funding costs for all banks on their fixed-rate mortgages, some quicker than others, but ultimately all will have to pass this on to their new borrowers.

And what’s key here is that we are returning to how fixed rates and margin trackers have been traditionally priced in the market over the last 30 years. And specifically, that there is a premium for fixing, and when taking a tracker rate that premium isn’t levied.

So, over the last 18 months we’ve had moments where the 5-year swap and the central bank rates were near parity, and that short-lived window has now likely closed, and you’ve kind of alluded to that today. And I think in hindsight, many commentators, including me, will dwell on that window of time that we had.

But, look, let’s not get too dramatic. We’re still looking at incredibly low funding rates versus the last 30-year average, which was around 7.5%.

JL: Great. Thank you, Stephen. So in regards to the UK property prices, what have we seen in 2021 and so far, and what’s your outlook for 2022 and beyond?

SM: OK. So, what we’ve seen in 2021 is UK prices nationally grow by nearly 10%, which many commentators now see as a once-in-a-generation shift in prices across the UK. What’s important is that within that 10% there are some real pockets of performance which are worth calling out.

So, across the UK, in terms of what we call prime coastal and prime regional, we’ve seen prices increase anywhere between 15% and 23%. The Cotswolds is a great example of where there is a unique supply and demand issue, higher demand and prices have risen close to 25% over the last 12 months.

In the London market, very interestingly, large homes have been hugely popular, again, driven by motivations around the pandemic. I can go into those in a little bit more detail, but the price increases we’ve seen there have been around the 15% mark. And that’s far more impressive against the broader London prime market, which, of course, includes flats and that’s been at just over 3%.

So, it gives you a real sense that those key drivers that have been around that pandemic window, which have included motivations such as multigenerational living, so having a home that many members of the family can live in, having access to space, which, of course, is driven by needing to have a kind of lockdown window availability of room.

But of course the hybrid working piece, really ensuring that both the technology and the space to be able to work from home over a prolonged period of time. But also making sure that those locations really resonate with a post-pandemic view of the world.

So, as we come out of this particular window of time, and really we see that demand for big cities returning, and we’re certainly seeing that in London, of course. Having a property that has that communication link, both technological and actually transport to London, remains key. So, if you manage to tick all of those boxes at the same time, then you’ve got some great stories around how prices will improve. And you can look at private estates, that St George’s Hill, Wentworth, for example, where prices have gone up over 20%.

So, that’s a bit of an indicator in terms of what’s happening. If we look slightly further afield at some of our other core markets, Jersey and Guernsey are very interesting. Again, large houses have increased by over 20%. If we look at Monaco, again one of our core markets, for the first time we’ve seen prices exceed €50,000 per square metre, again, driven by lack of supply and demand for that kind of space or isolation during the pandemic window. So, all of that has driven prices up in what we’d call our core markets.

In terms of the forecast, well, look, very interested in prime central London. Clearly, it’s one of our most important asset classes for our clients in real estate. There is modest growth expected, although in 2022 some commentators see that as far as an 8% uplift. Cumulative over the next five years, the view is, and this view has been fairly consistent over the last eight to 12 months, is an up to 25% increase.

And I think that’s really important for London as a whole, as we see that demand coming back in not only from UK domestic buyers, but actually international buyers coming into the UK too, you know, driven by all the key fundamentals that existed there before in that post-pandemic window.

It’s probably worth mentioning there is a slight dollar advantage available at the moment as well. That seems to be narrowing, but if you’re in dollars right now, and you’re looking to acquire a UK property, there’s possibly a window of opportunity that’s available there as well.

JL: So obviously we’ve seen a lot happen in the UK real estate market in 2021. Part of that is set to continue in 2022. Can you maybe shed some light as to what our clients are actually doing at this point in time?

SM: Yeah, absolutely. Look, when it comes to real estate, our clients have three strategies that we support. The first is acquisition, so that’s buying a property. That could be in the UK or one of our core markets.

Second, is trading up, so that’s holding their main home and buying something else, and that’s the strategy that’s really changed over the pandemic window. And thirdly, is diversification, so that’s using wealth that’s already been created during the current price rises, whether that’s historic or recent, and using that equity to fund some of those other acquisitions or luxury lifestyle expenditure, or just to create some liquidity to use for various funding costs.

And really the key motivators for acquisitions, certainly in the UK right now, is a return to the UK fundamentals. And the UK fundamentals is a phrase that we used in property a few years ago, and they’ve definitely returned. And what are they?

They’re the rule of law, again vis-à-vis other places around the world that our clients are maybe exposed to, the UK education, and now the medical, ecosystem. You know, those two things, certainly education has been critical in driving interest into the UK, migration into the UK, property acquisitions into the UK.

Low interest rates and that dollar value I alluded to, you know, again. Whilst funding costs may have increased, they are relatively low versus where they have been over the last 30 years, and that again represents an opportunity to lock in for longer-term funding when acquiring a property in the UK.

And the UK’s pandemic response, you know, that’s been in terms of how it stands up globally, has been one of those things that we definitely see as a driver to clients coming into the UK. And, look, where are they from?  You know, in 2021 it was really UK domestic year, and was the story for so many of the home property purchases that we funded.

However, over the last six months we’ve seen a huge interest from European mainland citizens moving to the UK, again, for all those reasons I’ve alluded to. We’ve absolutely seen an increase in those from the United States, again, coming to the UK driven by not only the pull factors, but actually some push factors as well in the US at the moment.

And then to a lesser degree Hong Kong, South Africa, a number of other Middle Eastern markets, again, very kind of obvious push and pull factors, both away from those jurisdictions and into the UK to diversify into UK property.

But, of course, you know, some of this is also about fulfilling needs and emotional requirements. Having a property in the UK is an aspiration for many people around the world, and certainly having two properties in the UK for somebody who is a UK domestic client, whether that’s keeping a property in London or a property outside of London, and/or a property outside of London, has become key. And that really is me alluding back to that second strategy that I mentioned around trading up.

What we’re seeing at this very moment in time is those that would have traditionally traded up, so sold their property to buy a property that was either bigger or in a different location, they’re holding onto those properties at the moment. And typically, a reasonable and accurate case study of what we see of that looking like, at the moment, is the big property in London, prices seem to have stabilised.

In fact, they look like they’re increasing, and the forecast looks healthy, it’s now not the time for me to let go of that property. I’m also not entirely sure whether I’m going to need to continue to be in London, but I do need another property outside of London for all of those kind of post-pandemic reasons.

So, our clients are not releasing those properties back into the market, they are still demanding properties outside of London, and as a result that is putting supply pressure and demand pressure on both of those transactions, in fact.

So, we’re seeing in London not only prices increase, and the forecasts where they are, but also rental yields that have been very sheepish and quite fragile over the last few years, they’re beginning to strengthen as those that come into London just don’t have properties that they can rent. So all of that will continue, in my view, to play out over the next six to 12 months, and one that we’ll be keeping a close eye on.

JL: Great. Thank you so much, Stephen. The UK real estate market has evolved and continues to do so rather quickly for the past few years, if you think about Brexit, now the pandemic, and higher interest rates on the table. We will certainly have you back on this podcast in the coming months for another update.

Now with that, let’s go back to markets and looking at the week ahead. This week should be relatively more quiet on the macroeconomic front, with all the attention again being on Ukraine. In fact, with the US market closed for President’s Day on Monday, we will have to wait until Friday for the first, and only, major data point in the form of the January PCE figure.

However, this may be the calm before the storm, as the next two weeks will be packed with catalysts, starting with the eurozone CPI number for February on 2^nd March, the US jobs report on the 4th, and the ECB meeting and Friday’s CPI in the US on 10^th March.

In other words, there will a lot for us to cover in upcoming editions of the podcast, but until then let me wish you all the best for the week ahead.