Markets Weekly podcast – 18 December 2023

Julien Lafargue (JL): Hello, and welcome to a new edition of Barclays’ Private Bank Markets Weekly podcast. My name is Julien Lafargue, Chief Market Strategist here at Barclays Private Bank and today, again, I will be your host.

This is the last podcast of 2023. We will be taking a couple of weeks’ break but we will be back in the new year with more content and more insight, of course. As usual, this week we will go through what happened last week, and it was a pretty busy week in the markets, and then we will be joined by our guest. And, today, I’m delighted to be joined by Stephen Moroukian, Product and Proposition Director for Real Estate Financing here at Barclays Private Bank to discuss a very important asset class and market, the real estate market.

But, before that, let’s recap last week’s events. And, as I said, it was a very, very busy week. We had three central bank meetings, starting with the Fed, followed by the BoE and the ECB. So, let’s take a look at what the central bankers said. And, really, the week started with a bang in the form of the FOMC, the Fed, not closing the door to interest rate cuts in 2024. 

Going into this meeting, the market was already pricing in around 100-basis points of cuts for next year, and the broad consensus was that the FOMC would push back against those expectations. Their latest ‘dot plot’, which is dated September, was suggesting about two interest rate cuts for next year, while the market was expecting the message to remain the same. And, in fact, the message could have been that the Fed is looking only at one rate hike in 2024, given how strong the macroeconomic data out of the US has been recently.

But what happened was the exact opposite, and the Fed and Jerome Powell filled a revised dot plot that points to three rate cuts in 2024, ie the FOMC is now suggesting that the Fed could lower interest rates by as much as 75 basis points versus 50 basis points previously.

As I mentioned, and quite counterintuitively, markets were already discounting more than 100-basis points’ worth of cuts going into that meeting. But, with the Fed’s blessing, the market took the dovish development as an encouragement to start discounting even more cuts and, as we speak, the market is now contemplating the possibility of 150-basis points’ worth of cuts next year. So, clearly, a very, very dovish development that took markets by surprise.

Now, on the other hand, the ECB and the BoE had a much, much more hawkish tone and didn’t follow through with what the Fed said. Starting with the BoE, it was pretty much business as usual with the central bank highlighting that inflationary pressures are still elevated and that more work’s needed to be done and, as a result, interest rates will stay higher for longer.

When it comes to the ECB, a fairly similar message. Again, the view that with wage pressure in particular still putting pressure on inflationary figures, the central bank hadn’t discussed and it’s not on its agenda to discuss interest rate cuts, ie interest rates will remain elevated for the foreseeable future. Now, this is what those central banks said. The markets didn’t necessarily listen exactly to what was said, and whether it’s on the UK or the euro area side, markets priced in further rate cuts as we go into 2024. So, in conclusion, markets really do not believe central banks at this stage and are preparing themselves for a significant interest rate cutting cycle as we move into next year.

So, does that make sense? Well, the Fed’s pivot was seen as a green light for stocks to rally further and for yields to collapse, something that, again, the ECB and the BoE couldn’t really change. And even if, post the FOMC meeting, we saw a Fed official commenting a bit on market expectations. In particular, the New York Fed’s Williams said that it is premature to be discussing a future policy move like cutting in the first half of 2024. Even that didn’t really curb the market’s enthusiasm.

We were surprised, clearly, by what happened and we were, as the market was, caught off guard by such dovishness from the Fed. Technically, this rally in equity markets and the collapse in yields would, in our view, need to consolidate in the short term.

Now, if we think more fundamentally, the Fed’s U-turn is a gamechanger for investors, at least for now, and there is nothing really stopping those investors from changing the tape between now and the beginning of 2024. 

Now, do we need to review our interest rate expectations? Well, our investment bank (IB) at Barclays has done so. The IB, as we call it, now expects the ECB to cut in coming meetings, stopping in April 2024. It will be followed by the Fed, which is now expected to cut three times next year, starting in June. And the BoE, maybe as an outlier, is expected to stay on hold until August 2024. But, clearly, although the timing may have shifted a bit, we think that the key message, which is one that we highlighted in our ‘Outlook 2024’ in November, is that as we go through 2024, and probably more so the second half of the year compared to the first half, but as the year progresses, we do expect interest rates to come down.

Now, we’ve seen a lot of repricing in the last few weeks and now may not be the perfect time to extend duration, as we suggested in our Outlook 2024. But we do believe that any opportunity and any volatility that would present itself in the coming weeks should be seen as an option to extend that duration.

That’s it for the market recap. Let’s now move on to our guest segment to discuss an asset class that will obviously be impacted by whatever happens in interest rates in 2024.

Stephen, welcome back to the podcast, always a pleasure to have you. Let’s rewind a bit looking at what happened this year, and maybe even before that. I think it’s been over a year, actually, since the ‘mini’ Budget. Maybe you can start by giving us a bit of a review of what 2023, the year that is about to close, has meant for property markets here in the UK, but also globally?

Stephen Moroukian (SM): Morning, Julien. Great to be back, thank you. You’re absolutely right. To answer that question, we need to go back to September 2022 where the markets reacted to the perceived poor fiscal discipline from the Treasury. The swap markets, which ultimately reflect fixed-rate mortgage pricing, spiked. These had been creeping up slowly in 2022. The war in Ukraine started in February of that year. And that did cause some attention, but nowhere near the sort of attention it did when the two- and five-year swaps moved to the dizzy heights of nearly 6%, which we saw in September and October of that year. 

And the reason why all of that’s important is, as a reminder, 80% of mortgage borrowers in the UK had taken fixed rates over the previous 10 years, and over 2022 to the end of 2024, the year ahead of us, over two-million borrowers, that’s about 25% of all the mortgage borrowers in the UK, will reach the end of their product term and need to remortgage or refinance on what will be materially higher interest rates.

And then there’s the myriad consequences that follow thereafter off the back of that. So, higher monthly interest payments impacting people’s disposable income for monthly budgeting, all of that happening at the same time as energy prices and food prices are spiking. The need for mortgage lenders to adjust to higher stress rates for affordability and, you know, all of that working its way through, that has an impact on the buying lag for people that are in property transactions. The mortgage charter, a package of measures to protect borrowers in specific circumstances which, of course, Barclays has adopted. And the inevitable change in property prices and outlooks based on the various dependencies on debt, but also because of supply constraints as the transaction market reacts.

So, there’s a lot to digest and, frankly, it’s probably impossible to accurately establish all the combinations and variable outcomes that could play out, but the fundamental thread, and I think you’ve been talking about it for a long time of course, and you’ve talked about it already this morning, is that we remain totally connected to these inflation numbers. 

And I believe that, you know, if the Bank of England’s 2% target is realistic in the medium term, then, clearly, mortgage rates will soften and the transaction market is likely to feel the benefit of that. And, of course, that isn’t just a UK characteristic that’s playing out, it’s playing out globally where debt-dependent borrowers, and some markets are insulated from that, have been taking advantage of low interest rates over the past 10 years and the UK has been particularly harder hit as sterling has had, you know, some of the greatest volatility, and also hasn’t had a regime of longer 20- or 30-year fixed rates.

JL: So, let me rebound on what you just said and we’ve touched on that already, obviously, this close link between interest rates and mortgage rates and, therefore, the health of the real estate sector. We’ve touched on what are our own expectations and what are the market expectations when it comes to interest rates going into 2024. How do you see that translating to the mortgage market and mortgage interest rates?

SM: Yeah, it’s a real crystal ball moment question, isn’t it? So, look, as far as mortgage rates can be interesting, I’m always excited when a number of things happen. One of those is when fixed-rate pricing is either flat or less than the Bank of England base rate. We saw this in April, and that coincided with some of the lowest fixed rates that were available during the year. This was a fairly short-lived window and borrowers that locked into those rates, I think, have felt pretty pleased with themselves throughout the year. 

The five-year swap today has dipped under 4%, and the two-year swap is anchoring at 4.5%, we haven’t really seen those type of numbers since April. And the interesting thing is, you know, when I started in mortgages 20 years ago, a borrower could expect to pay a premium for fixing their payments and expect some sort of discount to reflect the risks they were taking on with central bank rates. And, again, this was a fairly standard expectation, not only in the UK but across European and US mortgage markets. 

Today, we’re seeing those two costs as broadly the same, which is indicative, and, of course, it’s only an indication, of where the market sees rates versus where the central bank sentiment is sitting. And I think you kind of covered that in your statement this morning around perhaps an overtalking of the inflation battle versus where likely interest rates may fall.

So, I think if we continue to see that downward trend then, of course, that means that fixed-rate pricing, which has typically been very popular in the UK and other markets, begins to reduce and that will, overall, probably mean a reduction in the overall rates that are available over the next 12 months.

JL: OK. Is that a UK-specific thing, or do we see a different outlook based on the country or the region we’re talking about? Maybe, I don't know, Switzerland, Dubai, these are important markets, do you see things playing out the same way there?

SM: Well, I think you’ve hit on two of the more interesting property markets right now outside of the UK, Switzerland and Dubai. Arguably, there is very little in common with each of them. I think we can talk about Switzerland in a bit of detail, and briefly talk about Dubai. 

I think if I start with the Swiss market, that’s fairly mature and one that has seen phenomenal growth in prices over the last 10 years, really staggering numbers since the global financial crisis. As I referenced earlier, it’s not been entirely immune to the interest-rate rollercoaster but, of course, the Swiss franc has been remarkably calmer and less volatile than sterling, so somewhat easier to see what’s going on and likely to be a softer landing. What’s happening in Switzerland is a slowdown in transactions and a slowdown in price growth, which is partly being countered by a lack of stock. And, again, that’s a bit of a global theme wherever you see rental costs increasing.

The stock issue started in Switzerland probably around 2017, where there was a marked slowdown in new construction, varying canton rules on planning permission and a continued steady growth of inward migration, and specifically driving demand in the rental market. And, again, a global theme where you have particular global hubs where a lot of its patriots come into a particular country. Much of that was focused in the larger commuter towns and cities. 

However, then Covid-19 brought a new demand and, you know, people sought the kind of quiet tranquillity and relative seclusion of the Alpine markets. So, those Alpine markets themselves, they’re seeing and adapting to climate change and reinventing and repositioning themselves to be all-weather and all-seasons markets, and we’ve written a lot about this quite recently.

Notwithstanding, I think this year looks like there’ll be around 30% more snow than average in a bizarre twist, but I think the point is understood and so demand is up for those luxury homes, and that’s coming from old and new places. The demand from the UK and mainland Europe remains, but we’re definitely seeing increasing demand from the Middle East and the US right now for those particular regions. 

And lastly, at the very top of that market, and as a bank we spend a lot of time this time of year in places like Verbier, with a physical presence to be available to our clients. Many of the commentators believe, as there are in many ‘super-prime’ locations globally, that there will be signature transactions that break, or get close to, price records. And all of that serves to help determine where prices should be in markets where, you know, there’s a little bit of volatility, or there’s a little bit of softening. Overall, really, really interesting market. Likely to see a softening of prices, which represents an opportunity, but also best in class, as it’s called, probably seeing notable transactions. 

I can talk briefly about Dubai. You know, the Dubai market, double-digit growth over a short window of time. Certainly, I think the big news for Dubai is it has arrived as a super-prime location with luxury villas being sold for $100 million, over $200 million in undeveloped plots, and various reclaimed islands at $230 million with still the requirement to build. So, all of that is an indication of huge demand in the region from a lot of Asian, Middle Eastern and European investors. 

There’s obviously the US dollar peg in connection with the region, which has had a similar impact as we see transactions cooling off the back of interest rate increases and Dubai certainly won’t be completely insulated from that, and I think certainly where you have a region where there’s been a lot of transactions that have happened over a short period of time and that’s driven up demand and that’s driven up prices, you know, the market remains sensitive to some of that cooling down.

JL: So, we’ve talked about the snow in Switzerland. We’ve talked about maybe the sun in Dubai. Let’s bring it back home to rainy UK. Just before I let you go, a few things on your side as to what’s in store for the UK market in 2024 and, you know, since we’re talking about real estate, which tends to be a bit longer term, maybe beyond that.

SM: Yeah, I think for 2024, look, these are the things on my list in terms of things to watch out for and talking points. The landlord exodus and the residential investment property market, I think the term exodus has probably been slightly overused. Investor buyers into residential investment and buy-to-let properties in the UK are reducing, but that’s not to say that there isn’t a market. In fact, there’s still quite a number of transactions going through. High-net-worth borrowers and high-net-worth individuals see the longer-term opportunity, the inflation hedge available with property in the UK and don’t have to make the numbers work immediately. But also take a view of how that property may benefit them in the future for another purpose. So, that’s definitely a talking point for next year.

There’s a buyer/seller balance playing out at the moment and you’re likely to see a lot of research next year around who’s moving, what are their motivations, how far do they go, which demographic do they fall into, which regions are driving those decisions. There’ll be a lot more research about the detail around the motivations of buyers and sellers, all of which will be very interesting in terms of informing why people are making the decisions they’re making. Or, if they’re holding those decisions off, some of the other considerations that they need to think about. And, obviously, for global high-net-worth individuals, a lot of the political headwinds that are playing out, not only in the UK but actually all over the world, are interesting.

Town and country decisions. There’s really a lag factor from the pandemic. This is one that we expect to be talking about. Those with homes in the UK in a post-pandemic context might need to start making decisions. That’s being driven by higher interest rates forcing some of those decisions to be made with borrowers keeping one eye on their tax considerations, and really to start making decisions about where they want the larger property to be in a post-pandemic environment, where perhaps the London property had been the smaller one and perhaps something outside of London had been the bigger one. For every individual circumstance, multi-generational living, a whole range of other considerations, the motivations for those will vary and we expect to be having a lot of conversations about that. 

In central London, you know, there is a grey market and that’s really where transactions happen without being visible. Typically, that’s best-in-class assets that, you know, perhaps aren’t available in the market publicly but, of course, there’s an army of folks that make that market move. I think it will be very interesting to see which properties come through that transaction cycle and begin to change hands. Of course, all of that is very important because it tells us where prices will be gravitating to.

Globally, it is expected that value records will be smashed on some of the most expensive properties in the world. We’re already seeing that in London, Paris, New York and Monaco, you know, our listeners, undoubtedly, will be reading about super-prime property all over the world selling for incredible sums. And all of that is an indication of global wealth continuing to grow and the demand for luxury properties globally that have good connectivity and of a high quality remaining in increased demand. 

And I think that, you know, over the next two years as we see borrowing costs fall, perhaps that’s less than two years, you know, all of that will likely drive the sentiment for transactions, all of which is very important for the forecasting and the view of where those asset class prices will go over the medium term. So, I’m expecting a busy 2024.

JL: Yeah, it definitely sounds like it, whether it’s in public markets, real estate, across all asset classes, 2024 looks to be quite interesting as we head into it. Well, thanks again so much for joining us, Stephen. Wishing you all the best for the festive season and we’ll definitely get you back next year.

Now, before we conclude, just a quick note as to the few key events we have left to go through as we head into this week and it will be, obviously, a lot more quiet than it was last week, but still we want to pay attention to the BoJ decision as well as to the UK CPI and the US PCE for the month of November, which will come out on Friday. And, after that, it should be relatively quiet as we head into Christmas and then the new year.

That’s it from us at Barclays Private Bank. Once again, thank you very much for being listeners of this podcast, and thank you for sticking with us through 2023. As we discussed with Stephen, 2024 is likely to be potentially even more challenging so we’ll definitely be back. 

We’ll take a couple of weeks’ break, back on 8th January and, in the meantime, well, on behalf of everyone at Barclays, let me wish you a very happy festive season, a happy break. Please recharge for 2024. I would usually wish you all the best in the trading weeks ahead, but I also want you, as it’s even more important, wish you health as we go into the new year. Thank you so much once again. Speak in 2024.