Markets Weekly podcast – 24 July 2023

Henk Potts (HP): Hello. It’s Monday, 24^th July 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 with 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 consider the outlook for UK real estate. And finally, I’ll conclude by previewing the major events and data releases that are likely to shape the week ahead.

Equity markets continued to push higher last week, as investors digested the latest economic data releases, second-quarter earnings, and awaited the pronouncements from the Federal Reserve and the European Central Bank. The benchmark S&P 500 rose seven-tenths of 1%. The STOXX 600 in Europe outperformed and was up 1% over the course of the last week.

In commodity markets, wheat prices surged more than 10% after Ukraine’s grain-export deal wasn’t extended. Storage facilities were bombed, and Russia said that cargo ships could be seen as military targets. The renewed disruption to supply could have implications for both food security and inflation expectations.

Now, the headline grabber at the start of the week was the continued slowdown that’s been playing out in China. Second-quarter GDP grew at 6.3%. We should remember that that was against a very weak comparison of a year ago, when Shanghai was in lockdown, and below economists’ consensus expectations of 7.1%. The latest activity data pointed to a pronounced slowdown in consumer demand growth and continued weakness in the property sector.

Retail sales growth slowed from 12.7% in May to 3.1%. Despite a broad range of measures to try and shore up the housing market, property investment slumped 7.9% year on year. Youth unemployment, which we know has been a long-term structural problem, rose to 21.3%. The mixture of the deeper contraction in property activity, softer services and falling external demand have encouraged us to question whether China will be able to hit its official 5% growth target this year. In fact, we now expect the Chinese economy to grow at just 4.9% for 2023 and have lowered our 2024 forecast to 4%.

Now, given the activity undershoot and the risk of deflation, we would expect a policy response, including further cuts to policy rates, alongside which we also think the government will accelerate infrastructure investment, especially in the areas of datacentres and clean energy. We also think they’ll mobilise state-owned enterprises and use government subsidies to further spur high-tech manufacturing investment.

In the US, the consumer’s been impressively resilient, as we know, through the early stages of the downturn, as labour markets remained healthy, pay growth has been robust, inflationary pressures have been easing, although spending, we should know, has shifted towards services, and demand for goods has started to moderate.

Retail sales in June were up, but only up two-tenths of 1%. That was below the one-half of 1% that analysts had predicted and below the one-half of 1% increase that we saw in May. Sales increased in electronic stores, furniture outlets and online retailers, but purchases at building-materials stores, gas stations and grocery shops all declined.

In terms of the outlook for the consumer, well, given the clear economic uncertainty ahead, the stress on disposable incomes due to higher interest rates, and the forecast for a moderate increase in terms of unemployment, we would expect private consumption growth to materially weaken over the course of the next 12 to 18 months. In fact, we project private consumption growth just three-tenths of 1% in 2024. Now, given the fact that household demand accounts for 70% of activity, this has obviously damaged America’s growth prospects during the course of next year.

In the UK, inflationary pressures are now finally starting to ease, although it’s become abundantly clear progress has been painfully slow. The June consumer price index decelerated to a better-than-expected 7.9% year on year. That’s the lowest that we’ve seen in more than a year, significantly lower than that 8.7% May print. The slowdown was driven by base effects, falling fuel prices and an easing of food inflation. Core CPI eased from a three-decade high of 7.1% in May to 6.9% in June.

UK inflation, as we’ve noted before, has moderated at a slower pace than in other regions due to its dependence on natural gas for power generation, the structure of government policies to try and help shield the economy from higher energy bills, and the disruption caused to the supply of goods and labour as a result of the pandemic and Brexit.

Headline inflation is set to remain above the 2% target through the course of 2024 as pressure on the Bank of England to further tighten monetary policy continues. So, we still expect the MPC, the Monetary Policy Committee, to hike interest rates by half a point in early August, but given deceleration in headline core inflation, we do think the risk of a stepdown to 25 basis points has increased. After August, we look for a further quarter point at the September meeting, taking the bank rate up to 5.75%, which we think could be the terminal rate for this cycle.

So, that was the global economy and financial markets last week. Headlines over the course of the past few weeks and, indeed, months, have focused on the turmoil that’s been playing out in terms of the UK mortgage market and the fact that rates have surged. Here to discuss the current state of the market and the impact on property prices, I’m pleased to be joined by Stephen Moroukian, Head of Product and Proposition for Real Estate Financing at Barclays Private Bank.

Stephen, great to have you with us again today. Market swap rates have been on a bit of a rollercoaster ride over the course of the past few months, which is obviously concerning for UK mortgage holders. So, let’s start with that. What’s been happening with swap rates and how does that filter through to mortgage rates?

Stephen Moroukian (SM): Good morning, Henk. It’s definitely been another month of intense headlines in the mortgage industry. I think it’s clear that the link between the market rates on short- and medium-term fixed-rate pricing is at its most sensitive to sentiment on inflation, and the surge we’ve seen, very much driven by those inflation datapoints, really not showing any meaningful drops until last week.

Before that point, we’d seen a 30-day surge of half a per cent, with two-year money topping out at 6%, which, whilst it doesn’t sound like a big increase, is actually quite significant for a number of reasons. The first is it represents almost a line in the sand in terms of the expected market cost of short-term fixed rates and, therefore, saw UK banks publish mortgage rates at over 7%, and these are some of the highest mortgage rates we’ve seen in 15 years.

So, it really is a material ceiling that’s been surpassed. Thankfully, we’ve seen that surge fall off dramatically and a possible peak, but, of course, we’ve been here before, and watching the inflation and central bank narratives is probably the best and only influencer to those numbers right now.

The second important consequence of this milestone number relates to the way UK mortgages and UK borrowers are stressed, or rather how they were during the recent low interest-rate environment. So, as an example, taking a two-year fixed rate, at say 2% in 2021, you would have had your mortgage stressed at probably around 6% to 7%, depending on the lender. And that was a regulatory measure to ensure new mortgages in the UK were able to sustain interest-rate increases.

We’re now getting fairly close to those stress levels and once overloaded, as you say, with the inflationary impact to monthly expenditure and the obvious disproportionate impact we’ve seen to energy and fuel bills, it’s rightly causing some concerns on the borrowers most impacted and, of course, you know, how those things have been modelled over the years.

To this end, various sitting government and shadow-government groups have been meeting to try and work through ways of supporting not only those that have come off their short-term fixed rates but, of course, what future policy could look like to mitigate these volatilities in the future.

HP: Stephen, one development we have seen is the UK government mortgage lenders and the Financial Conduct Authority announcing the introduction of a Mortgage Charter. Can you explain to our listeners the details of new guidelines and what it means for mortgage borrowers in the UK?

SM: That’s right, Henk. This has been a fairly unprecedented set of events in the mortgage industry, and it’s really very important. The Mortgage Charter is a package of measures which looks to support UK mortgage borrowers who are experiencing their monthly repayments being affected by that recent surge in interest rates we’ve discussed. The charter looks to support them through the following commitments.

Firstly, effectively pause any repossession proceedings less than a year from a missed payment, and that’s really looking to alleviate the concerns of those borrowers who are impacted the worst and ensure that those struggling or worried about their mortgage are able to speak to their lender without any impact to their credit file and that lenders support those conversations though specialised staff.

The second is to make sure the borrowers who are coming to the end of their fixed-rate term, and really that’s where you see the biggest change in payments, that they’re able to secure new rates well ahead of time, and typically up to six months before, so they can fully consider their increased repayments and be able to think about their choices, and to also ensure that should a more favourable rate be available in the interim, that they’re able to benefit from that also.

The next change is relatively meaningful in terms of impact. This allows mortgage borrowers to switch to interest only for a short period of time, up to six months, in order to soften the impact of higher rates over a short window. And the option to extend the term of the mortgage, depending on when a borrower took the mortgage out, how much they have left on their overall term and their current planned retirement age, this could help the monthly mortgage payment decrease by increasing the timeframe over which it’s paid.

Now, all of these benefits have various considerations that need to be entered into very carefully and banks and building societies in the UK are working on how they’ll implement these new measures in the right way. And, look, just to give you some context, UK regulation for mortgages rarely changes on this sort of scale and size. It typically goes through consultation cycles lasting months, and it’s fair to say since 2004 it’s probably only happened twice, so to implement something like this this quickly is really moving the industry to respond and support those 1.4 million borrowers that will see material uplift to their mortgage payments between now and the end of next year.

And all of this is happening in the backdrop of new regulations across the UK, such as corporate consumer duty, which look to set a higher bar across a range of principles related to customer understanding and product manufacture, just to name a few.

HP: OK. The big question, which I’m sure you’re asked all the time, is what will happen to property prices from here?

SM: You’re right, Henk, I’m asked that a lot. I think a wait-and-see attitude seems a sensible answer, but given we’ve seen short-term history repeat itself in terms of the peak in interest rates, the last peak being September 2022 and then now, and that we know those peaks squeeze borrowers’ ability to purchase and move property, I think it’s right to say most commentators are using those factors in modelling the knock-on effect to house prices over the next six to 12 months.

However, what you must remember is there’s a significant lag effect also. Transactions typically take six months to proceed from start to finish, and those borrowers with mortgage rates at 4% or 5%, let’s say, secured in say March or April, will be looking to proceed over that time horizon. So, the exact impact won’t be fully understood until that long tail has worked its way through, and that’s a view that’s shared across most of the big commentators.

Across the UK, it’s fair to say that what was looking like a year of growth coming off since the August peak of property prices last year, is likely to be the same again. So, that was a reduction in prices of a modest 2.5%, and to see that again doesn’t seem unreasonable, perhaps even a little bit more. However, I suspect that won’t start coming through into the numbers until December at the earliest, at which point any number of overlaying factors which may even extenuate or dilute that point, for example, where interest rates have gone, locations of particular properties, the types of properties, and, of course, what we now have is, you know, the political considerations.

HP: Stephen, beyond the broad residential market, what’s the outlook for ‘super- prime’ property in London specifically?

SM: Well, London is in good shape. It’s a more resilient market in terms of mortgage interest-rate impact and the reliance on leverage. Its values didn’t see the same surge as the rest of the UK did over the COVID-19 window, so they calibrated off a very different starting point. If anything, demand is pouring back the other way as the commuters and overseas travellers return in droves.

Try to rent a property in London today and you’ll be up against people willing to offer on the property without even visiting it in a desperate attempt to secure. And the people I speak to tell me that that will only intensify as we hit the return-to-school window, as a lot of people from overseas start to come into the UK to secure those school places, or start those school places.

What we do know is that in quarter one (Q1), the number of purchase transactions on property in London over £5 million dropped about 30% versus Q4 in 2022. That’s not actually unusual for Q4 to be more as the year-end rush completes, and for Q1 to be a bit more muted, but what was quite notable this time round was the 30% delta.

So, the Q2 numbers will be out shortly, and that will be quite interesting from a datapoint perspective to inform what the rest of the year could look like for high-value transactions. The sentiment remains one of undersupply, especially for best-in-class assets, and that a typical premium for off-market acquisitions being as high as 15%, so very much a different market to the rest of the UK.

HP: So far, we’ve been concentrating on the UK market. Let’s try and broaden it out and consider the global outlook. Are some of these themes also playing out internationally?

SM: Really interesting question, Henk, and I’ll do my best to summarise it. The global property market at the moment has a real cohort of winners and losers, and there are jurisdictions that are doing incredibly well at the moment and the Middle East markets are just a really good example of that right now. Huge amounts of investment, huge amounts of demand and some very good returns being seen.

On the flipside, we can look at places like China, the US and parts of Europe where some of those increases that were seen over the last three-to-five years are really rebounding the other way and, again, driven by a number of factors, most of those factors very similar to the ones in the UK related to the cost of borrowing and the impacts to the interest-rate view over the short to medium term.

All of that means that there will be, as ever, winners and losers in terms of those particular markets. I think one interesting point for somebody like me working in the mortgage industry, you know, when we look at long-term fixed rates and how they’re arranged in places like the US and Europe, one of the key differentials we see there is the ability to secure longer-term fixed-rate funding which gives greater predictability, greater comfort over what payments will be for any particular borrower, sometimes over a 20-, 30-year period, and that just doesn’t exist in the UK.

And, as I said earlier, there’s been a range of roundtables that have been held with both the current government and shadow government, and I know that that’s definitely been one of the topics of conversation there. So, we can look at those particular markets which may not be doing as well right now but at the same time will have certain mechanisms in place that mean some of the government activity we’re seeing here is affected by some of the other things that they have in place historically.

Yeah, I think places like Canada and New Zealand, they’re other very interesting markets where a huge amount of foreign investment had gone in. That foreign investment was curtailed, again by government intervention, greater taxes to enter the market and, of course, that has had an impact and will continue to have an impact. So, I guess a very mixed bag, but all the themes are very similar.

HP: Well, thank you, Stephen, for your insights today. We know the UK property market and beyond is certainly a major area of interest, so it’s been fantastic to get some real clarity on the conditions of both the UK mortgage market and what’s happening in terms of property prices.

Moving on to the week ahead, where the focus will be on the interest-rate decisions from the Federal Reserve and the European Central Bank. The ECB has clearly signalled a 25-basis point rate hike at this week’s meeting, and we expect them to push ahead with that, taking the deposit rate up to 3.75%.

The greater debate is really around the path of policy after the July meeting. Now, European economic activity has clearly weakened, inflation has been moderating and financial conditions have tightened. This should buy the Governing Council some time to see how the data evolves in the coming months. So, we expect the guidance to maintain its hiking bias, thereby giving policymakers optionality in coming months, but we do think the July quarter point could be the last in terms of this hiking cycle.

Looking further out, we then expect rates to be on hold through to the second half of next year, after which we have 100-basis points of cuts pencilled in before the end of 2024. And this week will really be about the Federal Reserve, where the combination of resilient activity and robust labour markets, plus the latest ‘dot plot’ in the June summary of economic projections, the minutes of the June meeting and recent speeches from Fed officials suggest that the US central bank will also push ahead with a 25-basis point increase on Wednesday.

Whilst the June inflation print has reduced some of the urgency for another increase after this meeting, we still expect the FOMC will remain focused on getting inflation back to the 2% target and, therefore, expect the Committee to do another 25-basis point hike. We think that could come even in September or November and, therefore, see the terminal rate for this cycle being 5.5% to 5.75%.

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