Markets Weekly podcast – 5 June 2023
Are UK landlords turning their backs on buy-to-let? Join this week’s guest Stephen Moroukian as he reflects on an eventful few months in the mortgage market and considers the potential implications for borrowers and investors. Meanwhile host Henk Pott explores US debt, crude oil prices and China’s weakening recovery.
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Henk Potts (HP): Hello. It’s Monday, 5th June 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.
Relief over the debt ceiling deal, speculation of an increase in Chinese stimulus and advancing AI stocks helped to offset weakening Chinese activity, and the prospect of a higher peak rate.
US equities pushed higher as volatility declined last week. The S&P 500 rose 1.9%, its biggest weekly increase since the end of March. This quarter, the benchmark index is up 4.2%, and is up nearly 20% from October’s low. The volatility index, the VIX, often referred to as Wall Street’s fear gauge, dropped below 15, in fact, to its lowest level since February 2020 compared to an average of 23 over the course of the past year.
European stocks rallied 1.5% on Friday to erase the weekly loss. The STOXX 600 is up 0.9% during the course of this quarter.
Oil prices are rising this morning following the OPEC meeting over the course of the weekend. The weaker global growth backdrop and, specifically, the stumbling recovery in China, had been pushing down crude prices over the course of the past few months. You’ll remember, back in April, that the 23-nation OPEC alliance agreed to cut production by 1.2 million barrels per day, that started back in May. In fact, crude prices fell 11% during the course of last month.
At the OPEC meeting, Saudi Arabia said it will make a further voluntary supply cut of one million barrels per day, for the month of July, though that cut could be extended. Reduction will take Saudi production below nine million barrels a day for the first time in a decade. If you’re looking for a winner, well, it was the UAE. Its target will increase by 200,000 barrels a day from January.
What does all mean? Well, I think the decision showed that OPEC is still tightly controlling supply, despite the fact its own data indicates a 1.5 million barrel-per-day shortfall during the course of the second half of this year. Crude prices, as I say, have been rising, up around 1% today, Brent trading back above $77 a barrel.
Now, the bipartisan suspension of the debt ceiling in the United States until 1st January 2025 significantly reduces concerns the US might have defaulted on its debt for the first time in its history, an outcome that we know would have proved both calamitous for the US economy and the global financial system. Under the deal, which lasts beyond the next presidential election, federal spending on defence and domestic programmes will be capped for two years. The investment rules for energy and infrastructure development will be eased.
The Congressional Budget Office said the legislation would result in $1.5 trillion of savings over the course of the next decade. This fiscal contraction is expected to only have a slight impact on growth and the expected rate path. Given the structure of the deal, we have reduced our US GDP growth estimate by just 0.1 percentage point for 2023 and 2024.
China’s rapid rebound, following the abandoning of its zero-COVID strategy at the end of last year, appears to be losing momentum. The latest PMI survey showed manufacturing stayed in contraction for a second straight month. Construction is easing and services activity is slowing. In fact, the composite PMI fell to 52.9 in May from 54.4 in April. The data suggests that the weak property market remains a big drag on the growth recovery and is weighing on industrial product demand.
Consumption recovery has been softening and external demand, particularly from the US, has been diminishing. The poor PMIs, coupled with disappointing April activity data, is certainly increasing pressure on officials to deliver a policy response.
Now, we know authorities have already tried to stabilise the property market, which, remember, accounts for about 25% of GDP in China. But, real estate investment declined 13.2% in March, new home starts declined 37%, and property sales fell 27% in April.
Regulators are now reportedly considering further measures, including reducing the down-payment requirements to purchase properties in non-core neighbourhoods of major cities, lowering agent commissions on transactions, and relaxing restrictions on residential purchases.
Beyond the property market, we also expect the People’s Bank of China to reduce policy rates by 10 to 20 basis points and cut the reserve requirement ratio by a further 25 to 50 basis points over the next six-to-nine months.
As a result of the deterioration in activity, we have reduced our growth forecast for China. We now think the world’s second largest economy will grow by around 5.3% during the course of this year compared to our previous forecast of 5.6%, but we should remember that’s still comfortably above the official 5% target that was set at the National People’s Congress back in March.
While officials in China are considering loosening policy, resilient consumption, inflation and labour-market data suggests higher peak rates in the US and the UK. Ahead of the June Fed meeting, the FOMC will be digesting the stronger-than-expected real personal consumption expenditures figures. Remember, this is consumer spending, which rose by 0.5% month-on-month in April, certainly a strong figure there, and the lack of clear evidence the labour market is softening at the pace that was anticipated.
As we saw on Friday, nonfarm payrolls increased by 339,000 in May, way above expectations. If you look at job openings, well, they surged back above the 10-million mark at the end of April, but the household survey did show the unemployment rate ticked up to 3.7%, and average hourly earnings growth slowed to 4.3% year-on-year.
Meanwhile, headline inflation has been easing. When you look at core PCE services inflation, excluding housing, we know it jumped in April. An expected tightening of financial conditions as a result of the disruption in the banking sector has been less pronounced than previously envisaged.
What does this all mean for the path of policy in the United States? Well, we expect the FOMC to deliver two additional 25-basis point rate hikes, thereby pushing the target range up to 5.5% to 5.75% by the end of this year.
Now, the timing of those hikes actually still remains quite debatable. Friday’s strong employment report means the June meeting is live, so markets are currently pricing in just a 30% chance of a hike. So, the Committee may actually decide to delay the increases till the July and September meetings.
In terms of the UK, well, inflation has been moderating at a slower rate than anticipated. Headline CPI fell into single digits for the first time in eight months in April, but still registered an 8.7% increase. Core inflation registered a sizeable acceleration in April, getting up to 6.8%, and core services inflation printed above the Bank of England’s May forecast.
We have increased our UK inflation projection. We now expect CPI to average 7% in 2023 and 2.7% in 2024. And that should keep the pressure up, I think, on the Monetary Policy Committee, where we now look for 25-basis point hikes in June and August, bringing the bank rate to 5%.
So, that was the global economy and financial markets last week. The headlines, as we know, have been awash with stories of UK mortgage products being pulled from sale, the landlord exodus from the market and the prediction that property prices would face their most significant correction since the great financial crisis.
So, what’s been going on? Well, here, to answer that questions, is Stephen Moroukian, Head of Product and Proposition for Real Estate Financing at Barclays Private Bank.
Stephen, great to have you with us today. Can you tell us the story behind the headlines? What’s happening in terms of the mortgage product market? What’s been the major factors that have been driving the recent developments? And where does this now leave mortgage borrowers?
Stephen Moroukian (SM): Good morning, Henk. Great to be with you today. It’s definitely been a busy few weeks across the mortgage market.
It really all started after the last Bank of England base rate decision, where the rate outlook was higher than had originally been priced in by the swap markets, coupled with those UK inflation numbers, as you say, not budging quite fast enough.
The big UK high-street banks were selling quite attractive fixed rates, at the top end of 3%, against prevailing swap rates that were very quickly pushing over 5% for two-year money, 4.5% for five-year month. And, at those sort of market indications, it becomes impossible, similar to September last year, to commercially sustain those products and, hence, the headlines of nearly 1,000 mortgage deals being removed from sale, which, in reality, was largely fixed-rate products.
And what does that now mean for mortgage borrowers? Well, whether it’s those looking to remortgage or those looking to buy a property, is that borrowers are all in rates, whether that be a tracker rate or a fixed rate, that are likely to be higher than they were over a month ago. And so that certainly doesn’t quite feel like we’ve reached the peak that many thought we had. And, of course, between now and the end of 2024 there are just under two million borrowers in the UK reaching the end of their existing mortgage rates, and that will certainly cause a degree of concern for them.
HP: Stephen, last time we spoke you talked to us about the mortgage approval numbers and property prices. Are they still the key datapoints you continue to monitor? If so, how have they performed over the course of the past few months?
SM: Yeah, you’re absolutely right, Henk, and this datapoint has really become very important as a lead indicator to what property prices may do over the rest of the year and into 2024. Last time we spoke, we’d seen monthly home purchase mortgage approvals drop to the 30,000 mark in January, but across March and April they’ve rebounded to around 50,000 per month.
So, people are buying. They’re buying properties and they’re using a mortgage to do that, which certainly is in line with what you’d expect at this time of year as more properties come on to the market, people start to embrace the good weather to sell their homes.
However, the context is that there’s a three-year average of around 70,000 mortgage approvals per month for purchases, so we’re still some way off the numbers that sustained the price growth that we saw after 2020.
And what does that mean for prices? Well, certainly the cataclysmic collapse of value that some commentators were predicting hasn’t happened. We’ve seen about a year’s worth of value come off. So, the average house price today in the UK is about what it was this time last year, and only about 2% or 3% below the most recent peak, with continued downside of about the same expected over the next 12 months.
The notable exception is London, of course, where we predicted a much softer landing, and that seems to be playing out. London has generally remained fairly flat, highlighting its more muted starting position in terms of price, the shortage of good property on the market, and greater overseas buyer interest and that lower dependency on mortgage lending just keeping transactions moving through.
HP: OK. Let’s get into some more detail around the concept that a landlord exodus has been taking place. Are buy-to-lets going to become a thing of the past?
SM: Well, OK. So, this one really is the big story of the year so far and has everybody in the property business talking, and I’m sure will do so for the rest of the year. There will definitely be a period of evolution and transition for this sector. The planets have aligned in a somewhat challenging way that makes the decisions to enter or hold in the market harder than they have been, historically. But certainly, the UK still needs a strong private rental sector and the growth in tenant demand against available stock continues.
But the story really started with the changes in stamp duty for buy-to-lets and second homes in 2016, which brought in a higher minimum rate, followed by further tax changes which tapered the level of mortgage interest, which could be offset against tax, and that really hit higher-rate taxpayers hardest.
Now, we’ve got higher interest rates eating into yields, it makes certain scenarios less attractive. And, if we look down the track, there is the looming possibility of uplifted EPC requirements needed in order to put new tenancy agreements in place. It’s worth noting that in the UK, 50% of the housing stock is EPC-rated D or worse currently. And there’s proposed and current future government legislation that will enact reform to the rental sector.
All of these factors make the case for entering the market one that means investors really must do their homework. That said, of course, there’s no evidence of mass exodus from the market. There are still over 2.7 million landlords in the UK, and buy-to-let mortgages still account for around 14% of all mortgages being lent. It’s worth noting that landlords only made up about 15% of all properties that were sold last year.
The other point to note is that buy-to-let mortgages are really only a comparatively recent phenomenon. They date back 20 to 25 years, when they became the mainstream mortgage product they are today. In fact, the average buy-to-let landlord in the UK is around 50 to 55 years of age, so we’re definitely reaching a natural punctuation point for early investors that are now beginning to time their exit from the market. So, there really is a danger in reading too much into the headlines at the moment.
HP: Stephen, try and bring it all together for us if you could. How should investors be viewing the current market?
SM: Yeah, so in summary, look, yields are marginally up as prices have come off a little and rents are increasing. Of course, where there’s debt in place that plays a critical role in the calculations, but also considerations around tax structure is really key. Buying the right property has never been more important. Doing your research remains critical. Speaking to experts in the market, looking at demographics and future demand locations. The energy efficiency piece I’ve mentioned, but that’s really important at the moment, and the cost and potential of increasing those ratings are just some of those considerations.
Fundamentally, there’s still a critical shortage of property in the UK, and there really is no meaningful sign of that gap being bridged. As it becomes harder for buyers to enter the residential market, it will continue to fuel the rental growth we’re seeing and tenants will just be renting for longer as they make that transition.
US dollar investors are still seeing strong value in the UK, despite the additional costs to enter, and, of course, for many of our clients buying a rental property in the UK, the rental part is perhaps only one chapter of the property’s lifecycle. It may well become a family home in the future or a bolthole when work or education demands changing the role it needs to fulfil.
And lastly, of course, the old adage remains true. Property, like most investments, is a long-term strategy and, therefore, the current combination of today’s circumstances are really only a moment in time consideration.
HP: Well, thank you, Stephen, for your insights today. We spend time with clients around the world and we know the UK property market 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 and property markets.
Let’s move on to the week ahead where it looks like being a light week from an economic data perspective. But in the US on Tuesday, we look for the services ISM to rise 1.2 points, coming in at 52.3 in May, reversing some of the prior month’s 3.9 points decline. We’ll be paying particular attention to the prices paid index, which at 59.6 remained in the territory consistent with continued cost pressures in the service sector.
With that, we’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.
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