Markets Weekly podcast – 25 September 2023

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

As always, we will start by reviewing last week’s events before moving on to our guest segment. And, today, I’m delighted to be joined by Stephen Moroukian, our Product and Proposition Director for Real Estate Finance, to discuss the real estate market.

But first, let’s rewind the week that was, and it was a busy one. We started with the lower-than-expected inflation print in the UK, which made a BoE hike a lot less likely. Indeed, core prices climbed 6.2% year over year in August, well below July’s level, 6.9% and also below the consensus forecast that was for 6.8%.

But before we could know if the UK central bank agreed, we had to contend with a relatively hawkish Fed. As expected, the US central bank kept interest rates unchanged, but that wasn’t what mattered to markets. Instead, the focus was on the famous ‘dot plot’ and the FOMC interest rate projection.

On that front, the Fed came across as hawkish as the revised dots showed a median FOMC member calling for another hike this year, and only two cuts in 2024. The market was actually hoping, if not expecting, at least three cuts next year.

So, this means that if, and that’s a big if, the FOMC projections materialised, the Fed funds rate could be at 7.125% by the end of next year, and this is up from 4.62%, according to the June dot plot.

So, the main takeaways for investors really are that, first the Fed is done, or very close to being done, when it comes to this hiking cycle. 

Second, rates won’t come down immediately, as the central bank will want to be sure that inflation is under control. 

And third, the future remains highly uncertain and even the Fed doesn’t appear to be convinced if it can achieve a soft landing. Therefore, we are allowed to doubt that those projections will become reality one day.

Anyway, after the Fed it was the BoE’s turn to update investors, and there the decision was much more uncertain, partly based on this weaker-than-expected inflation print earlier in the week. And, in fact, the BoE itself had a hard time deciding whether to hike or stand still, as shown in the five to four vote. 

Ultimately, the BoE kept interest rates unchanged at 5.25% and at the same time the MPC decided to increase the pace of quantitative tightening, with a reduced gilt stock by £100 billion a month until September 2024 from a target of £80 billion previously. So, an accelerated pace around £20 billion-worth per month.

So, again, it was a relatively hawkish pause from the BoE in a similar vein to the Fed, and the ECB last week, if you remember, actually decided to hike.

So, where does that leave us? Barclays Investment Bank believes that both the Fed and the BoE are mostly done hiking for this cycle. The Investment Bank actually sees an extra hike from the Fed later this year, potentially in November, another 25 basis points, and that would be it.

And then the focus will move on to when those central banks start cutting rates. And here the BoE is seen as cutting rates in August next year, 25 basis points, while the Fed could do something quite similar around the same time. So, really rates shouldn’t start coming down before the second half of next year.

But maybe this is the right time to bring you in Stephen, since we’re talking about rates. So, in your mind, how does last week’s decision to hold the UK base rate affect the UK mortgage market? This is a very important topic for many of our listeners.

Stephen Moroukian (SM): Hey. Hi, Julien, great to be on today. Well, similar to your sentiment, this decision to hold the rate at 5.25% came as a real surprise to all of us and appears to have been a knife-edge decision, based on the minutes published. 

And the first and most important point to make here is that this will have been good news, welcome news to the nearly one million UK mortgage borrowers who are on a tracker or variable rate. And, you know, they’ve become accustomed to seeing an increase in their mortgage payments every six weeks over the last, you know, 15 months.

I think, secondly, it will have also signalled to many as evidence that the rate cycle is peaking and, I think, laid some hope to mortgage borrowers more broadly.

JL: OK. So, for those on floating or tracker rates that makes sense, but what about those who are on a fixed rates or maybe looking to fix in the future?

SM: Well, that’s a really important question at the moment. Many borrowers in the UK are thinking about their fixed rates that they’re on and the fixed rates that they’re going on. It’s a different set of considerations. The vast majority of mortgage borrowers in the UK are on fixed rates, so they do remain unimpacted by bank base rate movements. However, what’s key for those borrowers, as I said, is where in the rate cycle they took their fixed rates and when they will need to renew those mortgage rates.

The fixed rate mortgages are driven by swap market pricing and, specifically, over two, five and 10 years. We’ve now seen those rates peak, notably the two-year swap, which for a short window was over 6%. This has now come off by almost an entire percentage point, and as such fixed rate pricing in the UK is beginning to come down.

The challenge remains that these rates in February and April this year were, you know, well below 4% and I guess a full 2% versus the peak this year. So, that’s all evidence that we continue to be in an incredibly volatile period that is really related, you know, really intrinsically related to the inflation sentiments coming out.

So, it really is a little bit of a rollercoaster for fixed rate borrowers at the moment and as, you know, as we kind of go through the next three to six months, you know, will we see people taking fixed rates more, so actually beginning to think this now is the time to lock in, or will we see mortgage borrowers taking on longer-term tracker rates with a view that they can see a reduction in mortgage costs over a period of time? 

All of that is very important and requires good advice to be taken, but remains a consideration for a lot of borrowers at the moment, and a lot of worries for people, more generally, at the moment as well.

JL: OK. So, maybe on property prices, you know, we talked about rates in this but what sounds like a good or better news, what are we seeing in terms of all these moving rates when it comes to property prices?

SM: Yeah, well, look, rates might be falling and swaps are definitely falling, but property prices are falling too. So, the largest index, which captures the average UK home across all locations has seen prices fall by around 5%, and that is in line with the forecasts that we saw at the beginning of the year.

There’s probably more to come, but maybe not much more, and that still is all around 17% up on pre-pandemic levels. So, what’s key is how much of that pandemic premium that we saw where property prices increased will be eroded. What’s driving this at the moment is a slowdown in transactions and we can see that in the mortgage numbers.

So, UK mortgage purchases have had a three-year average of around 70,000 mortgages per month. Today, we’re still languishing at around 40,000 to 50,000 a month. And that really is a reflection of the higher interest rates biting into mortgage affordability and borrowers’ monthly appetite on what they can spend on their mortgage coming down.

I think you’ve got the cost-of-living crisis that you overlay on top of that. So, people are thinking very hard about how much they want to borrow, how much they can borrow and how much they’re willing to spend on a monthly basis.

We also have a very important lag factor, and that’s yet to play through. And this relates to those mortgages that were sold during that swap dip I mentioned earlier. Now, most mortgage offer letters and facility letters are valid for up to six months and, therefore, that gives the borrower that window of time to move their sale forward and to make the transaction go through.

If we think that most of those mortgage offers were issued as late as April/May, then we project six months and that takes us to around October time. And after that point would likely see completions fall in line with transaction levels that we’ve been seeing at the front end now, that 40,000 to 50,000 number.

So, it’s a very important window of time that we’re in. We’re calling it the lag factor, and really it’s important that we see those barometer numbers that I’ve talked about come through maybe around November/December time, which will give us a much greater sense of how those transaction numbers will begin to affect property-transaction volumes and, therefore, the prices also.

There is a difference in how those markets are working across the UK and prime-central London, prime-central London being a much more supply-constrained market and, therefore, that there is less best-in-class stock available and, therefore, the number of buyers, whilst that may drop off slightly, but it remains fairly consistent, those prices are holding their own. 

And, again, those particular buyers are not necessarily always using financing as a requirement, typically more on a discretionary basis, and we’re definitely seeing the cash buyer numbers increase in that particular market.

And, again, you know, there’s other factors that impact those buyers. The US-dollar advantage at the moment that exists, is one that’s certainly driving buyers from, you know, the North Atlantic corridor, the Middle East and Africa to use that benefit whilst they’ve got it here in London.

JL: Yeah, and you’re talking about other factors. I think there is an important one in the UK at the moment, and we’ve had announcements recently from the Prime Minister regarding the EPC rating and some changes there. So, what do you think are the impacts I guess mostly for landlords?

SM: Yeah, that’s a really very timely question, Julien. It’s a very important development I think, and it only really played out last week. I guess, as a reminder for our listeners, there was an expectation that properties that were rented out would need to meet specific EPC ratings by two particular dates, and one of those was January 2025, and it would require landlords to spend up to £10,000 to make their properties more energy efficient. 

Landlords today now have quite a few things on their mind that they’ve been concerned about, you know, EPC ratings is one of them. They’ve been concerned about interest rate increases. They’ve been worried about some of the tax benefits falling away over the years and so to have, I guess, one of their worries taken off the list I’m sure came to landlords as some good news. 

However, of course, the problem of energy inefficient homes in the UK doesn’t simply go away, and I’m certain this particular story will have plenty of airtime and considerations and different views over the coming weeks and months, but it’s definitely a very important development that’s happened.

JL: OK. Look, not trying to be too personal here but, you know, it’s not luxury real estate, let’s be clear, but I know the flat above mine has been sold recently, and it was bought by a cash buyer. And it looks like people with cash are the only ones who are actually able to transact, they don’t have to worry about, you know, interest rates obviously and they can grab some bargains with struggling landlords or homeowners. 

So, when it comes to cash buyers, is now a good time to be a cash buyer? Do you see any pros and cons and maybe for the seller, maybe on the more luxury residential side of things rather than my own situation.

SM: Yeah, OK. Well, let’s take both of those. So, I think in the UK residential market, being a cash buyer has always been an attractive trait to have when entering the market and, typically, you’ve seen cash buyers when we’re talking about the mass market really, where there are properties that have had specific nuances to them, which have made them possibly unattractive for mortgage lending, or where mortgage lending and that process would take slightly longer because of some unusual aspect about that property. 

That’s typically been because of the way that they’ve been constructed or perhaps title challenges that they may have legally around the way that they’ve been set up. Or leases that are quite short and, therefore, you know, the value of the property decreases at a much higher level disproportionate to anything else in that location.

These are typically common factors for cash buyers but, as you rightly say, that’s become a little bit more common in the mass-market arena and, certainly for sellers and estate agents, having somebody who can transact with some capital behind them is sometimes a more attractive solution.

That said, of course, you know, there are still 50,000 purchase transactions going on through mortgages every month and that remains fairly stable. So, you know, people are buying and they are buying with mortgages, so I wouldn’t see anything too alarming there. 

I think if we’re talking about the luxury residential property market and the global wealth markets, it’s always typically a head-versus-heart dilemma for our clients and global high-net-worth individuals whether to buy in cash or not. It’s always been a feature of the luxury global property market and the factors driving that decision typically start with how you position yourself as an attractive buyer in order to win a desired property or secure a discount. And, ultimately, the ability to be able to transact at pace can set buyers apart in these scenarios, and that’s very similar to the market I just talked about also.

However, given the global nature of luxury residential property buyers and their unique financial situation and all of their complexity, various other considerations around wealth planning, global currency exchange rates, global taxation regimes, you know, all of that has to be fully considered before making those sorts of decision. 

You know, decisions to buy in cash without fully considering these aspects can result in outcomes which may be irreversible. It’s critical that people seek timely and professional advice before considering a cash purchase to ensure every outcome has been appropriately deliberated. 

And there are a number of ways to achieve the benefits of being a cash buyer whilst not having to commit all your liquidity to the transaction. And also, I believe, you know, right now, if you commit all of your liquidity in the current interest rate environment, there’s a risk it can’t be leveraged out in the future due to the way that mortgage affordability is calculated. And I think that’s a really important factor that, again, seeking early and appropriate professional advice can ensure the solution, you know, is crafted in the right way.

JL: And that’s why we have you. Well, OK, look, just before I let you go, we talked a lot about the UK. Maybe a word on global trends. What are you saying globally?

SM: Sure. Well, there’s one trend at the moment I’m really excited by, and this is one that relates to global luxury property markets that specifically saw an acceleration of importance and, as a result, values based on factors that increased in demand during the pandemic. 

Some of those factors were already there underlying within those particular markets, but the pandemic window drove a number of very consistent types of activity which, when you sort of step back and you look at these markets, and I’ll give you three as an example that are geographically very distant from each other but have performed in exactly the same way. 

But the consistent factors they had was a lack of local supply of property, very, very tight rules on development and what you can and can’t build and where you can and can’t build it, high population density, an increase in the cost of labour, an increase in cost of materials, became popular draws for migrant workers, specifically professional migrant workers, maybe financial services etc, and favourable tax regimes.

And sort of, you can look at it over the last three years and think, goodness, right, the planets have really aligned for these particular areas, and it really gives a very strong outlook, not only in the short term but, actually, the medium and longer term. 

And I think specifically of markets that we work in in Barclays Private Bank in Monaco, Jersey and Singapore, you know, they’re geographically apart from each other, very different from each other, but when you think about those items that I’ve just listed, they’ve performed, you know, very well and are very positive in terms of anybody’s global index of property market in terms of holding value and long-term view.

So, I think those factors are very interesting and people have begun to think about spending more time in locations like that and having good communication links, whether that’s physical communication links or infrastructure communication links, to be able to do the day job or be able to travel to hubs, whether that be London, Paris, Berlin, Hong Kong etc, and be able to have all of that connectivity.

So, they’re markets that I think if we fast forward, you know, three to five years from now would have performed in a very interesting way and be an interesting case study.

JL: And I guess that’s why when people ask me for my view on real estate, I’ll always say it depends because it really depends where. Every market is a bit different, although there are similarities across the world. But, anyway, that was great. Thank you so much for all your time, Stephen, today. We’ll definitely get you back as we move past this peak in interest rates and see how things go from there.

Now, before we wrap up, a very quick update as to what to look for on the week ahead. The big focus this week will be on inflation. 

We’re going to have the inflation reading for September in Spain and Germany on Thursday. We’re going to have something that we typically don’t look at much, but that is gaining in importance, is the inflation for Tokyo, given what the central Bank of Japan is trying to do. 

And, closer to home, we’re obviously going to get the eurozone CPI for September as well as the US PCE for August, and both will come on Friday. So, we’re going to get a better sense as to what inflation is doing by the end of this week. And, of course, we will debrief all that next week.

In the meantime, though, let me wish you all the best for the trading week ahead.