May 2018

May 2018

Commentary

With the Academy Awards out of the way, global media attention now turns to the HANAs – the Oscars of the housing finance world. With Centrus and several of our clients shortlisted for awards, it promises to be a humdinger of a lunchtime, maybe an evening too…

Moving on to more mundane matters, one of the biggest first world challenges facing us at the moment is whether or not to put our winter coats away. The weather seems to oscillate between delightful warm Spring days and a distinctly cold, wet and windy British Winter which depending upon one’s preparedness and level of decision making skills can lead to one of several outcomes:

  • Warm, dry and snug
  • Cold, wet and miserable
  • Warm and dry but grumbling about lugging a heavy coat around with you

This left me feeling a certain empathy towards Mark Carney and the Bank of England’s Monetary Policy Committee as they try to plot a course between the chill wind of a slowing economy and the rising temperature of inflation. Poor recent GDP figures (0.1% growth for the quarter vs an expected 0.3% print) threw expectations of a 25 basis point base rate rise in May into serious doubt, re-enforcing the recent rally in gilt and swap yields.

Once again this highlights the on-going debate between those who believe we are at a long-term secular turning point in interest rates and their opponents who believe we are in for a long Japanese style deflationary grind at near zero interest rates. As ever, we aren’t foolhardy (or perhaps clever) enough to proffer our own position on the matter other than to point out that the risks of being wrong in one direction are considerably greater than the benefits of being correct in the other.

In the meantime, investors continue to deploy into corporate fixed income and alternative assets regardless, largely because they have little other choice, seeking at least some diversification away from government debt yielding next to nothing and equities trading at historically elevated valuations. While public market investors been supportive of recent long dated issuance from the likes of Optivo, Clarion and Bromford, the tone of the market has been somewhat softer (perhaps in anticipation of larger volumes of issuance from HAs) and this has been reflected in new issue premia of as much as 10bps. However, in the private placement space, there is some evidence that competition as new investors enter the market is supporting a narrowing of the premium over public market deals.

Away from the fixed income market, we covered some of the recent woes of the publicly listed social housing REITs in our last monthly update and the housing regulator has recently announced that it will be scrutinising some of the HAs entering into financing deals with these investors. However, readers will be aware of our view that the housing sector is unlikely to deliver its output ambitions by harnessing debt alone and that accessing the deep pools of equity capital available in the institutional market will be a key development over the next few years. The announcement by one of the UK’s largest insurers Legal & General that they have set up L&G Affordable Homes, a wholly owned housing provider illustrates that this trend is already gathering momentum.

Financial Markets and Economics Overview

April has seen a flurry of mixed market data, which has reduced the probability of a rate hike in May, which once stood at 90% at the beginning of the month. Positive outlooks based on a strengthening labour market and lower than expected inflation figures have been offset by a shock UK GDP growth data and low retail sales.

The high levels of inflation over the last few months has been a key driver for the Bank of England to hike rates in the near future but the downward trend, which began in February, continued as inflation fell to its lowest level in a year to 2.5% in March. This was below the expected forecast of 2.7%. Wage inflation on the other hand saw an increase of 2.8% in march, which meant that for the first time this year, UK workers saw their real wages rise. Unemployment figures also fell from 4.3% to 4.2%, which was mainly due to 55,000 more people in work than in the previous period. The pick up in wage growth and falling unemployment rate could also provide a signal that the slack in the labour market is tightening, which would eventually result in higher inflation for consumers. So although inflation fell more than expected, the mechanics of the labour market appeared to still provide the Bank of England good reason to raise rates from 0.5% to 0.75% in May.

The first hint of a push back on rate hikes came mid-April, when Mark Carney, Governor of the Bank of England, made a hawkish statement stating that the committee were in no rush to tighten markets soon. Later in the month, the UK was hit with the weakest annual growth figures since 2012. Growth slowed to 1.2% from 1.4%, whilst on a monthly basis the economy grew by just 0.1% in Q1 of this year when the forecast was 0.3%. Moreover, the data release caused sterling to depreciate again, with the month end rate falling standing at $1.377. Prior to the data, sterling had hit its high since Brexit referendum in 2016 to $14377.

Poor weather over February and March and the squeeze on consumer incomes led to low retail sales, which fell by 1.2% during this period. This was more negative than analysts’ initial expectations of 0.5%. This, coupled with the weakening of the economy has caused the market to hold back their expectations on an early rate hike in May.

UK equities have however rallied over this time, as the depreciation of the sterling continues to boost the attractiveness of stocks and they remained  resilient to weak GDP figures.

On the back of the sentimental view of the weak GDP figure, UK government bonds rallied and yields fell. However, when comparing on a monthly basis, the 30 year gilt yield has risen by 12bps to 1.83%. LIBOR instead has remained steady with very small movements, except on the 30 year 6ML, which as increased by 15bps to 1.65%.

House prices received positive news, as the Nationwide HPI showed 2.6% year-on-year growth, which was an increase compared the index over last two months. The optimistic numbers were due to a seasonal uplift in demand. However, with the subdued outlook on the UK economy, and the possibility that if inflation creeps up again, the squeeze on the pockets of consumers is likely to mean that house prices this year will grow modestly.

Interest Rates

Inflation

Capital Markets

Bank Credit