The unexpected U.S. election outcome has put the spotlight on the future direction of global interest rates.
2016 is a year of unprecedented low or even negative interest rate levels globally. The Bank of Japan pushed interest rates into negative territory, and the values of world’s negative-yielding bonds soared over the year. Bloomberg estimated that the amount of negative-yielding public and corporate bonds totaled US$10-12 trillion, mostly in Japan and Germany.
Chart 1: Negative-yielding bonds worldwide
Source: Bloomberg, October 2016
Normalisation of US interest rates will continue and it is still a safe bet for one or two Fed rate hikes between now and mid-2017, but the path of US monetary policy in the medium-term is less certain. Oxford Economics is now forecasting US GDP growth averaging under 2% per year with risks towards the downside. However, it is also likely that President Trump’s deficit spending plan will stoke higher inflation.
Central banks in Europe and Asia should remain accommodative in 2017 but there is less scope for further easing. The European Central Bank should continue quantitative easing (QE) but in tapered form. Here in Asia Pacific, China will cushion reforms with credit expansion, but at the same time watching out for shadow banking and corporate debt. The Bank of Japan may refrain from more QE but instead targets 10-year government bond yield at zero percent.
Despite potential for rate rises in the medium term, it looks like global interest rate levels will generally stay low next year. And Asia Pacific real estate should be relatively well placed in this scenario.
Capital continues to be deployed into investment will help buoy corporate occupational demand and rent performance. Attracted by real estate’s safe haven nature and relatively higher returns, some of the world’s largest investors are still looking to increase their allocations to the asset class. Not surprisingly, achieving positive returns will remain challenging. With yields in core asset classes under pressure, investor demand has pushed A grade property yields in Asia Pacific towards new lows although positive spreads to risk free rates remain.
In these times of uncertainty, investors should also stay vigilant towards risks. Due to prolonged period of low interest rates, valuations look stretched in the housing markets in Greater China and some cities in Australia. Hong Kong seems particularly frothy (see chart). Recent price rises have prompted the government to announce in November a more than double increase in the stamp duty on property transactions across the board. It remains to be seen how the market will react to the new policy measure plus the expectation for future rate hikes.
Chart 2: Some housing markets look frothy
Source: The Economist, Global house prices
Lastly, currency volatility, in part due to uncertain interest rate outlook, will be an area of concern for cross border investors. Currency volatility after Brexit and immediately after the US elections has shown that it has a big impact on real estate total returns for international investors, and it will continue to impact on real estate returns the year ahead.
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