This is my regular weekly market update.
Investors hate surprises and we got many this week – to the point where I begin to wonder whether markets are fundamentally broken as they were driven higher by good results from some of the magnificent seven, despite the shock revelation of mounting losses from commercial property by little-known banks in New York and Tokyo. And then the US jobs number came in so hot, as to lift bond yields while Central Bankers this week played a cautious hand, suggesting that they need to see more evidence before they start cutting rates, against market expectations.
Let’s start with commercial property. The problems particularly the office sector are well known: a combination of remote work and ageing buildings has pushed up vacancy rates and pushed down valuations; office property values in the US fell more than 20 per cent last year.
That’s a problem for landlords that must refinance loans against commercial property; about $US2.2 trillion of loans from the US and European commercial real estate sectors will come due between now and 2025.
US property billionaire Barry Sternlicht told a conference this week the US office property sector was worth $US3 trillion, and now it’s worth $US1.8 trillion. “There’s $1.2 trillion of losses spread somewhere, and nobody knows exactly where it all is.” At least some is in America’s regional banks, where commercial property loans account for about 30 per cent of all loans, compared with 6.5 per cent at large US banks.
Regional US lender New York Community Bancorp and Japan’s Aozora revealed problems with commercial property loans and dropped their share prices significantly underscored a critical question: is this the start of something bigger? Morgan Stanley strategist Mike Wilson says that even if banks holding this debt can cope with the losses, it crimps their ability to lend to other businesses.
But if there’s one broader lesson from the sudden re-emergence of commercial property fears, then it’s this: we still haven’t cleared out the excesses that built up in the era of very low interest rates, and were compounded during the pandemic period of extreme froth.
The world is now so indebted, and so financialised, that these cycles aren’t allowed to occur. With “households and corporates becoming hooked on leverage”, we can’t let bubbles pop because they’re “the essence of our economies”.
This is why investors are cheering the prospect of rate cuts with such gusto. And it’s why the fear of higher-for-longer interest rates – which the Federal Reserve reminded the world of on Thursday by killing off hopes of a March cut – is still real.
“The market has been horribly wrong about the near-term trajectory of Fed policy and this is another instance where that’s the case,” said Kevin Gordon, senior investment strategist at Charles Schwab in New York.
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