By Patrick Ma, Director, Listed Products and Research, Admiral Investments
Nov 7, 2023 – The theme of a “higher for longer” interest rate outlook remained dominant in October for the global capital markets, especially following the release of the September FOMC meeting minutes that suggested higher interest rates might be necessary to cap inflation at the Fed’s 2% target. The US third-quarter real GDP grew at an annualised rate of 4.9% quarter-on-quarter, showing a resilient US economy. US bond rates soared in October on the economy’s strength and the anticipation of a larger-than-expected issuance of US bills. The US 10-year government bond yield breached a new high of 5%.
In addition, the sudden attack on Israeli civilians and foreign tourists by the Hamas militant group and Israel’s retaliation towards Hamas and its bases in the Gaza Strip had heightened geopolitical risks, raising risk premiums across different asset types. Most notably, the US dollar strengthened, with the US dollar index staying at the 106 level for the month.
With higher bond yields, strong USD and heightened geopolitical risks, the global markets came under tremendous selling pressure. Global equities dropped 2.9% in October, following a 4.4% fall in September. Asia Pacific region’s equity markets weakened further with a 4.2% decline. In addition to global economic and geopolitical pressures, a weak outlook for China’s economic growth and expectations of Japan’s tweaking its yield-curve control policies also contributed to weakness in equities in the region.
REITs fared worse under the circumstances. Global REITs and Asia Pacific REITs fell 5.0% and 5.6%, respectively, underperforming the equity markets. Japan REITs fared relatively better, with only a 3.5% drop, outperforming the country’s stock market. The expectations of Japan tweaking its yield curve and potentially changing monetary policy from a zero interest rate policy supported Japan REITs’ performance.
At the start of November, the US Fed put benchmark interest rates on hold, prompting market expectations that the rising interest rate cycle is ending. Investors were expecting interest rate cuts as early as mid-2024. The reversal of market sentiment from pessimism to bottoming out is reflected in the movements of US treasury yields and the US dollar index. The US 10-year government bond yield dropped from 5% to the current l4.577%, and the US dollar index retreated from the 106 level. Global capital markets return to a risk-on mode, with equities and other risk assets rising in price at the beginning of November.
Peaking global interest rates should be positive for Asia Pacific REITs, which are sensitive to interest rates and the USD strength that often accompanies changes in US interest rates. After the initial shocks of the Israel-Hamas war, the market also seemed adjusted to higher geopolitical risk premiums. In particular, Japanese REITs are seen as likely to continue their outperformance. Firstly, the Bank of Japan’s decision to tweak its yield curve control presages an eventual reversal of its longstanding zero interest rate policy, which we believe to be positive for Japan’s asset prices as its economy starts to enter a reflationary cycle. Secondly, while investor sentiment on real estate has stayed weak throughout the year, investor enthusiasm for Japan’s real estate assets is still high, especially for residential and industrial properties, which should support Japan REITs’ valuation.