Faris Lee Experts Break Down the Flattening Yield Curve
The yield curve has taken a turn recently that has caught the eye of many in commercial real estate. That’s mainly because in the past as the difference between longer- and shorter-term bonds flattens and the gap narrows, it has been a harbinger of economic troubles. Connect Media asked Faris Lee’s Jay Quinn and Rick Chichester to share insights on what the yield movement means and how it may play out in our latest 3 CRE Q&A.
Q: What does a yield curve flattening mean and why is this happening?
A: Jay Quinn During healthy economic growth, the yield on a 30-year bond usually would be three points higher than the yield on a three-month bill. An inverted yield curve means investors believe they will make more by holding onto a longer-term Treasury than a short-term one. They know that with a short-term bill, they have to reinvest that money in a few months. If they believe a recession is coming, they expect the value of the short-term measures to plummet soon.
So, why does the yield curve invert? As investors buy more long-term Treasury bonds, the returns on those bonds fall. They are in demand, so they don’t need as high of a yield to attract investors. The demand for short-term Treasury bills falls. They need to pay a higher yield to attract investors. Eventually, the yield on short-term Treasuries rises higher than the yield on long-term bonds, and the yield curve inverts. Markets sold off heavily in the last couple of weeks as the yield curve partially inverted, the first inversion since before the Great Recession. The sell-off immediately spurred a flight to quality; the 10-year T yield dropped a low 2.82% on December 7th, the two-year fell to 2.69%.
Q: Should we be concerned about this? Why is it scary?
A: Quinn Many market-watchers interpret the flattening yield curve as a signal that a slowdown is coming for this bull market. In actuality, though, it’s closer to the truth to say that a flattening yield curve indicates that many investors believe that we are heading toward recession. The current yield curve is not similar to past occurrences. Recent statements by ex-Fed Chairs Bernanke and Yellen suggest a feeling that this indicator may not be relevant. Bernanke pointed out that regulatory changes and quantitative easing in other jurisdictions have distorted the standard market signals (by normal he means the old normal). However, the Fed is set on raising rates this week, despite pressure from the President to leave rates unchanged. The futures markets in Fed Funds and the LIBOR curve have lowered their 2019 rate forecasts considerably over that past few weeks, as economic growth expectations continue to cool in China and Europe, and the effects of tax cuts and government spending will be wearing off in the U.S.
Q: What will be the impact on retail real estate and the economy?
A: Rick Chichester The yield curve has been a relatively accurate, far-leading indicator of investor sentiment with regard to economic stability and growth. It is important to note that for the past 30+ years an inverted yield curve has preceded every recession by 6 to 24 months, which is why, too often, a recession gets called too early, or just ignored. With that said, we are long in our economic recovery and expansion. We have built most of this momentum via abundant, inexpensive debt, the significance of which cannot, and should not be ignored. The World economy is slowing, emerging markets are at risk, and the US is moderating as a result, but, for the near term, the economic fundamentals are sound.
I think the equities market might be over-reaching in the short term and looks to be pricing for either no growth or a recession, where in truth the market might be simply overpriced and adjusting.
As for alternative investment, commercial real estate can be an excellent investment, especially in times of equity market challenges and dislocation. As for property sectors, retail holds some of the best values for investors, as retail and retailers have already filtered through many of their issues and repriced accordingly. The economy is fundamentally sound, and consumer confidence is good albeit it most likely to moderate in 2019.
The yield curve is an important metric and suggests that now is an excellent time to begin to risk adjust your investment strategies, re-balance your investment portfolio. Retail real estate provides an attractive investment option to consider going forward. But, retail real estate is not passive and needs to be actively managed to minimize risk and optimize value.