It’s all about hitting the bull’s-eye – or in Japan’s case – not.
Yutaka Harada, the Bank of Japan’s (BOJ) newest board member, admitted at his inaugural press conference today that the 2% inflation goal the BOJ set in a two year time frame would be difficult if not impossible to achieve.
Japan isn’t the only one in danger of missing its inflation target. Europe faces growing deflation and the U.K. has hit zero inflation for the first time. The Fed similarly faces low wage and price inflation, yet is soon declare “mission accomplished” on stimulus as they raise rates. Don’t tell this to property markets or REIT investors around the world, whose market values are surging.
As the central banks around the world admit that price deflation and real wage stagnation is a long- term phenomena, they are focusing on what really matters to bank balance sheets, and the one area that monetary stimulus has proved a runaway “success” – property price inflation (if increasing unaffordabilty can be deemed a successful policy).
Each bank has its own mechanisms to spur property markets and consequently shore up bank balance sheets. The Fed bought over $1 trillion of mortgage-backed securities, sending mortgage rates to historic lows and as Bloomberg reports, “Wages climbed by 1.3% from the second quarter of 2012 to the second quarter of 2014, compared to a 17% increase in home prices around that time, according to a new report from RealtyTrac.” (A 13X greater rate of property price growth than wage growth, Bloomberg notes).
With rates rising and wage growth sluggish, the US increasingly depends on institutional and international investors searching for yield to purchase the inflated market. “In many markets, the housing recovery has “largely been driven over the last two years by buyers who are not as constrained by incomes – namely the institutional investors coming in and buying up properties as rentals, and international buyers coming in and buying, often with cash, “Daren Blomquist, vice president at RealtyTrac and author of the report, said in an interview.
The European Central Bank (ECB) has explicitly targeted the asset-backed security (ABS) market in their public purchase program with dramatic success on both ABS prices and consequently bank return on equity for new lending. Last month the ECB bought 4 billion euro in ABS. Bloomberg reports this pushed the prices of notes to the highest level in 7 years. “The debt sales are the first indication that the ECB is breathing life into the ABS market, which the ECB is targeting,” Bloomberg said.
“Average prices for bonds secured by assets ranging from Dutch mortgages to Spanish small business loans is at 98.2 on the Euro, near the highest since October 2007, according to data compiled by Barclays. They were quoted as low as 74.3 cents in May 2009, the data show”, Bloomberg said.
Consequently yields on the senior tranches, which are floating rate have collapsed to nearly zero. While much of the emphasis on the first round of purchases is that it “frees up bank balance sheets”, the more important long term effect not discussed is that a buyer of senior risk near zero yield significantly improves the return on equity on banks new lending after it’s securitised. As European banks place their AAA tranches with the ECB at near zero yield, the return on equity on their retained junior trances surges, i.e. by collapsing the yield of the AAA ABS tranches (“the funding assets”), the ECB has spurred property lending per their goal by driving the premium into the pieces of the lending structure retained by banks, thus driving up the return on equity of the securitised lending activity.
The hope is that by incentivizing securitisation in this manner, this will spur new lending and issuance in the moribund European ABS market. The ECB is targeting an important aspect of the price and transmission of credit in Europe that had all but collapsed.
According to Bloomberg: “Europe’s asset-backed securities market contracted more than 40% since 2010, while annual issuance averaged 77 billion euros over the past five years, down from a peak of 524 billion euros in 2006, according to JPMorgan Chase & Co. Sales will reach 100 billion euros this year, Morgan Stanley and Barclays forecast.”
The BOJ has gone a step further, via the direct purchase of REITS in their QE program, with Yutaka Harada opining in his inaugural comments that this program can be expanded.
This follows Bank of Japan Governor Haruhiko Kuroda’s comments in Japan’s parliament Monday that the central bank aims to “revive overall markets by lowering risk premiums” and that the purchases of J-REITS is “extremely small” compared to the size of those markets. As Bloomberg reports: “The remarks suggest Kuroda is comfortable that the central bank isn’t yet pushing any limits on its purchases of assets linked to Japan’s equity and property markets” Kuroda said the BOJ has bought about 190 billion yen ($1.6 billion) worth of J-REITS out of a market worth 10 trillion yen (less than 2% of the market. Minuscule compared to their 100% purchases of net JGB issuance).
REIT investors globally have harvested a windfall. Over the last year the largest traded U.S. REIT ETF (Vanguard) has surged 28% vs 11% for the S&P. In Europe the difference is more dramatic with REIT ETFs jumping 32% vs 16% for the Eurostoxx 50 Index. In Japan, REITs have slightly underperfomed the Nikkei (thus possibly the “room” for expansion of this program) nevertheless returning 28% vs the Nikkei’s 34%. However when viewed at a longer horizon Japan’s REITs have been the runaway global winner, up 107% in 5 years vs 77% for the Nikkei, 70% for U.S. REITs, and a mere 46% for European Reits (they are after all just getting started).
The efficacy of property targeting by central banks has not escaped the notice of the People’s Bank of China (PBOC). “In his report at the opening of the National People’s Congress, China’s premier, Li Keqiang, said the country will focus on encouraging investment and domestic consumption to maintain stable economic growth in 2015. One of the six areas of consumption Li highlighted was housing, listing it as the top category in the government’s plan to encourage consumption.” The PBOC is focusing on reducing regulations, bank ratio requirements, and reducing rates among other measures to bolster the property market and boost domestic demand. As we have commented before, given the reticence for China to devalue its currency as it looks to join the IMF’s Special Drawing Rights basket this year, the need for greater internal stimulus for domestic growth via a targeted QE on the property sector is a priority.
In every market the result has been and will be the same. Bank’s balance sheets are shored up, investors take over the property sector as affordability is driven further from wage earner’s reach. The great wedge between capital markets and housing as an item of personal consumption looks set to grow yet larger around the world as central banks push back their broader economic targets and focus on the one item they’ve proven they can succeed in inflating, namely property prices.
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