Following the spike in corporate bond yields through a turbulent 4Q18, yields declined through the first quarter of 2019. Positive signals on the health of the U.S. economy and the Fed’s reversal on interest rates mollified corporate bond markets. Cap rates were relatively unchanged during this time. As a result, the cap-rate-to-corporate-bond ratio rose modestly to 114 bps in 1Q19. Although the spread is below its long-term historical average of 118 bps, it remains within one standard deviation of this average, indicating that commercial real estate remains fairly priced relative to fixed-income alternatives.
Following a lackluster performance through the final months of 2018, the listed real estate sector regained its footing through the early part of 2019, resulting in a total return of 15.9% in 1Q19. In contrast to the listed sector’s recent volatility, private real estate remained steady, generating a return of 1.8% during the first three months of 2019, supported by steady income returns and modest improvement in capital growth relative to recent quarters.
The term spread continued to tighten through May 2019, reaching its lowest level this cycle – a reflection of growing investor uncertainty about economic growth going forward. The 3-month/10-year Treasury spread contracted to single-digit basis points, as a yield curve inversion appears increasingly likely. With no rate hikes expected through the remainder of 2019, upward pressure on short-term rates will recede, while this still- accommodative interest rate environment should also promote growth, rising inflation and a widening term spread. The reliability of the yield curve as a growth indicator has come into question, given the artificial constraints on the term premium resulting from quantitative easing (QE). Although QE has likely distorted the timing between yield curve inversion and recession, the shape of the yield curve remains a valuable early indicator.
Supported by continued employment growth, the recent rebound in stock prices, and improved consumer expectations, the leading economic indicators index increased by 0.1% from the previous month to 111.9 in March 2019. Despite the gains through the early part of 2019, the index’s more modest performance in recent months portends a deceleration in economic growth over the near term.
After trending up through late 2018 and breaching the 4.0% mark in January 2019, the unemployment rate declined in subsequent months. The unemployment rate reached a new cyclical-low, slipping to 3.6% through April 2019, supported by healthy employment growth. Through the first four months of 2019, the monthly pace of job creation averaged 205,000 jobs – a pace on par with the rate of employment gains observed in recent years.
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