Aided by a reversal in Fed monetary policy, BBB corporate bond yields have declined dramatically through the first half of 2019 to multi-year lows. Since cap rates remained relatively unchanged from the previous quarter, the cap-rate-to-corporate-bond-yield ratio spiked, raising the relative value of commercial real estate to fixed income. However, given the volatility of interest rates in recent quarters, the ratio could continue to swing widely.
Listed real estate returns rebounded through the first half of 2019, erasing the effects of a tumultuous end to 2018. Overcoming financial market volatility, healthy market fundamentals across most property sectors supports REIT investment. The REIT total return for the first half of the year was 17.0%, while the return for private real estate was 3.3%, which maintained a positive but decelerating trend fueled increasingly by income growth.
Sustaining two-months of consistent yield curve inversion, the 3-month/10-year Treasury spread continued to fall through early August, sending its strongest alarm signal since prior to the GFC. The combination of rising U.S.-China trade tensions, a slowing global economy, and the possibility of a “no-deal” Brexit, have overshadowed signs of positive economic growth domestically. However, the picture is clouded by central banks’ unprecedented manipulation of rates through quantitative easing.
The leading economic indicators index has seemingly plateaued, declining 0.3% from the previous month, following five consecutive months of gains. Driven by weakness in manufacturing activity and residential permits, as well as the flat yield curve, the LEIs recent performance points to more subdued economic growth through the remainder of the year.
As the U.S. economy added jobs at an above-average rate of 173,000 jobs per month through July 2019, the unemployment rate remained near its cyclical low of 3.6% through the first half of 2019. Since the current unemployment rate is still below recent trend, the economic outlook remains sanguine.
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