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Weekly Comic: Banking collapses heighten Commercial Real Estate fear



Weekly Comic: Banking collapses heighten Commercial Real Estate fear

By Geoffrey Smith — The rout of 2023 is turning into a whodunnit without a murder weapon.

One of the big differences between the current wobble in the banking sector and 2008 is that the crucial weakness of banks involved has been on the liability side. It was the deposit runs from Silicon Valley Bank and Signature Bank that exposed the weaknesses in how they managed their assets: these were of good quality, but had to be sold hastily to cover demands for liquidity, thus making paper losses real ones.

That’s a clear contrast with 2008, when the core problem was junk mortgage loans offered to people who had little or no chance of repaying them.

We argued last week that one key reason to think that the financial system will avoid a rerun of 2008 is that there is no class of assets big enough or rotten enough to play the role that subprime credit did then. That is still true today. But if you were forced to finger one asset class take could play that role, it would most likely be commercial real estate.

CRE is a big market – accounting for over $5.6 trillion in outstanding loans, according to Goldman Sachs analysts. Concentration risks are also high. Over half of the total, Goldman says, is owed to banks. Worryingly, it has grown quickly: $725 billion has been thrown at the sector since the middle of 2021, according to the Federal Reserve. 

CRE is also a highly leveraged business, that can wipe out equity quickly when the cost of debt rises sharply, as it has done over the last year. Consultancy firm Oxford Economics forecasts that U.K. property prices will fall by 10% for a second straight year in 2023, due largely to changes in interest rates. Euro zone prices will also fall by 10%, after a 3% drop last year, Oxford’s Mark Unsworth reckons.

“CRE is highly interest rate sensitive,” Unsworth wrote in a note to clients. “After a decade of easy money, it now looks exposed, particularly the parts of the market that have used excessive leverage to boost returns, such as private equity.”

MSCI researchers, meanwhile, estimate that some $3.2 trillion of assets were sold over the 11 quarters when the bond yield was lower than 2%, a time when it seemed that cheap money would last forever and that yield-hunting was a low-risk strategy.

In the absence of adequate interest rate hedging (as with Silicon Valley Bank) or the ability to exact higher rents, a large amount of those property investments are now underwater. Big names in the sector, such as Brookfield (NYSE:) and PIMCO, have already let affiliates default on commercial mortgage-backed securities to cut their losses.

CRE investors aren’t stupid. They know this and they react as you would expect them to – by pulling their money today rather than tomorrow. That exposes their intermediaries – often Real Estate Investment Trusts, or REITs – to acute liquidity risks: office buildings cannot be liquidated quickly, except at a massive discount. Blackstone Real Estate Investment Trust has been rationing redemptions from its wealthy investor base for four months already, precisely to avoid such loss-generating firesales (thoughts and prayers for the University of California, which put in $4 billion at the start of the year).

Indeed, when a market like commercial real estate moves quickly, it is hard to know exactly what anything is worth, because sales volumes dry up. According to, Manhattan sales volumes were down 73% on the year in the fourth quarter, while the number of transactions was down by nearly half.

When real prices are hard to come by, lenders have not just the opportunity but also the incentive to fill the data vacuum with flattering valuation assumptions. It is at this point that we reacquaint ourselves with that old favorite from 2008, the ‘hard-to-value asset’ that just gets carried on the books at historic cost, even though no rational person would pay that amount for it anymore.

All of this is playing out at a time when uncertainty over the real estate market is exceptionally high. The pandemic may well have changed working patterns forever, and has certainly accelerated changes in shopping patterns. Mass layoffs at Big Tech and elsewhere are now hurting demand for new office space.

On his last earnings call, Vornado Realty Trust (NYSE:) chief executive Steven Roth poured scorn on landlords who claim they can work their way from around 60% in-person office occupancy back to 90%, noting that far fewer workers head into the office on Fridays post-COVID than was the case pre-COVID.

“I think you have to assume Friday is dead forever,” Roth said.

If an investor can’t be sure how many days there are in a week anymore, then what certainty can he or she attach to more nebulous things like book valuations? For now, perhaps the only thing standing between us and a real crisis is the fact that CRE, unlike subprime, doesn’t represent the intersection of Main Street and Wall Street, which is where most market car crashes happen.

Even so, there is more than enough wrong with the sector to warrant extreme caution in the current weeks.



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Marketmind: Counting down the $70 billion to a debt deal




Marketmind: Counting down the $70 billion to a debt deal
© Reuters. FILE PHOTO: U.S. President Joe Biden hosts debt limit talks with House Speaker Kevin McCarthy (R-CA), Vice President Kamala Harris and other congressional leaders in the Oval Office at the White House in Washington, U.S., May 16, 2023. REUTERS/Evelyn Hock

A look at the day ahead in European and global markets from Vidya Ranganathan

The week draws to a close with pretty much the same buzz around artificial intelligence and U.S. debt diplomacy that it kicked off with.

Stock markets were getting a breather after the excitement over the blowout forecast from chipmaker Nvidia (NASDAQ:) Corp and the follow-through rally in AI-related companies, which powered the Nasdaq’s best day in three weeks.

maintained its momentum, however, after data showed inflation again well above policy targets and as foreign money poured into the market.

But all eyes are on the U.S. debt ceiling debate, where it looks like President Joe Biden and top Republican lawmaker Kevin McCarthy are just $70 billion apart on discretionary spending, according to a person familiar with the talks.

The deal’s going down to the wire, which itself is a moving target. Treasury’s announcement of a slate of bill auctions for early next week had some market participants suggesting the debt ceiling’s so-called “X-date”, when the government runs out of cash, may not in fact be June 1. Figures on Thursday showed that Treasury’s cash balance is down to just $49.47 billion.

The deal is not final, and work requirements for anti-poverty programs are a sticking point as is funding for the Internal Revenue Service to hire more auditors and target wealthy Americans. But funding for discretionary spending on military and veterans is on, as per sources.

Meanwhile, markets are growing less confident that the Federal Reserve will keep rates on hold in June. The CME FedWatch Tool now puts the chances of a quarter-point rate rise to 5.25-5.50% on June 14 at more than 50%.

Main economic indicators on Friday include the U.S. Commerce Department’s personal consumption expenditures (PCE) price index figures for April, which could show a small rise similar to March.

Key developments that could influence markets on Friday:

U.S. PCE price index

ECB’s Philip Lane and Croatian central bank Governor Boris Vujcic speak at events

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Inflation in Tokyo slows in May, but key gauge hits four-decade high




Inflation in Tokyo slows in May, but key gauge hits four-decade high
© Reuters. FILE PHOTO: A man buys fish at a market in Tokyo, Japan March 3, 2023. REUTERS/Androniki Christodoulou/File Photo

By Takahiko Wada and Leika Kihara

TOKYO (Reuters) -Core consumer inflation in Japan’s capital slowed in May, but a key index stripping away the effect of fuel hit a four-decade high, underscoring broadening price pressure that may keep alive expectations of a withdrawal of ultra-loose monetary policy.

The data for Tokyo, which is seen as a leading indicator of nationwide trends, showed companies continued to pass on rising costs to households in a sign inflationary pressure could last longer than the Bank of Japan (BOJ) projects.

The Tokyo core consumer price index (CPI), which excludes volatile fresh food but includes fuel costs, rose 3.2% in May from a year earlier, government data showed on Friday, roughly matching a median market forecast for a 3.3% gain.

While inflation slowed from the previous month’s 3.5%, it stayed above the BOJ’s 2% target for a full year as steady food price gains offset falling fuel costs, the data showed.

An index that strips away both fresh food and fuel costs rose 3.9% in May from a year earlier, marking the fastest pace of increase since April 1982 when Japan was experiencing an asset-inflated bubble.

“Inflation already appears to be overshooting the BOJ’s forecasts. Prospects of higher wages are prodding more firms to pass on rising labour costs through price hikes,” said Takuya Hoshino, chief economist at Dai-ichi Life Research Institute.

“Depending on how upcoming data plays out, there’s a chance the BOJ could respond to elevated inflation with a tweak to its ultra-loose policy,” he said.

Separate data released on Friday showed the price service companies charge each other rose 1.6% in April from a year earlier, marking the 26th straight month of gains, as the economy’s re-opening from pandemic curbs boosted tourism demand.

Japan’s economy is finally recovering from the scars of the COVID-19 pandemic, though risks of a global slowdown and rising food prices hang over the outlook for exports and consumption.

With inflation already exceeding its target, markets are rife with speculation the BOJ could soon phase out ultra-loose monetary policy under new governor Kazuo Ueda.

Ueda has repeatedly said inflation will slow in coming months as cost-push factors dissipate, and that the BOJ will maintain ultra-loose policy until stronger wage growth ensures Japan can sustainably see inflation hit its 2% target.

But he told a group interview on Thursday that the BOJ will “act swiftly” if its inflation projection proves wrong, and could tweak policy if the cost of stimulus outweighs the merits.

In a Reuters poll released on Friday more than half of the analysts surveyed expect the BOJ to start unwinding its yield curve control (YCC) policy by end-July, such as by raising the current 0.5% cap set for the 10-year government bond yield.

The BOJ will review its quarterly growth and inflation forecasts at a two-day policy meeting concluding on July 28.

Under projections made in April, the central bank expects core consumer inflation to hit 1.8% in the current fiscal year ending in March 2024. That is much lower than a 2.3% forecast in a poll released on May 15 by think tank Japan Center for Economic Research.

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Analysis-Wall Street prepares for Treasuries mess as default looms




Analysis-Wall Street prepares for Treasuries mess as default looms
© Reuters. FILE PHOTO: The Wall Street entrance to the New York Stock Exchange (NYSE) is seen in New York City, U.S., November 15, 2022. REUTERS/Brendan McDermid

By Gertrude Chavez-Dreyfuss, Saeed Azhar and Davide Barbuscia

NEW YORK (Reuters) – Anxiety is increasing in parts of Wall Street that rely on Treasury securities to function, with some traders starting to avoid U.S. government debt that comes due in June and others preparing to deal with securities at risk of default.

U.S. President Joe Biden and top congressional Republican Kevin McCarthy are closing in on a deal that would raise the government’s $31.4 trillion debt ceiling for two years while capping spending on most items, as a June 1 “X date” approaches for when the Treasury Department has said it could run out of money to pay its bills.

Treasury securities are used widely as collateral across markets. A key question for market participants is how would bonds that are maturing next month be treated if a deal is not reached in time and the Treasury is unable to pay principal and interest on debt.

One such area is the $4 trillion repurchase, or repo, market, for short-term funding used by banks, money market funds and others to borrow and lend. Some counterparties, including banks, were shying away from Treasury bills maturing in June in bilateral repos, where the trade is between two parties, said an executive at a U.S. fund manager who decline to be named. There are 14 T-bills maturing in June.

Scott Skyrm, executive vice president for fixed income and repo at broker-dealer Curvature Securities, said some repo buyers or cash lenders did not want to accept any bills maturing within a year. Skyrm said stress began to appear in the market at the start of May, with some lenders refusing to accept Treasury bills that they perceived as at risk of delayed payments in some types of trades. He declined to name buyers who were not accepting T-bills.

“I don’t think counterparties want to deal with collateral around the X-date,” said Jason England, global bonds portfolio manager at Janus Henderson.

An executive at an independent broker-dealer in the repo market who declined to be named said they were still financing Treasury securities for now. Their focus, instead, was on rewiring their systems in anticipation of steps that the Federal Reserve and Treasury might take to prevent a default. The executive said they expected to work through the weekend to get their systems in place.

At least three big banks that deal directly with the New York Fed in its implementation of monetary policy were also accepting all Treasury securities, three sources familiar with the situation said.

The dislocations in the repo market, a crucial source of funding for day-to-day operations of many financial institutions, come amid growing stress in financial markets as talks drag on in Washington. A default could have devastating consequences, as the $24.3 trillion treasuries market underpins not just the U.S. but the global economic order. 

To be sure, a default remains a distant possibility. Many market participants expect the Treasury will be able to continue to pay its bills after the June 1 date as it could conserve cash in other ways to prioritize debt payments. 

In the case that it needs to delay payments on some securities that are maturing, expert groups have suggested in the past that Treasury could help markets to keep functioning by extending the so-called “operational maturity date.” The proposal, detailed in a December 2021 contingency planning document prepared by an expert group, calls for extending the maturities of securities at risk of default by one day at a time.

That could allow the security to be technically traded and available for settlement on the Fedwire Securities Service system used for government debt. However, the group warned that it would need many broker-dealers to adjust their trading systems to also be able to do so and the consequences of a delay in payments on securities would still be severe. 

The broker-dealer executive said the process was cumbersome because maturity dates subsumed several other calculations about the value of the security. Extending the maturities required the firm to “basically break their own system,” the executive said. 

Even so, allowing the security to default would be worse. “If you don’t extend the date, I really don’t know what happens,” the executive added.

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