Interpreting the Bond Market's Signals for Commercial Real Estate
Volatility has made its way back into the markets, and the U.S. economy appears to be walking a tightening rope. Timing the market has never been easy, but evidence for a slowdown may reside in some quieter economic corners.
In recent months, growth has been triggered by tax cuts, positive jobs reports (until last week at least), regulatory rollback, and overall macroeconomic momentum following nearly ten years of post-crisis recovery. Then rancor crept into the picture in the form of proposed tariffs as the back and forth between the U.S. and China stoked uncertainty around global trade.
These views are well documented among leading news outlets. What tends to get less attention is the bond market and what it may be telling us about the economy. Specifically, short- and long-term yield curve rates have been coming together in recent months, with the gap narrowing between 10-year and one-month treasury yields. In the past, this convergence often indicated a pending economic slowdown. Should the short-term curve cross the long-term curve at some point (not too soon we hope), we could find ourselves in a recession.
So what implications might this hold for those in commercial real estate? Prophesying is among the less profitable professions, but awareness and preparation can insulate against and any negative surprises.
What's an Asset Manager to do?
If short-term yields surpass long-term yields, then investors and lenders may shy away from longer term exposure. That sounds like it could be bad news for commercial real estate. Adding to that, the Fed's Stress Test Index could be signaling increased financial stress on markets. If the economy weakens, the typical sectors that feel pain early are those exposed to consumer discretionary spending, construction, and lending, to name just a few. Consumer credit is already getting tighter according to Fed data, and consumers appear to be saving more now than they were just a year ago according to commerce department data. The foundations for tighter economic times may be wrapping at our door.
For now, asset and portfolio managers should at the very least consider evaluating existing exposure to tenants in these more sensitive sectors. Look at the credit quality of material tenants. Monitor sources of liquidity and be mindful of their fixed cost coverage. Engage with the tenant, and consider requesting financial statements now for a baseline reading on credit if that option is available. And as always, reach out to us as a resource for questions and support.