Feb 1, 2023
Bond Bulls Are Waiting for the Next Housing Market to Crack
(Bloomberg) -- For bond investors looking to bet big on a rally this year, signs of distress in the world’s highly-leveraged housing markets are only adding to their conviction.
Places like the UK, New Zealand and Sweden — where house prices are slumping and mortgage payments are rocketing — are high on their watchlist. The logic is that policy makers, loath to kill off a key engine for growth in many advanced economies, will pause or eventually reverse some of the aggressive tightening delivered over the past year.
Central banks warn that higher debt burdens are squeezing homeowners already struggling with inflated food and energy bills. With commercial property also floundering, almost $175 billion of real estate credit is trading at distressed levels, according to data compiled by Bloomberg.
Schroders Plc’s James Ringer has gone overweight gilts and Swedish government bonds after extensive analysis of which housing sectors are most at risk of a correction, and what that might mean for financial markets. Martin Harvey, a Wellington Management portfolio manager who runs the Hartford World Bond Fund, expects strong returns from Antipodean bond markets in 2023 for similar reasons.
“It does feel like this theme is starting to play out,” said Ringer. “The housing market is the most interest-rate sensitive part of any economy, so it’s a very good lead of where the rest of the economy could be in quarters to come.”
UK house prices fell for a fifth month in January, the longest string of declines since the financial crisis more than a decade ago, data from Nationwide Building Society showed Wednesday. Mortgage approvals fell to their lowest level in two and a half years in December, according to Bank of England figures published Tuesday.
In Sweden, some analysts expect a 1% economic contraction this year as home construction plummets. The number of companies filing for bankruptcy soared to the highest level in at least a decade in January, with builders accounting for a fifth of that figure.
Economists are warning of a scenario they call “mortgage dominance,” when housing-market pain can be enough to derail further rate hikes. The Bank for International Settlements noted last year that, while a moderate rise in rates could help tame overheating markets, a sharp reversal in house prices carries significant risk.
Central bankers are also wary. The Bank of Canada last week cited a substantial decline in housing market activity as it signaled a pause in rate rises. Sweden’s central bank governor said Tuesday that high household debt levels are a risk to the economy. The Bank of England warned in December that four million UK households would feel a significant increase in mortgage payments this year.
“Housing markets globally could be the big hurdle to central banks raising rates enough to tackle sticky inflation,” Eva Sun-Wai, fund manager at M&G Investment Management, wrote in a blog post in January.
The level of household debt and the proportion of short-term or variable rate mortgages are good indicators of housing market vulnerability, according to investors. Chris Jeffery, head of rates and inflation at Legal and General Investment Management, said those factors signal where “you are most likely to see the rate-hiking cycle biting first” and boosts the case for buying bonds.
Countries like Germany, which has the lowest home ownership in the European Union, according to eurostat data, or France, where regulation controls mortgage rate rises, are seen as less vulnerable to a real estate crack. In fact, the euro area’s economy has proved more resilient than feared and traders are pricing another 150 basis points of hikes by July. That led Schroders’ Ringer to offset larger positions in UK and Sweden bonds with an underweight in Germany.
The US also looks more resilient, as the prevalence of 30-year fixed-rate mortgages helped delay the impact of higher interest rates on homeowners. Analysts say it’s still too soon to gauge the severity of the downturn, and Federal Reserve Chair Jerome Powell may push back against wagers on rate cuts as policy makers meet this week.
To be sure, inflation remains a major threat despite a string of lower readings, imposing a challenge on policy makers willing to ease up soon.
Take Australia, where the housing market posted its biggest annual slump since 2008 last year and employment and retail sales are starting to fall. Yet inflation unexpectedly accelerated last quarter, forcing traders to price in an interest-rate increase at the Feb. 7 central bank meeting. Earlier this week, a surprise jump in Spanish inflation prompted traders to boost ECB rate-hike bets.
“We’re looking for where rate cycles might turn over relatively quickly and housing markets are a core part of that,” said Harvey.
--With assistance from Libby Cherry.
(Updates with detail on Swedish market in seventh paragraph.)
©2023 Bloomberg L.P.