先進国

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Highlights We took a walk along a section of Fifth Avenue that is home to several mass affluent retailers, … : Sometimes strategists have to get out from behind their screens and take a look around, so we made a survey of the retail spaces on Fifth Avenue between 14th and 23rd Streets. … where the enormous glut of storefronts demonstrated that not every segment of the economy is subject to upward inflation pressure: We counted 78 spaces, only 49 of which were filled. It's a great time to rent retail space in the Flatiron/Union Square area and may well be in much of the rest of the country, too. Overall, the implications from our one-mile stroll appear to be constructive for financial markets and the economy: Stories about tight supplies and rising prices are getting all the headlines, but there are also pockets of the economy with excess capacity, and the inflation genie is not yet out of the bottle. Declining commercial rents help much more of the publicly traded universe than they hurt, and we still like equities. Feature Sometimes economists have to yank their heads out of the blizzard of data and models swirling around them and take a look at the real world beyond their screens. We did so last week, walking along a nine-block stretch of Manhattan’s lower Fifth Avenue. The segment, between 14th and 23rd Streets, runs from Greenwich Village’s prewar apartment buildings and nineteenth-century townhouses to the turn-of-the-century Flatiron Building, traversing the heart of Silicon Alley and running just west of some of the city’s best restaurants. Although the well-to-do long ago decamped uptown (Teddy Roosevelt’s and Edith Wharton’s childhood homes were within a block of our route), and the most elite retailers from the area’s Ladies’ Mile heyday followed, its heavy concentration of storefronts are generally filled by retailers seeking to appeal to a mass affluent constituency. In other words, it’s a nice area and one would expect those storefronts to be occupied, or in the process of being quickly refurbished to meet the needs of their next tenants, when the economy is booming. Instead, we find that only 49 of its 78 retail spaces are currently filled, leaving a whopping 37% vacancy rate.1 A two-part schematic of the properties shows the blocks from 14th to 19th Streets (Figure 1) and from 19th to 23rd Streets (Figure 2). The rendering treats every property as if it were the same size and makes no attempt to reflect its true relative scale. Blank spaces are inserted solely to balance blocks with unequal numbers of storefronts on the east and west side of the street. A vacancy’s most recent tenant is listed only when it can be definitively established by onsite and/or internet examinations. Figure 1Fifth Avenue Storefronts, 14th Street To 19th Street Figure 2Fifth Avenue Storefronts, 19th Street To 23rd Street A Tale Of (At Least) Two Economies The Many Winners The tumbleweeds blowing by the empty storefronts on Fifth Avenue illustrate the economic bifurcation that has resulted from the pandemic and the policy efforts undertaken to combat it. A handful of segments are suffering badly, which is par for the course after a recession, but an unusually high number of the rest are thriving. Many households in the bottom two-thirds of the income distribution have received more income than they would have if the pandemic had not occurred. The low-income unemployed were able to pocket more from augmented unemployment insurance (UI) benefits than they did from their jobs, while all singles earning $75,000 or less and married couples earning $150,000 or less were eligible for three rounds of economic impact payments that amounted to $3,200 per adult and $2,500 per child ($11,400 in total for a family of four). Constraints on their ability to spend their windfalls have bloated their savings and placed them on a sounder financial footing (Chart 1). Chart 1Aggregate Household Debt Is Manageable And Easy To Service Households in the upper reaches of the income distribution have seen their wealth expand as generous monetary and fiscal policy helped financial markets recover faster than you can say “exploding budget deficit.” Suburban and exurban homeowners have seen the value of their homes surge (Chart 2, top panel) and many homeowners, no matter where they reside, have been able to refinance their mortgages at lower rates (Chart 2, bottom panel), pushing down their monthly payments. Nearly all households that were able to maintain their income have saved more since the onset of COVID-19 simply because of their reduced ability to consume amidst activity restrictions (Chart 3). Chart 2Homeowners Have Had A Good Pandemic Chart 3Households' Pandemic Windfall Large-cap business borrowers, who have participated in the cascade of corporate bond issuance that has allowed them to pre-fund their cash needs, term out their debt and reduce their debt service burden, have also been among the winners. So, too, have small-business employees who continued to be paid thanks to the forgivable Paycheck Protection Program loans extended to their employers. They may not have reaped the rewards of the median unemployed worker who received UI benefits exceeding their pay by more than a third, but they did get to share in the economic impact payment bounty. Banks have escaped the credit losses that reliably accompany a recession (Chart 4) and can look forward to capital-boosting loan-loss reserve releases as the year proceeds. Chart 4Banks Have Had A Good Pandemic, Too The Losers Chart 5CRE Weakness Is Not A Systemic Threat The reason why the forgoing list of winners is so long, and indeed, why equities and credit have had such a good recession, is because Congress and the Fed stitched together an enormous safety net. It couldn’t break everyone’s fall, however, and so there have been some losers. At the top of the list are the proprietors of PPP businesses, like restaurants, bars, concert venues and independent theaters, which have operated at partial capacity (at best) or have simply seen demand evaporate as cities cleared out and office workers remained home. On the territory covered by our walking survey, Eisenberg’s,2 which had occupied the same space opposite the Flatiron Building from 1929 to 2020, is the poster child for this unfortunate group. These independent businesses’ landlords or the lenders who hold their mortgages must be feeling the pinch, too. Despite rock-bottom interest rates that have pushed down the cost of financing property purchases, retail property cap rates (akin to the inverse of their P/E ratios) have been creeping higher, reaching a seven-year high in March, per Real Capital Analytics data on Bloomberg. It is easy to envision portfolios of properties on the nine blocks of our survey generating losses, as even one space with no revenue can be enough to make a handful of properties a loser. It is also easy to see landlords missing mortgage payments. The good news for the financial system is that overall bank exposure to commercial real estate (CRE) loans is at the low end of its 35-year range (Chart 5, top panel), with small banks holding two-thirds of them (Chart 5, bottom panel). While CRE loans account for a quarter of small banks’ aggregate loan book, they comprise just 6% of large banks’ lending portfolios (Chart 5, middle panel). A CRE credit event would sting commercial mortgage-backed security (CMBS) investors, like the life insurers and pension funds that have been avid CMBS buyers, but it would not have any meaningful adverse impact on the availability of credit. Investment Takeaways From A Mile Of New York City Sidewalk Falling rents will help S&P 500 profit margins. Supply and demand dictate that retail rents on Fifth Avenue between 14th and 23rd Streets will fall. 37% of its spaces are empty and they are owned by a patchwork of individual landlords, represented by at least five separate CRE brokers. Competition among the landlords to rent the spaces – to get any revenue in the door to offset the fixed outflows for mortgage payments and property taxes – will be fierce, just as it will among the brokers seeking to capture commissions, and it should preclude any potential for supplier collusion. This is a lessees’ market if there ever was one. Table 1Tenants Outweigh Landlords In The S&P 500 The Fall 2020 edition of the semi-annual retail rent report compiled by the Real Estate Board of New York (REBNY) echoes that conclusion. The “decreases [in average asking price-per-square foot rents] are historic, with 11 corridors [of the 17 surveyed] experiencing their lowest … averages in at least a decade. While asking rents dropped significantly, taking rents can be much lower, with some brokers citing average differences … around 20%. Increases in retail availabilities and feedback from … brokers indicate that we are in a tenant’s market.”3 The vacancy picture is not so bleak everywhere across the country, but many shopping center, strip mall and enclosed mall owners are likely to have to drop prices or ease terms to entice tenants. A shift in surplus from landlords to retail tenants should be afoot nationally, just as it should be from office owners to office tenants. Those surplus shifts will benefit S&P 500 earnings, as the aggregate market capitalization of retailers with a physical store presence far outstrips the market cap of retail REITs, and the aggregate market cap of S&P 500 constituents that rent office space dwarfs the market cap of office REITs (Table 1). Brick-and-mortar retail isn’t dead. Chart 6Absence Makes The Heart Grow Fonder The rise of internet retailing has been perhaps the single biggest business development of the twenty-first century, and last spring’s lockdowns accelerated its already rapid market share gains. But e-commerce has lost some share in the early stages of relaxed restrictions and it will presumably lose more once a fully reopened economy allows people to re-engage in public activities (Chart 6). We do not challenge the proposition that e-commerce will take an even greater share of retail sales in the future, but the revealed preferences of retailers indicate that they believe it is important to maintain a physical presence. Retailers like The Gap, with three of its brands occupying the entire western side of Fifth from 17th to 18th Streets as well as the storefront at the southeast corner of Fifth and 18th (Figure 1), tout the strategic advantages of their omnichannel platforms, marrying a robust online presence with a well-located portfolio of physical stores. One could easily hawk Harry Potter-themed wares on the internet, but the impending opening of the massive Harry Potter store on the southeast corner of 22nd and 5th has generated buzz among the Peta children that would not have occurred virtually, given the cruel and horribly unfair restrictions that limit their online exposure. It and other brick-and-mortar retail concerns will find it easier to turn a profit in the current rental market.4 As both The Gap and lululemon noted in their earnings calls for the quarter ended January 31st, reduced rents contributed to wider gross margins. Runaway inflation is not a foregone conclusion, at least not any time soon. Central banking critics have been calling for runaway inflation ever since the Fed cut rates to zero and launched its large-scale asset purchases program in December 2008. They were further inflamed by QE2 in 2010 and QE3 in 2012, but their End-Is-Near warnings failed to come to pass. We expect that the combination of maximally easy monetary policy and fiscal largesse on an unprecedented scale may well produce annual consumer price increases that break out of the sleepy range that’s prevailed over the last two decades. As our previous two Strategy Reports have detailed, however, we don’t think the breakout is going to occur any time soon. The release of pent-up demand is sure to overwhelm restrained post-pandemic capacity in many segments of the economy. As a friend making travel arrangements from Washington, DC to Chicago for his daughter’s just-opened graduation ceremony reports, there were barely any available seats on flights and finding a hotel room in the Windy City was especially difficult. Inflation in those segments will be offset to some degree by commercial rent deflation, however, along with falling prices for used bar and restaurant equipment. Furthermore, we are confident that individuals and businesses throughout the economy will ramp up capacity as soon as it appears likely to be profitable. Employment will come back. All but the newest publicly traded retailers are actively engaged in rationalizing their physical store footprints, but Fifth Avenue’s vacant storefronts will not remain empty forever. Neither will all the spaces that held now-shuttered restaurants, bars and entertainment venues. There will be money to be made from the release of a year-plus of pent-up demand and sole proprietors, small businesses and national chains will jockey to capture their share of it. Any publicly traded company needs growth to satisfy the stock market and any concern that wishes to be acquired needs growth to obtain the highest possible sales price. Even if recovering retail activity initially takes the form of clusters of pop-up stores, conventional leases will again be signed once entrepreneurs get the sense that the demand to support business is here to stay. And once the businesses come, the employees to staff them will follow. April 2020 through May 2021 may have been a great fourteen months to be unemployed, but the United States is far from an idler’s paradise. When contractors’ and gig workers’ temporary UI benefit eligibility, along with the federal UI benefit supplement, expire everywhere by September and as early as June or July in 21 states and counting, people will return to work. Intervention creates winners and losers. If the authorities can’t bail out everyone when shocks hit the economy, there will be an observable divide between those who received support and those who didn’t. The gap between the winners and the losers may undermine social cohesion, but disparities offer professional investors an opportunity to separate themselves from the crowd. It might be a good time to acquire retail properties with sound longer-run prospects from holders whose financial positions may have become untenable. It may also be a good time to acquire businesses in the worst-hit segments, or to team up with the people who have the expertise to run them. Equities still have the wind at their back. When we came out from behind our terminal to do some first-hand research on Fifth Avenue, we also took note of the televised scenes from Madison Square Garden, less than a mile away to the north and west, and from Kiawah Island, off the coast of South Carolina. The spontaneous joy on display at the Garden and NBA playoff venues across the country as fans were once again able to come together to cheer on their favorite teams, and at the site of the PGA Championship, where the gallery engulfed popular soon-to-be champion Phil Mickelson and his playing partner as they made their way to the eighteenth green,5 leads us to believe that consumers are ready to be released from the past year’s constraints and gather, celebrate and spend. Looking around, we get the sense that a new, post-COVID chapter may have begun in the US. If the whole country is as keyed up as sports fans were two weekends ago, our view that corporate earnings growth can surpass even currently elevated expectations appears to be on track. As long as the virus truly is in retreat, equities will remain the place to be. Doug Peta, CFA Chief US Investment Strategist dougp@bcaresearch.com Footnotes 1 We conducted our in-person survey of the properties on Sunday, May 23rd and Monday, May 24th from the sidewalk, without accessing any of the vacant spaces. Our 78-space count is based on the properties’ current configuration, which is subject to change upon alterations by the properties’ owners. 2History – Eisenbergs NYC 3 REBNY Research, "Manhattan Retail Report (Fall 2020)." Accessed May 27, 2021. 4 REBNY’s Fall 2020 Retail Rent Report found that mean asking rents on Fifth Avenue from 14th to 23rd had fallen by 22% year-over-year and noted that effective rents have reportedly been much lower than asking rents. 5Golf crowd pours onto Ocean Course, mobs Mickleson on 18 | The State

Underweight Our underweight in the S&P communications equipment index is slightly in the green, and today we reiterate our below benchmark allocation in this niche tech sub-sector. The key reason for concern is industry pricing power. While the US economy is inflating on nearly every metric, communications equipment manufacturers are struggling to keep up, and their relative pricing power is sinking like a stone (second panel).  In fact, year-over-year (y/y) growth for CSCO’s enterprise orders is at the 0% mark. Keep in mind that Q1/2020 is the earliest quarter that the pandemic started to wreak havoc, yet CSCO couldn’t even show a positive y/y number, despite soaring CEO capex intensions (bottom panel)! Thus, we view this tech sub-group as a value trap rather than an opportunity and we think there are valid reasons why the market is currently valuing this index at a 20% discount to the broad market on a forward P/E basis to the broad market (third panel). Bottom Line: We reiterate our underweight stance in the S&P communications equipment index.  The ticker symbols for the stocks in this index are: BLBG: S5COMM – CSCO, JNPR, MSI, ANET, FFIV. ​​​​​​​

Weekly Performance Update For the week ending Thu May 27, 2021 The Market Monitor displays the trailing 1-quarter performance of strategies based around the BCA Score. For each region, we construct an equal-weighted, monthly rebalanced portfolio consisting of the top 3 stocks per sector and compare it with the regional benchmark. For each portfolio, we show the weekly performance of individual holdings in the Top Contributors/Detractors table. In addition, the Top Prospects table shows the holdings that currently have the highest BCA Score within the portfolio. For more details, click the region headers below to be redirected to the full historical backtest for the strategy. BCA US Portfolio Total Weekly Return BCA US Portfolio S&P500 TRI 0.20% 1.03% Top Contributors   AMKR:US AN:US HCA:US WY:US PCH:US Weekly Return 14 bps 13 bps 11 bps 9 bps 9 bps Top Detractors   TX:US WES:US HE:US UTHR:US KOF:US Weekly Return -13 bps -13 bps -9 bps -8 bps -8 bps Top Prospects   TX:US ESGR:US SCCO:US MPLX:US UHAL:US BCA Score 99.45% 95.61% 95.20% 94.61% 94.57% BCA Canada Portfolio Total Weekly Return BCA Canada Portfolio S&P/TSX TRI 1.10% 1.23% Top Contributors   AUP:CA LNR:CA WEED:CA PBL:CA NXE:CA Weekly Return 35 bps 21 bps 17 bps 14 bps 13 bps Top Detractors   FTT:CA CSU:CA DIR.UN:CA GIB.A:CA EMP.A:CA Weekly Return -17 bps -8 bps -7 bps -7 bps -7 bps Top Prospects   CS:CA IFP:CA CFP:CA RUS:CA LNF:CA BCA Score 99.88% 99.63% 99.18% 97.79% 97.27% BCA UK Portfolio Total Weekly Return BCA UK Portfolio FTSE 100 TRI -0.37% 0.04% Top Contributors   SPI:GB GLTR:GB IPO:GB BAKK:GB CVSG:GB Weekly Return 83 bps 10 bps 10 bps 9 bps 7 bps Top Detractors   DEC:GB FDEV:GB VCP:GB NFC:GB SVST:GB Weekly Return -33 bps -32 bps -25 bps -14 bps -12 bps Top Prospects   SVST:GB TUNE:GB NLMK:GB BPCR:GB GLTR:GB BCA Score 99.46% 97.73% 97.39% 95.76% 94.98% BCA Eurozone Portfolio Total Weekly Return BCA EMU Portfolio MSCI EMU TRI 1.39% 1.18% Top Contributors   ALTA:FR SES:IT FTK:DE POST:AT EURN:BE Weekly Return 24 bps 17 bps 17 bps 14 bps 14 bps Top Detractors   SOL:IT TESB:BE CNV:FR SOLV:BE SO:FR Weekly Return -11 bps -7 bps -7 bps -6 bps -6 bps Top Prospects   SOLV:BE STR:AT FSKRS:FI POST:AT SOL:IT BCA Score 99.15% 97.97% 97.56% 97.45% 96.59% BCA Japan Portfolio Total Weekly Return BCA Japan Portfolio TOPIX TRI -2.13% 0.80% Top Contributors   4966:JP 8595:JP 6877:JP 4326:JP 4781:JP Weekly Return 24 bps 11 bps 8 bps 7 bps 4 bps Top Detractors   7545:JP 9729:JP 8795:JP 9543:JP 8131:JP Weekly Return -23 bps -22 bps -21 bps -20 bps -18 bps Top Prospects   6960:JP 4966:JP 8133:JP 3291:JP 9436:JP BCA Score 99.19% 99.13% 98.74% 98.18% 97.33% BCA Hong Kong Portfolio Total Weekly Return BCA Hong Kong Portfolio Hang Seng TRI 2.60% 2.62% Top Contributors   867:HK 116:HK 1830:HK 3798:HK 327:HK Weekly Return 43 bps 31 bps 26 bps 25 bps 22 bps Top Detractors   2798:HK 1816:HK 719:HK 1866:HK 2232:HK Weekly Return -17 bps -5 bps -4 bps -4 bps -3 bps Top Prospects   990:HK 1606:HK 323:HK 316:HK 2232:HK BCA Score 99.73% 99.33% 99.01% 98.76% 96.69% BCA Australia Portfolio Total Weekly Return BCA Australia Portfolio S&P/ASX All Ord. TRI 1.62% 1.27% Top Contributors   DDR:AU CDA:AU RIC:AU BSE:AU ADH:AU Weekly Return 43 bps 31 bps 30 bps 24 bps 20 bps Top Detractors   MGX:AU CAJ:AU RBL:AU CVW:AU HT1:AU Weekly Return -24 bps -17 bps -16 bps -13 bps -9 bps Top Prospects   GRR:AU MGX:AU BSE:AU PSQ:AU PL8:AU BCA Score 99.31% 98.55% 97.86% 97.63% 96.16%

Highlights Our long-term FX REER models suggest the dollar remains overvalued, especially against the Chinese yuan.  The cheapest currencies are the yen and the Russian ruble. The Scandinavian currencies are surprisingly expensive, according to these models. This has been due to falling relative productivity. Other notable expensive currencies are the Hong Kong dollar and Saudi riyal. That said, we do not expect the peg in the former to break anytime soon. Our limit-sell on the yen was triggered at 109. Place stops at 112. We are looking to buy a basket of petrocurrencies that include the COP and RUB. These have significantly lagged the rise in oil prices.  Feature This week’s report focuses on our long-term fair value models. But a few words first on currency developments. In our view, currency markets are likely to remain driven by five important trends in the coming months. A rotation of growth from the US to other parts of the world (dollar bearish): This has been the dominant theme that has played out since the peak in the DXY index in March. The manufacturing sector in other countries first caught up to the buoyancy we saw in the US, and their service sectors are now recovering as the world vaccinates its population and reopens. In the developed world, Japan, which has been a laggard, could witness a bout of positive surprises. Market focus on inflation, and the potential of an overshoot (dollar bearish): Most market participants have been paying close attention to the inflation overshoot in the US, and whether it is transitory. Currency markets however, specifically the dollar, have been paying close attention to the inflation differential between the US and other countries, and what that means for relative real rates. A rising inflation differential between the US and its trading partners has been negative for the dollar (Chart I-1). We have noted that the US will continue to provide relative upside surprises in inflation as the US output gap closes ahead of other countries. This has been in part due to the most generous fiscal stimulus in the developed world. Chart I-1The Dollar And Relative Inflation Move Opposite Ways A Federal Reserve that stays ultra-accommodative (dollar bearish): Most market participants are again focused on the Fed tapering and what that will mean for asset markets. The reality is that the Fed has started to lag many other central banks, like the Bank of Canada, the Reserve Bank of New Zealand and the Bank of England in tapering asset purchases. This could suggest it would also lag in the speed and magnitude of lifting policy rates in the medium term. This will keep US real rates depressed relative to many of its trading partners. A risk event (dollar bullish): We have been highlighting that a risk event, like a market reset, is a strong positive for the dollar, given the negative correlation with risk assets (Chart I-2). A dollar that remains expensive (dollar bearish): Our medium-term (12-18 month) target for the DXY index is 80. This will bring the currency towards fair value, according to our purchasing power parity models. As we highlighted last week, the trade balance in the US continues to deteriorate, which is one of the symptoms of an overvalued currency. Chart I-2The Dollar And Risk Assets Move Opposite Ways Despite our bearish dollar view, it is important not to overstay our welcome. This week, we are updating our long-term models, another technical tool we use to help us navigate FX markets. These models are mostly driven by relative productivity, but we have also fine-tuned the models for each currency to account for other factors such as terms-of-trade shocks, real rate differentials and proxies for global risk aversion. These models cover 22 currencies, incorporating both G10 and emerging FX markets. The dollar remains expensive according to these models (Chart I-3). Chart I-3The US Dollar Remains Expensive It is important to note that these models are very poor timing tools and are not designed to generate short- or medium-term forecasts. Instead, they reflect imbalances in the current equilibrium fair value of a currency. For example, a currency might be flagged as overvalued now, but a productivity boom in the next few years could allow the currency fair value to gravitate higher. So will a commodity boom. From a technical perspective, these models are like the ones we published in our last report, but with a very important change – the weights assigned in calculating relative productivity are based on dynamic trade weights. This has allowed China (which has much better productivity growth) to impact the currency fair values significantly. For all countries, the variables are highly statistically significant and are of the right signs. Finally, as housekeeping, we were triggered into a short USD/JPY position this week as our limit-sell at 109 was touched. The yen is one of the cheapest currencies according to these models. It will also benefit from all of the five key drivers for currency markets we listed above, especially real rates that are likely to stay very favorable in Japan, compared to the US (Chart I-4). Chart I-4Less Inflationary Pressures In Any Japanese Economic Rebound The US Dollar Chart I-5 The dollar is expensive by 7% according to the long-term fair value model. This is despite the 13% drop in the US dollar DXY index since the March 2020 highs. In hindsight, strong reversals in the dollar occur when the currency is about two-standard deviations above the mean, which occurred with last year’s rally. Our bias is that the dollar has entered a multi-year downtrend, which will only be supercharged by expensive valuations. The big driver for the uptrend that started in 2011 was positive real interest rate differentials. As US real rates continue to rollover, relative to its G10 counterparts, this will lower the greenback’s fair value. The Euro Chart I-6 The euro is slightly cheap according to our fundamental models. More importantly, the euro’s fair value has been rising in recent quarters. This has been driven by a nascent improvement in the trade balance (and current account balance), following the Covid-19 crisis. Historically, when the euro has hit its fair value bands, it has tended to mean revert. Therefore, this model does a better job of catching intermediate turns in the euro, compared to the US dollar model. Our bias is that the long-term fair value for the euro sits near 1.35, something that should continue to be reflected in future model updates. The Yen Chart I-7 The fair value of the yen has been relatively flat over the last few years. Given that the real exchange rate has not fluctuated much either, the yen has been chronically undervalued by about one standard deviation below the mean. The yen is cheap by most measures of relative prices. We believe the yen sits at a beautiful juncture. A pickup in economic activity will keep the fair value rising, from an improvement in the current account. Meanwhile, any deterioration in economic data will lead to higher risk aversion and a higher fair value (the yen is a risk-off currency). We are short USD/JPY as of 109 this week.   The British Pound Chart I-8 This model shows that the pound is fairly valued, while cable remains cheap by most of our other models. That said, at fair value, the pound can still overshoot to at least 1.5 standard deviation above/below the mean, as it has in prior episodes. The key reason the pound is not cheap in this model is due to a deterioration in the UK’s productivity growth, relative to its trading partners. In this iteration of the model, China’s larger share of British trade has exacerbated the downtrend in the fair value. However, a turnaround seems underway, as the UK puts the Brexit woes behind it (and Scottish independence is not an immediate concern). The Canadian Dollar Chart I-9 The loonie has overshot its fair value. More importantly, the fair value for the Canadian dollar has been falling since the peak of the commodity cycle in 2011. If we are indeed entering a new commodity super-cycle, then the model should begin to turn around, and assign a higher fair value to the loonie. However, Canada’s terms of trade will face strong headwinds as we move away from fossil fuels, especially oil. As such, the productivity gains in other sectors (such as metals) that will benefit from new green investments will need to be sufficiently high to offset falling productivity in crude oil.  The Australian Dollar Chart I-10 The Australian dollar has been rising along with the improvement in its fair value. The rising fair value has been due to the exceptional rise in commodity prices (iron ore and coal) that have boosted the current account. However, like the Canadian dollar, the fair value of the Aussie has also been dropping in recent years on the back of previously depressed commodity prices. Given the growing importance of liquified natural gas in Australia’s export mix, we believe terms of trade will remain a tailwind for the Aussie over the longer term. The New Zealand Dollar Chart I-11 The kiwi is slightly more expensive than its antipodean neighbor. But like other commodity currencies, its fair value has fallen in recent years. The catalyst has been the drop in commodity prices and the fall in relative real rates. More recently, the fair value of the kiwi has taken a positive turn as real rates improve, and risk aversion recedes. With the RBNZ striking a hawkish tone, this remains positive for the kiwi for now, but could adversely impact financial conditions later. The Swiss Franc Chart I-12 On a fundamental basis, the Swiss franc is as cheap as the yen, with our models showing it as about one standard deviation undervalued. The biggest driver for the rise in the fair value of the franc has been the structural trade surplus, driven by rising productivity. The Swiss franc is traditionally a defensive currency. As such, the fair value has taken a small hit due to the fall in the gold-to-oil ratio, a proxy for risk aversion. Should the market experience some turbulence in the coming months, the franc will benefit. The Swedish Krona Chart I-13 The Swedish krona is showing up as expensive in our models, together with the Norwegian krone. Paradoxically, on a PPP basis, the Swedish krona is one of the cheapest currencies in our universe. The key model inputs for the Swedish krona are interest rate differentials and relative productivity trends. With the rise of China as a trading partner, the productivity differential for Sweden has fallen even more steeply in this iteration of the model. It also means that the currency is no longer massively undershooting fair value, as had been the case in previous iterations. The Norwegian Krone Chart I-14 Like the Swedish krona, the Norwegian krone is showing up as expensive in our models. However, it is one of the cheapest currencies on a PPP basis, which presents a paradox. We will be looking at the Norwegian economy in-depth next week, to help explain this paradox. A more immediate explanation is that the trade balance for Norway has been nosediving in recent years, which helps explain why the model judges the currency as becoming incrementally expensive. With the rise of China as a trading partner, the productivity differential for Norway has also fallen. The Chinese Yuan Chart I-15 The Chinese yuan is currently at about one standard deviation below fair value. Since the history of our model, the fair value of the yuan has been mostly rising. This is driven by rising relative productivity in China. Concurrently, real interest rates in China have also shot up, which has led to a strong rally in the Chinese RMB. We expect the RMB to keep appreciating in the coming years, as the fair value keeps rising.  The Brazilian Real Chart I-16 The Brazilian real is slightly above fair value, according to our fundamental models. Meanwhile, the fair value has been falling since 2011, in line with other commodity currencies. However, if we are indeed in a new commodity super cycle, the fair value of the real should start to rise. The Mexican Peso Chart I-17 The Mexican Peso is trading a nudge above fair value, but the fair value has been rising since 2019. This means going forward, we could see a rising peso, coinciding with a rapid rise in its fair value. The peso is highly cyclical, so two key drivers have been working in favor of the currency. First, a falling in risk aversion (proxied by a decline in the gold-to-oil ratio) has been positive. Meanwhile, the cumulative current account will also continue to improve should global growth remain strong in the near term, especially US growth. The Chilean Peso Chart I-18 The Chilean peso is currently at fair value, according to our fair value model. The fair value of the Chilean peso has been falling in recent years, but this decline was even sharper when Chinese productivity gains were given a greater weight in the modelling exercise. Going forward, Chilean exports of copper will be in a structural uptrend, due to the green technology revolution. As such, the fair value of the peso should begin to gradually rise. The Colombian Peso Chart I-19 The Colombian peso is cheap, and so constitutes an attractive play if oil prices remain strong in the medium term. The reason is that it has one of the strongest correlations to oil prices among commodity currencies. That said, structurally, the fair value of the Colombian peso has been falling, like many other petrocurrencies. The South African Rand Chart I-20 The South African rand is now trading slightly below its fair value, a positive contrast to the BRL which is slightly expensive. Meanwhile, the fair value of the rand is gradually picking up, after a structural decline over the last decade.   The correlation between precious metal prices and the South African rand is picking up again, as the current account moves back into surplus. We are positive gold (and silver) as inflation hedges. Meanwhile, platinum and palladium will continue to benefit from a push towards better environmental standards among traditional autos. The Russian Ruble Chart I-21 The Russian ruble is now sitting around one standard deviation below its fair value. We are constructive on oil, which will boost the fair value of petrocurrencies, including the Russian ruble. Meanwhile, real interest rates are at relatively high levels in Russia, even though this does not have significant explanatory power. Given cheap valuations, we are looking to buy a petrocurrency basket, including the RUB and the COP. The Korean Won Chart I-22 The Korean won has underperformed this year, and has been trading at a negligible divergence from its fair value over the last few years. The fair value of the Korean won has also been flat over the years. This suggests that Korean productivity growth has kept pace with its trading partners. Going forward, it also suggests the next move in the Korean won is likely to be driven by the trend in the currencies of its trading partners, especially China and the US. The Philippine Peso Chart I-23 The Philippine peso is expensive by about one standard deviation. This has been partly due to a decline in the fair value of the peso, a process that began in 2015.  The Philippine peso is one of the few currencies whose REER tends to have well-defined and long cycles that last 5-8 years. It will be important to watch if the recent appreciation in the currency has more room to run, given expensive valuation. The Singapore Dollar Chart I-24 The Singaporean dollar is another currency whose REER tends to have long cycles, probably a feature of the managed float. The Singaporean dollar is a defensive currency, and so the appreciation in other emerging market currencies has brought relative valuations back towards fair value. The Hong Kong Dollar Chart I-25 The REER of HKD has been rising in recent years, meaning inflation in Hong Kong SAR has been outpacing that elsewhere. This has made the HKD expensive, according to our models. However, the fair value has started to fall suggesting productivity gains in the city state have also been lagging, probably a result of political unrest. That said, we expect the peg to remain in place for some time, as we highlighted in a previous special report. The Saudi Riyal Chart I-26 The fair value of the Saudi Riyal has been falling for quite a while on declining relative productivity. This has made the Riyal incrementally expensive. However, oil prices are currently elevated, which means it might take much more stretched valuations to begin to cause greater tensions for the peg.   Chester Ntonifor Foreign Exchange Strategist chestern@bcaresearch.com Trades & Forecasts Forecast Summary Core Portfolio Tactical Trades Limit Orders Closed Trades

特別レポート

Highlights House prices are rising rapidly across the developed markets, in response to the extraordinary monetary and fiscal policy stimulus implemented to fight the pandemic. Evidence points to the house price surge being driven by monetary policy that has left real interest rates far below equilibrium levels. Supply factors are a secondary cause of the house price boom. Financial stability risks stemming from rising house prices are less acute than the pre-2008 experience, as overall household leverage has grown more slowly during the pandemic and global banks are better capitalized. Rapidly rising house prices are forcing some central banks to turn less accommodative earlier than expected. The recent hawkish turns by the Bank of Canada and Reserve Bank of New Zealand may be canaries in the coal mine for other central banks – perhaps even the Fed – if house prices and household leverage start rising together. Feature The COVID-19 pandemic led to the sharpest economic recession since World War II, alongside an enormous rise in unemployment. Consensus expectations call for the output gap to be closed (or mostly closed) in most advanced economies by the end of this year, but it remains an open question how quickly these economies will be able to return to full employment amid potentially permanent shifts in demand for office space and goods sold at physical, “brick and mortar” retail locations. Despite this sizeable and swift economic shock, house price appreciation accelerated last year in the developed world. Chart 1 highlights that US house prices rose at an 18% annualized pace in the second half of 2020, whereas they accelerated at a high-single digit pace in developed markets ex-US (on a GDP-weighted basis). This, in conjunction with a sharp rise in the household sector credit-to-GDP ratio (Chart 2), has unnerved some investors while raising questions about the implications for monetary policy. Chart 1House Prices Are Surging Around The World Chart 2Rising Fears About Deteriorating Household Balance Sheets Before we discuss the investment implications of the global housing boom, however, we must first accurately determine the reasons why it is happening. The Work-From-Home Effect: Less Than Meets The Eye When analyzing the surprising behavior of the housing market last year, the working-from-home effect brought upon by the pandemic emerges as an obvious factor potentially explaining house price gains. Last year, following recommended or mandatory stay-at-home orders from governments, most office-based businesses rapidly shifted to work-from-home arrangements as an emergency response. However, in the month or two following the beginning of stay-at-home orders, several national US surveys found many office workers preferred the flexibility afforded by work-from-home arrangements. Many employers, correspondingly, found that the productivity of their employees did not suffer while working from home, or that it even improved. Several prominent corporations in the US have subsequently made some work-from-home options permanent, or even allowed employees to work from offices in a different city than they did prior to the pandemic. Newfound work-from-home options have undoubtedly created new demand for housing, and thus explained the surge in house prices seen over the past year in the minds of some investors. However, in our view, evidence from the US, the UK, and France suggests that the work-from-home effect better explains differences in price gains across housing types and within large metropolitan areas, rather than aggregate or national-level changes in house prices. Chart 3 provides some quantification of the impact of work-from-home policies by plotting US resident migration patterns by city. This data has been compiled by CBRE, and the impact of COVID is shown as the change in net move-ins from 2019 to 2020 per 1000 people. This helps control for the underlying migration pattern that existed in US cities prior to the pandemic. Chart 3Work From Home Policies Have Impacted Migration Trends… The chart highlights that the negative migration impact from COVID has been mostly concentrated in New York City and the three most populous cities on the West Coast (by metro area): Los Angeles, San Francisco, and Seattle. And yet, Chart 4 highlights that house price inflation in these four cities has accelerated to a double-digit pace, only modestly below the national average. Chart 4...But Cities With Outward Migration Still Have Very Strong House Price Gains The house price indexes shown in Chart 4 represent aggregate, metro area trends, and clearly some regions within these metro areas have experienced house price deceleration or outright deflation versus gains in areas outside the urban core. But Chart 5 highlights that house prices have declined in Manhattan basically in line with the change in net move-ins as a share of the population, underscoring that double-digit metro area-wide house price gains appear to be vastly disproportionate to changes in net migration. Similarly, Chart 6 highlights that rents decelerated in the US over the past year but remained in positive territory and grew at a 3.5% annualized rate from February to April. Chart 5In Manhattan, House Prices Have Tracked Net Migration Chart 6Rent Costs Have Decelerated, But Have Not Contracted Evidence from Paris and London also suggests that a work-from-home effect is insufficient to explain broad house price gains. Panel 1 of Chart 7 highlights that house prices in France have accelerated significantly, but that apartment prices have decelerated only fractionally in lockstep. Panel 2 shows that the acceleration in house prices does reflect a work-from-home effect, as prices have risen faster in inner Parisian suburbs. Panel 3, however, highlights that Parisian apartment prices, the dominant property type in the urban core, have decelerated modestly. Chart 8 highlights that house price gains have not even decelerated in greater London; they have been merely been modestly outstripped by gains in Outer South East (outside of the Outer Metropolitan Area). Chart 7In France, Parisian Apartment Prices Are Simply Lagging, Not Falling Chart 8In The UK, Greater London Property Prices Are Accelerating     The Policy Effect: The Fundamental Driver Of The Housing Market Despite the broader location flexibility that work-from-home policies now provide to potential homeowners, it seems inconceivable that the housing market would have responded in the manner that it has over the past year given the size of the economic shock brought on by the pandemic without significant support from policy. Above-the-line fiscal measures to the pandemic have totaled in the double-digits in advanced economies (Chart 9), and monetary policy has contributed to easier financial conditions via rate cuts, asset purchases, and sizeable programs to support financial market liquidity. Chart 9There Has Been A Massive Fiscal Policy Response To The Crisis In fact, Charts 10-13 present compelling evidence that fiscal and monetary policy have been the core drivers of significant house price gains over the past year. Charts 10 and 11 plot the above-the-line fiscal response of advanced economies against the year-over-year growth rate in house prices as well as its acceleration (the change in the year-over-year growth rate). The charts show a clearly positive relationship, with a stronger link between the pandemic fiscal response and the acceleration in house prices. Chart 10Differences In Last Year’s Fiscal Response… Chart 11…Help Explain Differences In House Price Gains Chart 12Pre-Pandemic Differences In The Monetary Policy Stance… Chart 13…Do An Even Better Job Of Explaining 2020 House Price Gains   Charts 12 and 13 highlight the even stronger link between house prices and the pre-pandemic monetary policy stance in advanced economies, defined as the difference between each country’s 2-year government bond yield and its Taylor Rule-implied policy interest rate as of Q4 2019. We construct each country’s Taylor Rule using the original specification, with core consumer price inflation, a 2% inflation target, and real potential GDP growth as the definition of the real equilibrium interest rate. The charts make it clear that easy monetary policy strongly explains house price gains in 2020, particularly the year-over-year percent change rather than its acceleration. This makes sense, given that monetary policy was already quite easy in many countries at the onset of the pandemic – meaning that changes were less pronounced than they would have been had interest rates been higher. The explanation that emerges from Charts 10-13 is that historic fiscal easing, combined with an easy starting point for monetary policy – that became even easier last year – enabled demand from work-from-home policies to manifest during an extremely severe recession. We agree that work-from-home policies have shifted the geographic preferences of some home buyers and likely provided a new source of net demand from renters in urban cores purchasing homes in outlying areas. But we strongly doubt that the net effect of work-from-home policies in the midst of an extreme shock to economic activity would have caused the rise in house prices that we have observed, certainly not to this level, without major support from policy. This underscores that policy, and not the work-from-home effect, has and will likely remain the core driver of the global housing market. The Supply Effect: Mostly A Red Herring Chart 14Countries Fall Into Two Groups In Terms Of The Relative Trend In Real Residential Investment One perennial question that emerges when analyzing the housing market, particularly in markets with outsized house price gains, is the impact of constrained supply. It is frequently argued that constrained supply is squeezing prices higher in many markets, and that the appropriate policy solution to extreme house price gains is to enable widespread housing construction – not to raise interest rates. We do not rule out the potential impact of constrained supply in certain cities or regional housing markets, and we have highlighted in previous research that a positive relationship does exist between population density in urban regions and median house price-to-income ratios.1 But as a broad explanation for supercharged house price gains, the supply argument appears to fall flat. Chart 14 presents the most standardized measure of cross-country housing supply available for several advanced economies, the trend in real residential investment relative to real GDP over time. These series are all rebased to 100 as of 1997, prior to the 2002-2007 US housing market boom. The chart makes it clear that advanced economies generally fall into two groups based on this metric: those that have seen declines in real residential investment relative to GDP, especially after the global financial crisis (panel 1), and those that have experienced either an uptrend in housing construction relative to output or have seen a flat trend (panel 2). If scarce housing supply was the core driver of outsized house price gains, then we would expect to see stronger gains in the countries shown in panel 1 and smaller gains in the countries shown in panel 2. In fact, mostly the opposite is true: Charts 15 and 16 highlight that the relationship between the level of these indexes today relative to their 1997 or 2005 levels is positively related to the magnitude of house price gains last year, suggesting that housing market supply has generally been responding to demand over the past decade. The US and possibly New Zealand stand as possible exceptions to the trend, suggesting that relatively scarce supply may be boosting prices even further in these markets beyond what fiscal and monetary policy would suggest. Chart 15Countries That Have Seen A Stronger Pace Of Residential Investment… Chart 16…Have Experienced Stronger House Price Gains   Chart 17Is This Not Enough Supply, Or Too Much Demand? As a final point about the inclination of investors to gravitate towards supply-side arguments related to the housing market, Chart 17 presents a simple thought experiment. The chart shows a simple housing supply-demand curve diagram, in a scenario where the demand curve for housing has shifted out more than the supply curve has (thus raising house prices). Is this a scenario in which supply is too tight? Or is it a case in which demand is too strong? In our view, the tight supply answer is reasonable in circumstances where the increase in demand is normal or otherwise sustainable. But Charts 10-13 clearly showed that housing demand is being boosted by easy policy, which in the case of some countries has occurred for years: interest rates have remained well below levels that macroeconomic theory would traditionally consider to be in equilibrium, and this has occurred alongside significant household sector leveraging (Chart 18). As such, in our view, investors should be more inclined to view the global housing market as generally being driven by demand-side rather than supply-side factors. This Is Not 2007/08 … Yet We highlighted in Chart 2 above that the household sector debt-to-GDP ratio increased sharply last year, which has raised some questions about debt sustainability among investors. For the most part, the rise in this ratio actually reflects denominator effects (namely a sharp contraction in nominal GDP) rather than a huge surge in household debt. Chart 19 shows BIS data for the annual growth in total household debt in developed economies was roughly stable last year, at least until Q3 (the most recent datapoint available from the BIS). Chart 18Low Interest Rtaes Have Fueled Household Leveraging Chart 19Total Credit Growth Has Been Stable, But Mortgage Credit Growth Is Accelerating Chart 20US Mortgage Growth Is Picking Up, As Repayments Slow Consumer Credit Growth But Chart 19 shows the recent trend in total household debt, which masks diverging mortgage and non-mortgage debt trends. In the US, euro area, Canada, and Sweden, household mortgage debt has accelerated to varying degrees, underscoring that households have likely paid down non-mortgage debt with some of the savings that they have accumulated from a significant reduction in spending on services. Chart 20 shows this effect directly in the case of the US; mortgage debt growth accelerated by roughly 1.5 percentage points in the second half of the year, whereas consumer credit growth (made up of student loans, auto loans, credit cards, and other revolving credit) decelerated significantly. This aligns with data showing that US households have used some of their savings windfall to pay down their credit card balances. This changing mix within household debt - less higher-interest-rate consumer credit, more lower-interest-rate collateralized mortgage debt – could, on the margin, help mitigate financial stability risks from the housing boom by moderating overall debt service burdens. The starting point for the latter matters, though, in accurately assessing the risks from rising house prices and increased mortgage debt, particularly in countries where household debt levels are already high. According to data from the BIS, the US already has one of the lowest household debt service ratios (7.6%) among the developed economies (Chart 21).2 This compares favorably to the double-digit debt service ratios in the “higher-risk” countries like Canada (12.6%), Sweden (12.1%) and Norway (16.2%). On top of that, US commercial banks have become far more prudent with mortgage loan underwriting standards since the 2008 financial crisis. The New York Fed’s Household Debt and Credit report shows that an increasing majority of mortgage lending made by US banks since the 2008 crisis has been to those with very high FICO credit scores (Chart 22). This is in sharp contrast to the steady lending to “subprime” borrowers with poor credit scores that preceded the 2008 financial crisis. The median FICO score for new mortgage originations as of Q1 2021 was 788, compared to 707 in Q4 2006 at the peak of the mid-2000s US housing boom. Chart 21Diverging Trends In Global Household Debt Servicing Costs Chart 22US Banks Have Become More Prudent With Mortgage Lending   US bank balance sheets are also now less directly exposed to a fall in housing values. Residential loans now represent only 10% of the assets on US bank balance sheets, compared to 20% at the peak of the last housing bubble (Chart 23). This puts the US in the “lower-risk” group of countries in Europe, the UK and Japan where mortgages are less than 20% of bank balance sheets. This compares favorably to the “higher risk” group of countries where residential loans are a far larger share of bank assets (Chart 24), like Canada (32%), New Zealand (49%), Sweden (45%) and Australia (40%). Chart 23Banks Have Limited Direct Exposure To Housing Here Chart 24Banks Are Far More Exposed To Housing Here   Like nature, however, the financial ecosystem abhors a vacuum. “Non-bank” mortgage lenders have filled the void from traditional US banks reducing their lending to lower-quality borrowers, and they now represent around two-thirds of all US mortgage origination, a big leap from the 20% origination share in 2007. Non-bank lenders have also taken on growing shares of new mortgage origination in other countries like the UK, Canada and Australia. Chart 25Global Banks Can Withstand A Housing Shock Non-bank lenders do not take deposits and typically fund themselves via shorter-term borrowings, which raises the potential for future instability if credit markets seize up. These lenders also, on average, service mortgages with a higher probability of default, so they are exposed to greater credit losses when house prices decline. However, the risk of a full-blown 2008-style commercial banking crisis, with individual depositors’ funds at risk from a bank failure, are reduced with a greater share of riskier mortgage lending conducted by non-bank entities. This is especially true with global commercial banks far better capitalized today, with double-digit Tier 1 capital ratios (Chart 25), thanks to regulatory changes made after the Global Financial Crisis. Net-net, we conclude that the overall financial stability implications of the current surge in house prices in the developed economies are relatively modest on average. The acceleration in mortgage growth has occurred alongside reductions in non-mortgage growth, at a time when banks are better able to withstand a shock from any sustained future downturn in house prices. However, if house prices continue to accelerate and new homebuyers are forced to take on ever increasing amounts of mortgage debt, financial stability issues could intensify in some countries. Services spending will recover in a vaccinated post-COVID world, as economies reopen and consumer confidence improves, which will likely end the trend of falling non-residential consumer debt offsetting rising mortgage debt in countries like the US and Canada. Overall levels of household debt could begin to rise again relative to incomes, building up future financial stability risks when central banks begin to normalize pandemic-related monetary policies – a process that has already started in some countries because of the housing boom. The Monetary Policy Implications Of Surging House Prices Rapidly appreciating house prices are becoming an area of concern for policymakers in countries like Canada and New Zealand, where the affordability of housing is becoming a political, as well as an economic, issue. In the case of New Zealand, the government has actually altered the remit of the Reserve Bank of New Zealand (RBNZ) to more explicitly factor in the impact of monetary policy on housing costs. The Bank of Canada announced in April that it would taper its pace of government debt purchases and signaled that its decision was based, at least in small part, on signs of speculative behavior in Canada’s housing market. Macroprudential measures like limiting loan-to-value ratios of new mortgage loans are a policy option that governments in those countries have already implemented to try and cool off housing demand. Yet while such measures can help alleviate demand-supply mismatches in certain cities and regions, the efficacy of such measures in sustainably slowing the ascent of house prices on a national scale is unclear. In the April 2021 IMF Global Financial Stability Report, researchers estimated that, for a broad group of countries, the implementation of a new macro-prudential measure designed to cool loan demand reduced national household debt/GDP ratios by a mere one percentage point, on average, over a period encompassing four years.3 If macroprudential measures are that ineffective in sustainably reducing demand for mortgage loans, then the burden of slowing house price appreciation will have to fall on the more blunt instruments of monetary policy. Importantly, surging house price inflation is not likely to give a boost to realized inflation measures – an important issue given the current backdrop of rapidly rising realized inflation rates in many countries. Housing costs do represent a significant portion of consumer price indices in many developed countries, ranging from 19% in New Zealand to 33% in the US (Chart 26), with the euro area being the outlier with housing having a mere 2% weighting in the headline inflation index. Chart 26A Limited Impact On Actual Inflation From Housing Yet those so-called “housing” categories overwhelmingly measure only housing rental costs and not actual house prices. This is an important distinction because rents – which are often imputed measures like in the US and not even actual rental costs - are rising at a far slower pace than actual house prices in most countries, so the housing contribution to realized inflation is relatively modest. So the good news is that booming house prices will not worsen the acceleration of realized global inflation that has concerned investors and policymakers in 2021. Yet that does not mean that central bankers will not be forced to tighten policy to cool off red-hot housing demand that is clearly being fueled by persistently negative real interest rates. In Chart 27 and Chart 28, we show both nominal and real policy interest rates for the “lower risk” and “higher risk” country groupings that we described earlier. The real policy rates are nominal policy rates versus realized headline CPI inflation. The dotted lines in the charts represent the future path of rates discounted by markets. Specifically, the projection for nominal rates is taken from overnight index swap (OIS) forward curves, while the projection for real rates is calculated by subtracting the discounted path of inflation expectations extracted from CPI swap forwards. Chart 27Markets Discounting Negative Real Rates For The Next Decade Chart 28Negative Real Rates Are Unsustainable During A Housing Bubble   There are two key takeaways from these charts: Real policy interest rates are at or very close to the most deeply negative levels seen since the 2008 financial crisis. Markets are discounting that real rates will be at or below 0% for most of the next decade. Admittedly, there is room for debate over what the equilibrium level of real interest rates (a.k.a. “r-star”) should be in the coming years. However, we deem it a major stretch to believe that real rates need to be persistently low or negative for the next ten years to support even trend growth across the developed economies. In our view, the current boom in housing demand and mortgage borrowing provides clear evidence that negative real rates are below equilibrium and, thus, are stimulating credit demand. Thus, the only way for a central bank to cool off housing demand will be to raise both nominal and, more importantly, real interest rates. Canada and New Zealand will be the “canaries in the coal mine” among developed market central banks for such a move. According to the latest Bank of Canada Financial Stability Review, nearly 22% of Canadian mortgages are highly levered, with a loan-to-value ratio greater than 450%, a greater share of such mortgages than during the 2016/17 housing boom (Chart 29). Canadian house prices have risen to such an extent that home prices in major cities like Toronto, Vancouver and Montreal are among the most expensive in North America.4  Stunningly, a recent Bloomberg Nanos opinion poll revealed that nearly 50% of Canadians would support Bank of Canada rate hikes to cool off the red-hot housing market (Chart 30). The central bank will be unable to resist the pressure to use monetary policy to slam on the brakes of the housing market – investors should expect more tapering and, eventually, rate hikes from the Bank of Canada over at least the next couple of years. Chart 29Canadians Are Leveraging Up To Buy Expensive Homes Chart 3050% Of Canadians Want A Rate Hike To Cool Housing   In New Zealand, worsening housing affordability has reached a point where a 20% down payment on the median national house price is equal to 223% of median disposable income (Chart 31). This is forcing more first-time home buyers to take on levels of mortgage debt that the RBNZ deems highly risky (top panel). Like the Bank of Canada, the RBNZ will prove to be one of the most hawkish central banks in the developed world over the next couple of years as the central bank follows their newly-revised remit to try and cool off housing demand in New Zealand. Who is next? Housing values, measured by the ratio of median national house prices to median national household incomes, are rising in the US and UK but are still below the peaks of the mid-2000s housing bubble (Chart 32). Meanwhile, housing is becoming more expensive across the euro area, but not in a consistent manner, with valuations in Germany and Spain having increased far more than in France or Italy. Housing valuations have actually improved in Australia over the past couple of years on a price-to-income basis. The most likely candidates for a housing-related hawkish turn are in Scandinavia, with housing valuations in Sweden and Norway closing in on Canada/New Zealand levels. Chart 31New Zealand Housing Is Wildly Unaffordable Chart 32Global House Price/Income Ratios Are Trending Higher   Investment Conclusions The current acceleration in global house prices is an inevitable outcome of the extraordinary monetary and fiscal easing implemented during the pandemic. Higher realized inflation is pushing real rates deeper into negative territory in many countries, fueling the demand for housing. Central banks in countries with more stretched housing valuations will be forced to turn more hawkish sooner than expected, leading to tapering and, eventually, rate hikes to cool housing demand. This has negative implications for government bond markets in countries where housing is more expensive and real yields remain too low, like Canada, New Zealand and Sweden (Chart 33). Investors should limit exposure to government bonds in those markets over the next 6-12 months. Chart 33Negative Real Yields & Expensive Housing Valuations – An Unsustainable Mix Bond markets in countries where house prices are not rising rapidly enough to force policymakers to turn more hawkish more quickly – like core Europe, Australia and even Japan - are likely to be relative outperformers. The US and UK are “cuspy” bond markets, as housing valuations are becoming more expensive in those two countries but the Fed and Bank of England are not facing the same domestic political pressure to use monetary policy tools to fight the growing unaffordability of housing. That could change, though, if overall household leverage begins to rise alongside house price inflation as the US and UK economies emerge from the pandemic. Current pricing in OIS curves shows that markets expect the RBNZ and Bank of Canada to begin hiking rates in May 2022 and September 2022, respectively (Table 1). This is well ahead of expectations for “liftoff” from other developed markets central banks, including the Fed in April 2023. The cumulative amount of rate hikes following liftoff to the end of 2024 is highest in Canada, New Zealand, the US and Australia. Those are also countries with currencies that are trading at or above the purchasing power parity levels derived from our currency strategists’ valuation models. This highlights the difficult choice that central bankers facing housing bubbles must confront, as the rate hikes that will help cool off housing demand will lead to currency appreciation that could impact other parts of their economies like exports and manufacturing. Table 1Hawkish Central Banks Must Live With Currency Strength Tracking the second-round economic consequences of eventual monetary policy actions to control excessive house price inflation, particularly in “higher risk” countries, is likely to be the subject of future Bank Credit Analyst / Global Fixed Income Strategy reports. Robert Robis, CFA Chief Fixed Income Strategist Jonathan LaBerge, CFA Vice President The Bank Credit Analyst   Footnotes 1 Please see Global Investment Strategy "Canada: A (Probably) Happy Moment In An Otherwise Sad Story," dated July 14, 2017, available at gis.bcaresearch.com 2 Importantly, the BIS debt service ratios include the payment of both principal and interest, thus making it a true measure of debt service costs that includes repayment of borrowed funds – a critical issue in countries with high loan-to-value ratios for home mortgages. 3 Please see page 46 of Chapter 2 of the April 2021 IMF Global Financial Stability Report, which can be found here: https://www.imf.org/en/Publications/GFSR/Issues/2021/04/06/global-financial-stability-report-april-2021 4 “Vancouver, Toronto and Hamilton are the least affordable cities in North America: report”, CBC News, May 20, 2021