November 11, 2016

It looks like global interest rate levels will generally stay low next year, but there is greater potential for rate rises in the medium term. Asia Pacific real estate should be relatively well placed in this scenario.

Uncertain interest rate path
Despite the unexpected U.S. election results, the U.S. Federal Reserve is expected to continue with cautious monetary tightening and it is likely we’ll see one or two Fed rate hikes between now and mid-2017. The path of U.S. monetary policy in the medium-term is less certain – the new president’s deficit spending plan points to higher inflation, but it is also likely that volatility may push the economy into recession.

Central banks in Europe and Asia should remain accommodative in 2017 but there is less scope for further easing. The European Central Bank should continue with quantitative easing but in tapered form. Here in Asia Pacific, China may cushion reforms with credit expansion, but at the same time keep a close watch on shadow banking and corporate debt. The Bank of Japan may refrain from more quantitative easing but instead targets 10-year government bond yield at zero percent.

Effects from interest rate channels
Recent research by the Bank of International Settlements on financial spillovers showed that policy interest rates in emerging and advanced open markets, as a group, tend to co-move together with U.S. interest rates. JLL research also confirmed that domestic real 10-year government bond rates in five out of six Asia Pacific countries tend to move in the same direction as their U.S. counterpart.

JLL estimated that prime office yields in five out of six Asia Pacific core markets move together with the U.S. real 10-year government bond rates. This means that if U.S. long-term interest rates are to normalise at a slower pace or U.S. 10-year expected inflation is to increase faster than expected, prime office yields in Hong Kong, Seoul, Shanghai, Singapore and Tokyo would stay low or compress further.

The highest correlation (at around +0.7) was seen between Seoul, Shanghai and Singapore prime office yields and U.S. real long-term government bond rates, and lower correlation (at around +0.5) in Hong Kong and Tokyo. Only in Australia were prime office market yields uncorrelated with U.S. real long-term bond rates.

Effects from currency channels
Currency movements, in part due to the uncertain interest rate outlook, will also be an area of concern for cross border investors. Market consensus predicts most major currencies to slightly depreciate against the U.S. dollar over 2016-17, as the normalisation of U.S. monetary policy can potentially lead to capital outflows from the rest of the world.

Currency volatility after Brexit and immediately after the U.S. elections has shown that it has a big impact on real estate total returns for international investors diversifying into real estate outside their home markets. For cross-border investors, currency movements will continue to have a big impact on real estate total returns over 2016-18, with foreign exchange gains or losses significantly increasing or decreasing international investors’ total returns.

Click to read our report on how future movements in eight key currencies will affect total returns for cross-border investors into prime office markets in Asia Pacific.


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