The US Federal Reserve raised its Federal Funds Rate (FFR) by 75 basis points (bps), taking it to the highest level since the Global Financial Crisis, to 3% to 3.25%. The 75 bps hike was more than fully priced in, but the new dot plots imply another 120 bps or so of interest rate hikes by year end, which is why market watchers are expecting a 75 bps hike in November and most likely, a further 75 bps hike in December. The median FFR dot plot for 2023 was raised to 4.6% (from 3.8%).
Ray Sharma-Ong, investment director, multi-asset investment solutions at abrdn, says: “The Fed does not intend to slow down anytime soon with chairman Jay Powell indicating that three conditions need to be met before pace of rate hikes will moderate.” These are below-trend growth, softer labour market conditions and evidence that inflation is moving back to 2%.
“As such, we expect a Fed monetary policy induced recession, and that the Fed will only ease after a recession has occurred. The probability of a hard economic landing has increased, and we would not be surprised if terminal policy rates go up to 5%,” Ong says. “In the near term, we see US 10-year yields possibly pushing towards 3.75%–4%, however we foresee the curve inverting further as the back end of the curve lags.”
Higher 10-year yields are not good for REITs which take their pricing off a yield spread based on these yields. As at Sept 21, the US 10-year treasury yield was 3.57%. When yields on 10-year treasuries were below 1%, S-REITs with US assets were trading at around 5% to 7%. Hence, investors can do their own sums as to why S-REITs with US assets are trading at such high yields.
Similarly, some of the smaller hospitality trusts were trading at similar 5%–7% yields when yields on 10-year Singapore Government Securities (the local risk-free rate) were below 1%. This could be the main reason why hospitality trusts are unable to move much higher from their current levels despite an increasingly bullish outlook based on DBS Group Research.
On the other hand, if the distributions per stapled security (DPS) of the hospitality trusts are able to rise to compensate for higher risk-free rates, then the hospitality trusts are likely to remain firm. In the year to August, hospitality trusts with a preponderance of Singapore-based assets outperformed because of the reopening story. DBS remains positive on the hospitality trusts.
See also: STI steadies despite overbought US markets and rising US risk-free rates
“Hospitality S-REITs’ share prices have flatlined since June– July over concerns of the impact of an economic slowdown on distributions as well as their ability to maintain DPU growth due to higher costs. The ability for RevPAR to outpace higher operational costs and interest expense will be a key item to monitor, in our view,” a DBS report dated Sept 22 says.
“We expect booking visibility to improve as we progress through the rest of the year and into 2023. Based on data from Singapore Tourism Board, we note that average daily rates (ADR) have exceeded 2019 levels since May, gaining further strength up to July with ADRs for luxury hotels 19% above that of 2019 levels and 15% for upscale hotels, pointing to strong takeup for rooms. This implies that hospitality landlords should be able to enjoy stronger profitability and pass on most of the cost increases to travellers,” the DBS report adds.
Whether these underpinnings meaningfully add to hospitality trusts’ DPS is an open question. In the meantime, these trusts remain in the shadow of the Fed.
