Needed or not, a rate
cut is coming
After planning for multiple rate hikes this year, the Fed now indicates a rate cut is on the horizon. What does that mean for commercial real estate?
After weeks of market anticipation, Chairman Powell signaled last week that a rate cut is coming, as soon as the next Fed meeting at the end of this month. Such a cut would likely equal 25 basis points. If a rate cut occurs, it will signal a stark reversal on the part of the Fed over the last nine months — from a course of multiple rate hikes planned for 2019 to potentially multiple rate cuts. This raises an important question — does the economy need a rate cut? Let’s examine the evidence on both sides of the debate. But note that either course of action, whether cutting or standing pat, contains downside risks.
The argument in favor of a rate cut rests on these key pillars:
- Trade tensions are dampening the mood at home and producing a headwind around the world, notably in countries with significant manufacturing and export sectors like China and Germany.
- Slowing global economic growth (even excluding the impact of trade tensions) is creating a more difficult environment for U.S. exporters.
- Inflation remains below the Fed’s target rate of 2%, potentially indicating slack in the economy.
- Parts of the yield curve have inverted, which has historically signaled a subsequent recession.
- The Fed is coming under significant market and political pressure to cut rates, despite the chairman’s statements otherwise.
The basic argument, in sum, lies with the premise that although headwinds are not yet negatively impacting the economy, they could do so (“uncertainties” in Fed speak), and it is better to get ahead of things and attempt to inoculate the economy now.
The argument against a rate cut includes:
- The labor market remains incredibly strong – the unemployment rate sits near a half-century low; weekly unemployment claims also hover near half-century lows; open, but unfilled jobs, remain near their record-high level; and wages are growing faster than 3%, roughly double the Fed’s preferred measure of inflation. Job growth remains healthy, near 170,000 net new jobs per month, year-to-date.
- The overall economy is growing faster than predicted, even if second quarter growth pulls back significantly from the first quarter.
- Financial conditions remain the loosest in decades by some measures, with equity markets lurking near an all-time high and interest rates still near historically low levels.
- Although undershooting, inflation sits marginally, not significantly, below the Fed’s target.
- Consumer confidence and business sentiment remain at elevated levels with consumers spending at healthy levels.
Implications for CRE
While no clear consensus exists on whether or not a rate cut should occur, one with one likely coming we should consider the implications for commercial real estate (CRE).
For CRE specifically, market fundamentals across property types and markets remain healthy and valuations sit near historically-high levels, at least on a nominal basis. We do not see a rate cut having any real impact on fundamentals because it should impact the economy very little. Cap rates across most primary and secondary markets show little to no sign of expanding. Even without a rate cut, our proprietary forecast models showed little deterioration in fundamentals in the coming quarters and not significant upward pressure on cap rate. Removing any upward pressure on cap rates from interest rates virtually guarantees at least stable cap rates in the short term. If investor appetites turn even more ravenous, transaction volume could get a boost in 2019 relative to the current trajectory.
What we are watching this week
With the Fed siphoning so much oxygen out of the room, data releases could get overlooked. We are watching retail sales for any sign of greater-than-anticipated slowing, though sales should remain firm. Initial jobless claims should show little sign of trouble. And consumer sentiment should likely show that consumers remain optimistic.
Thought of the week
The average American works roughly 34 hours per week, six more than the average French workers and eight more than the average German worker.