Q&A with Serafino Tobia, Managing Director & Head of Agency CMBS Trading at Greystone
After a volatile first half of the year, where do you see interest rates settling in Q3/Q4?
Unless we see further substantive improvement in inflation, we are anticipating that interest rates stay in the current range of 3.50% +/- 25 basis points (as measured by the 10-year Treasury rate). Two and a half months ago, the 10-year Treasury rate marked a recent high at 4.06% (on 3/2/23) just before the insolvencies of Silicon Valley Bank and Signature Bank. 10-year Treasuries dropped some 40-50 basis points in the three to four days following this event, and have been in the range of 3.50% since then, +/- 20 basis points. Our view is based on an expectation that the US inflation rate stays sticky and further improvement will be slower to achieve.
What about inflation?
We have had a steady improvement on inflation over the past year – the CPI, year-over-year, broke through 5.00% for April 2023 (4.90%). That’s down from 6.50% earlier this year (and from just over 9.00% last summer). This inflation improvement so far was the “easy” part – largely “transitory” due to supply chain disruptions and demand for excess goods due to the COVID pandemic. Getting from around 4.9% inflation down to the 2% Fed Reserve target inflation will likely prove more difficult. Also, we don’t expect inflation to reignite; the Federal Reserve is pursuing a hawkish/restrictive monetary policy which is likely to result in a recession later this year (and the hawkish Fed policy will combat inflation and keep longer term interest rates from moving higher).
What should be the multifamily sector’s biggest concern with the looming recession?
With an economic recession, multifamily property owners and developers will likely experience reduced rent revenue growth and marginally higher vacancies. Rental housing is a core need for consumers and insolated somewhat from the impact of an economic recession. In fact, the multifamily sector may actually benefit from an economic recession with consumers limiting their home purchases and renting instead. An economic recession would also help reduce inflation pressures and allow the Federal Reserve to start reducing interest rates and result in lower borrowing rates for multifamily owners and developers. With inflation having ignited over the past two years, the Federal Reserve Bank has pursued a restrictive monetary policy (a higher Fed Funds rate and quantitative tightening, QT, the sale of securities that the Fed had accumulated during 2020-2021 COVID pandemic response). Property owners and developers have had to pay higher interest rates for acquisition and new construction mortgage debt. Over the past year and a half, floating rate bridge loan interest rates moved from 3.00% to 4.00% range to 8.00%-9.00% as the Fed moved the Fed Funds rate from near zero to the 5.00%-5.25% range. Fixed-rate mortgages have increased as much as 2.50% during this timeframe as well; FHA-insured multifamily loans are now just over 5.00% (FHA mortgage rates were as low as 2.50% before the Fed started moving rates higher in early 2022). A recession would allow for interest rates to move lower, a net benefit for the multifamily sector.
What is the best way for the Fed to move inflation closer to its 2% target from today’s levels?
Unfortunately, the Federal Reserve Bank has only limited and blunt tools to address high inflation and the Fed cannot directly control inflation. The Fed uses its monetary policy tools to manage economic activity to address its dual mandate – maximum employment and price stability (i.e., control inflation). The Fed’s monetary policy toolbox includes:
- Increasing and decreasing the Fed Funds rate. The Fed Funds rate is the interest rate that banks can charge other banks to borrow funds overnight to meet reserve requirements with the Fed. The Federal Reserve sets the range of the Fed Funds rate. The Fed uses the Fed Funds rate to encourage or limit economic activity.
- Increasing and decreasing the Discount Rate. The Discount Rate is the interest rate the Fed charges to make overnight loans directly to banks.
- Conducting Open Market Operations (also known as Quantitative Easing “QE” and Quantitative Tightening “QT”). The Fed can buy and sell Treasuries, mortgage-backed securities and other securities in the open market to regulate the money supply and financial conditions. The Fed can ease financial conditions by purchasing securities and add cash money supply into the banking system (QE) or tighten economic conditions by selling securities to reduce the money supply (QT).
- Jawboning (also known as “Fed Speak”). Lest we forget that the Fed has the ability to use “moral suasion” to address how they want the markets and businesses to act.
The Fed was pursuing an easy monetary policy in 2020 and 2021 to address unemployment and recession brought on by the COVID pandemic. During this timeframe, the Fed moved the Fed Funds rate down to near zero and was buying upwards of $120 billion of securities monthly (QE, quantitative easing) to add cash into the money supply. As we moved out of the pandemic, inflation in the United States increased from below 2.00% to just over 9.00% in the early summer last year (June 2022). Many economists believe that the Fed had pursued an easy money policy for too long. In early 2022, the Fed pivoted to a restrictive money policy moving the Fed Funds rate (0.25% - 0.75% at each Fed FOMC meeting). The Fed Funds rate was moved from near zero at the beginning of 2021 to a range of 5%-5.25% currently. Last September 2022, the Fed also started quantitative tightening, QT, or buying securities to reduce the money supply. A good part of the inflation over the past two years was “transitory,” brought on by supply disruptions and goods demand from consumers during the COVID pandemic.
Inflation has come back down from just over 9.00% last summer to 4.90% in April (as measured by the Consumer Price Index, CPI). Getting inflation down another 3.00% (from 4.90% currently to Fed’s 2.00% target) may prove more difficult and many economists are concerned that a further restrictive monetary policy from the Fed will bring on a recession and increase unemployment. There is an expectation that the Fed will pause any further increases in the Fed Funds rate and they will wait at this level to allow the higher rates to work through the economy.
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