FEAR “THE FED” ?
The Federal Reserve Bank continues to make news and waves with rate increases which have shaken both the equity and bond market of late. New chairman Powell speaks directly and in doing so has taken this bull market by the horns with plans for additional rate increase in December and anticipates 2 or 3 more in 2019. Currently, key benchmark interest rates are shown below vs. one and two years ago.
Today Nov.’17 Nov. ‘16
Fed Funds Rate* 2.25 % 1.25 % 0.75 %
Prime Rate 5.25 % 4.25 % 3.75 %
10 Year US Treasury Bond 3.15 % 2.30 % 1.52 %
* The Federal Reserve Banks guidance may yield a rate of 3.25 % by Fall 2019.
These key rates drive virtually all areas of the US economy from business loans, housing, auto sales and commercial real estate. Banks utilize the Fed Funds rate to determine their cost of funds and higher interest rates on floating rate debt yield higher profits with each rate increase flowing directly to their bottom line. It is also true that banks eventually come under market pressure to pay higher interest rates on all deposits; (savings and money market accounts) to retain those key deposits which are the sole source for loans. There is often a delay in the deposit rate increase and is why you are seeing higher bank earnings reported for the most recent quarter. Banks are now experiencing such pressures which are likely to result in a reduction in commercial lending with loans at higher interest rates which correlate to the banks cost of deposits going forward.
The FED’s actions while long anticipated and necessary after years of “near zero rates”, run the risk of pushing rates up too fast and/or too high and effectively stifling the near 10- year bull market the US has enjoyed since the Great Recession. Only time will tell and all of this will be balanced against worldwide market reactions to “headline” events that cannot be foreseen. Some voice a more cautious approach thru Q2-’19 to gauge the effects of the new tax cuts on corporate earnings and consumer sentiment.
Commercial real estate markets which have enjoyed high occupancies and rising rental rates are in for some adjustments as a result of interest rates rising. Since the 2016 Presidential election the key benchmark 10-year US Treasury rate has increased by 110% and the days of financing commercial real estate projects with rates of 3.00-4.0% are clearly in our collective rearview mirrors. The new paradigm is apparently a 5%+ interest rate market which is likely to rise over the next 9-12 months. With higher rates lenders can also be expected to tighten their loan underwriting metrics which will result in a reduction in loan proceeds into 2019. Owners with stabilized commercial realty assets with a desire to retain solid cash flow investments, “time is of the essence” should be refinancing bank debt NOW with long term fixed rate debt.