Fed Hikes Interest Rates to 22-Year High… Is This the Last Time?
Jerome Powell raised the federal funds rate 25 basis points Wednesday, and didn't rule out another hike.
If Jay Powell were a poker player, he might say, “I’ll see your interest rate pause and raise you one more.”
As economists predicted, Federal Reserve Chairman Jerome Powell raised the Federal Funds Rate 25 basis points Wednesday, bringing the benchmark interest rate up to between 5.25 percent and 5.5 percent in July. The rate hike follows a brief pause in June and is the 11th interest rate increase over the past 16 months — culminating in the fastest interest rate increase seen in 40 years.
In an announcement regarding the hike Wednesday, the Federal Reserve stated: “The committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the committee decided to raise the target range for the federal funds rate to 5.25 to 5.5 percent.”
At a press conference Wednesday, Chair Powell said the Federal Reserve would make “careful assessments, meeting by meeting,” as to whether further rate hikes would occur, and those decisions would be heavily “data dependent.”
The window for another rate hike in September does indeed seem to be open, however, as the Federal Reserve works to determine the extent of future additional policy firming needed to reach its 2 percent inflation target, Powell said. Factors taken into consideration will include the “cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments,” Powell said, and the Federal Reserve will make future rate hike decisions based on totality of that incoming data and its “implications for the outlook for economic activity and inflation, as well as the balance of risks.”
The Federal Funds Rate stood at 0.25 percent to 0.5 percent in March 2022 prior to Powell’s aggressive policy aimed at reducing inflation and slowing down an overheated economy. Interest rate hikes raise the cost of borrowing and contribute to asset price deflation.
Still, so far, Powell’s policy appears to be working. The consumer price index reached a high of 9.1 percent in June 2022, but has since fallen to 3 percent in July 2023. Real gross domestic product (GDP) growth increased at an annual rate of 2 percent in the first quarter and is expected to reach 2.4 percent in the second quarter, according to the Federal Reserve Bank of Atlanta.
Powell noted Wednesday that the labor market also remains “very tight,” with job gains averaging 244,000 jobs per month over the past three months, and the unemployment rate at the low level of 3.6 percent. He also spoke of continued signs that supply and demand in the labor market are “coming into better balance,” with the labor force participation rate ticking up, especially for individuals aged 25 to 54 years.
All this could point to brighter days ahead not just for the American economy, but for commercial real estate as well.
“You can point to a proactive Fed policy, Bidenomics, whatever you want to call it, but I think something is working, it really is,” said Matthew Swerdlow, capital services expert at Ariel Property Advisors. “People are buying deals. It’s happening.”
But the long string of Fed rate increases resulted in a broad pullback of bank lending activity and impacted the long-term securities holdings on the balance sheets of many lenders, contributing to a regional banking crisis that shook the nation this past spring and left commercial real estate capital markets increasingly starved for liquidity.
“Eight of 10 banks, they’ll tell you, one, we’re only focusing on existing depository relationships and if you’re not one of those, then we have little to no appetite for your loan opportunity,” Swerdlow explained. “Or, we’re interested in your loan opportunity, but it will have to come with an amount of deposits somewhere in the ZIP code of 10 to 50 percent of the loan amount.”
Lisa Pendergast, executive director of the Commercial Real Estate Finance Council, expressed bewilderment at Powell’s comments that rates would continue to rise after the June pause due largely to persistent inflation and labor-market strength. She said she suspects he may have only paused in June to wait for more economic data.
“I’m confused by the Fed a little bit,” Pendergast said. “It’s been one of the most aggressive, fastest Fed hiking cycles we’ve seen in four decades.”
However, some economists believe Powell is being very deliberate with his actions.
Thomas LaSalvia, head of commercial real estate economics at Moody’s Analytics, said that Powell likely made his decision based on unsettling numbers that indicate a tight labor market.
While unemployment stands at 3.6 percent, the ratio of job openings has greatly outpaced the number of job seekers, and the number of workers quitting remains higher than those being laid off or fired, according to LaSalvia.
“Those two measures are telling the Fed that the labor market is still too hot for their liking,” he said. “What they’ll worry about there is the wage-price spiral: as wage growth is too high, it keeps consumer spending too strong, and that demand pressure will not allow the Fed to get to that 2 percent [inflation target].”
But if the Fed remains focused on the labor market, it might not be attuned to the pressures another 25 basis point rate increase puts on the fragile commercial real estate industry.
Greg Friedman, managing principal and CEO at Peachtree Group, a CRE investment platform, noted that certain asset classes like hospitality trade at higher capitalization rates and are less sensitive to interest rate hikes than asset classes like multifamily and self-storage that usually trade at lower cap rates and feel the burn of a hike.
“[The hike] does impact all commercial real estate owners, because ultimately the cost of debt increases as rates increase, and it does have correlation to the values underlying assets that we’re lending to or that we own,” Friedman said. “We got used to this really low interest rate environment, and now we’re sort of on the other side of that trade.”
But even as certain asset classes remain fragile to a higher cost of credit, Powell’s battle to tame inflation is no longer expected to plunge the economy into a recession.
“We have been seeing the effects of our tightening policy on demand in the most interest-rate sensitive areas of the economy, particularly housing and investment,” Powell said Wednesday. “It will take time for the full effects of our ongoing monetary restraint to be realized, especially on inflation.”
Numerous CRE experts said they expect Powell to steer the economy into a soft landing in the next 12 months.
“There are enough strengths in household budgets and there is enough capital in the financing system to prevent the type of decline that I think many of us were worried about a year ago when this all started,” LaSalvia said.
Even skeptics like Pendergast, who noted that the aggressive rate hikes have caused the yield curve to invert — meaning two-year Treasury notes are trading higher than 10-year Treasury notes — concluded a recession is no longer imminent despite data that once pointed in that direction.
“The curve is inverted, and that normally spells recession, but the more data that we see … a lot of economists are saying we might avoid a recession and some type of soft landing is possible. I’m all for that,” Pendergast said.
Cathy Cunningham contributed reporting.