How the Fed is Responding
Steady Gains and Cautious Optimism
Key jobs reporting this past Friday (12/6), coupled with Powell’s recent comments last week, suggest a continued “wait and see” approach from the Fed as they remain cautiously optimistic about the economy’s current strength. Powell said on Thursday that the U.S. economy was “in remarkably good shape” and “stronger than we thought it would be in September.” The U.S. added +227K jobs in November, beating expectations of 202K. The continued strength of the labor markets, as well as record consumer spending leading into the Holiday season, has given the Fed pause when considering additional rate cuts into year-end. A looming transition period in Washington also weighs on the Fed as they gauge how policy changes brought about by the Trump administration will affect the economic outlook.
Job Growth Highlights Economic Complexity
Previous job market data saw a revision upward as the October report added +36K following the resolution to the strike of port workers across the eastern seaboard earlier this fall. Worth noting, 142K (63%) of the jobs added in November were Government roles (33K), leisure (53K), and healthcare (56K)–industries that historically have made up a smaller percentage of the overall growth multiple of the U.S. economy. Layoffs in tech and a slowdown of hiring in finance and manufacturing continue to give the Fed heartburn when assessing the state of full employment. Despite this, the unemployment rate remained steady at just over ~4%, what Powell described as “a very, very low level.”
Powell Comments on the State of the Economy as Jobs Data Continues to Surprise to the Upside
Source: Bloomberg, LLP | Economic Calendar
Record Holiday Sales and Consumer Strength Challenge Fed’s Inflation Goals
As we move into the holiday season, all eyes move toward retail and e-commerce spending. American retail titans Amazon and Walmart already reported record sales at the onset of the shopping season. Black Friday shoppers spent a record $10.8bn this year, a +10% increase over 2023 spend. Cyber Monday spending came in at a whopping $13.3bn, a +7% increase compared to 2023. There remains a record +/-$6T in cash and liquid money market fund reserves both at the retail and institutional levels. As the risk-free rate of return (treasuries) continues to degrade, this “dry powder” will need to be allocated into risk assets (equities, crypto, real estate, private investments) to keep up with investors’ demand for a respectable rate of return. This consumer strength and spending continues to serve as a headwind for the Fed as it props up stubbornly resilient underlying inflation.
While a 25bps Cut is All but Baked in for Their Dec-18 Meeting, Expect the Fed to Continue to Keep an Eye on Key Inflation Indicators Released Next Week as They Decide Policy Direction for 2025
Source: Bloomberg, LLP | Economic Calendar
Odds for a 25bps Cut for Their Dec-18 Meeting Have Increased by ~20% Since Last Week on the Back of Powell’s Comments and Recent Developments in Washington
Source: CME Group | FedWatch Tool as of 12/8/2024
Looking Ahead to Their Jan-29 Meeting We See More Uncertainty With Fed Policy. Markets Have Bet that We Should Expect to See a 25bps Cut in December or January, but not Both
Source: CME Group | FedWatch Tool as of 12/8/2024
Market Reacts to New Leadership and Policy Proposals
After remaining stubbornly elevated post the November Fed meeting, Treasuries have finally started to give away some gains. While much of this is macro-based, favorable political tailwinds are coming from Washington D.C. – or better yet, Mar-a-Lago. Trump’s picks for the Treasury Secretary and the Department of Government Efficiency (DOGE) were well received by the markets. Scott Bessent, who will spearhead Trump’s goal to reinstate tariffs on China and Mexico and oversee efforts to implement further tax cuts, was the CEO of hedge fund Key Square Capital Management and a top investment officer for Soros Fund Management. Markets responded well to the selection, as experts believe Bessent will be slower and more methodical in implementing tariffs and other Trump economic policies that could threaten to disrupt global supply chains.
On the other end of the spectrum, the announcement of DOGE – to be co-headed by Elon Musk and Vivek Ramaswamy – has received mixed reviews; with center-right and libertarian groups lauding the long overdue promise of increased scrutiny on government waste and excessive regulation, and with left-leaning circles arguing that cuts in regulation will simply go to enrich Musk and his companies while doing little to help individual Americans. Regardless of political spin, on November 20th when the duo published their opinion piece in the Wall Street Journal outlining DOGE’s directive, the 10-year treasury yield contracted by -5bps shortly after – equating to roughly +/-$15bn/year in interest expense saved. Currently, the U.S. is on pace for the interest payments alone on the national debt to be >$1T next year.
Capital Markets: Development Insights, Tailwinds for Construction, Rampant Re-Trades, & Deal Spotlights
With the election now behind us, developers find themselves in a unique position whereby both parties of government may favor increased development, with the potential to even lower cumbersome zoning and environmental standards that have plagued the development community in many urban areas across the country. A clear example of this cross-over between development and politics comes with the recent “City of Yes” affordable housing proposal approved by the New York City Council. The proposal removes certain parking-space restrictions and will produce +82,000 new housing units over the next 15 years.
Additionally, continued rate cuts and a favorable economic outlook continue to buoy developers as key rates tied to construction and bridge financing (Prime, SOFR) move down in tandem with rate cuts. While treasuries do not move pari-passu (“on equal footing”) to the Fed funds rate, Prime and SOFR do; meaning that with each cut in rates, the financial models of development firms eyeing bridge acquisitions, office conversions, and ground-up developments, begin to pencil a bit better. There has been an explosion of requests for construction debt (especially for self-storage in the Sunbelt), as lenders are getting as aggressive as Prime-1% (6.75%) in some unique cases. Many lenders are re-assessing their buckets for 2025, and this trend is expected to continue as rates continue to come in.
Benchmark Rates SOFR and Prime Continue to Move Down In Lock-Step With Cuts to the Fed Funds
Source: CME Group | FedWatch Tool as of 12/8/2024
Sector-By-Sector Analysis
Multifamily – Agency continues to reduce its spreads in order to remain competitive. However, bank and credit union execution has quickly gained pace on rate and terms. Coupled with less arduous underwriting standards for new borrowers and mom-and-pop refinances, we expect larger banks and competitive credit unions to continue to shine here. It will remain important to price out each deal for best execution.
Retail – Local bank and credit union execution has been much nimbler on smaller strip center and non-anchored deals while Life company and CMBS continue to look for larger, quality credit, anchored deals – with a lean toward grocery stores and away from big box retailers. Lifeco’s have reinstated their floor rates at ~6.00%. Current spreads are 170-250bps over the treasury – CMBS falling around T+240-300. Major groups are re-assessing lending buckets for new Q1 2025 opportunities.
STNL – Credit Union execution continues to dominate by offering no prepayment penalties to borrowers betting on interest rates coming down. Bank SWAP deals are making more sense for borrowers looking to hold assets long-term. Tenant credit and lease term are the two most scrutinized factors by lenders given the recent headwinds and credit downgrades for tenants like Dollar Tree/Dollar General & CVS/Walgreens.
Industrial – Continues to thrive at the institutional investment level as other core assets stagnate. Positioned to take advantage of swings in U.S. foreign policy as we look to onshore manufacturing. Expect to see more sale-leaseback scenarios as tenants affected by continued fallout from supply chain constraints and Covid-era demand shock look to raise capital.
Self-Storage – Continues to be the belle of the ball at the institutional investment level given its stability and growing market share/new construction pipeline. Bank and Credit union lenders are still hesitant to lend above 70% LTV and are partial to asset quality showing stabilized cash flow and regulated OpEx. Lifeco/CMBS execution is possible on sizeable & stable portfolios.
Bridge/Construction – One of the most active lending spaces currently with a plethora of private credit groups popping up to fill the gap in transactions left by traditional lenders. Terms are incredibly deal-specific, with a focus on sponsorship experience and exit strategy. Current spreads anywhere from 400-600 over SOFR.
Office & Hospitality – Many conventional lenders are completely paused on office and hospitality. Debt funds and bridge groups will look at conversions and more niche hotel assets that have a path to stabilization. We expect lending conditions to continue to be choppy in the office space for the foreseeable future. Medical office is a sub-asset class that has been a relatively bright spot, drawing lender attention with its high cash flow and sticky tenancy.
