Federal Reserve Shifts Tone and Overnight Rate in September
The Federal Reserve announced on Wednesday a 50-basis point cut to the federal funds rate, bringing the overnight rate to the 4.75%-5.00% range. While the Fed has successfully reduced the pace of inflation since Core PCE growth peaked in 2022, the Federal Reserve’s preferred inflation measure has remained at 2.6% for the past three months. Labor market dynamics are complicating inflation drivers; rising unemployment indicates a softening job market, yet layoffs and discharges remain minimal. The BLS’ announcement of preliminary employment revisions showing 818,000 fewer jobs than previously reported likely played a role in increasing the importance Fed members placed on job markets. Chairman Powell noted that the risks of weakening labor markets and persistent inflation are in balance, suggesting the Fed’s focus will be equally divided between employment trends and inflation in upcoming meetings.
Markets Reacted to Lower Rates Before the Fed Meeting
The decision to cut rates 50 basis points in September indicates that the Fed is trying to be proactive in its rate movements following a delayed response to rising inflation initially. With the market anticipating a downward movement in September, treasury yields have declined sharply in recent weeks, suggesting the 10-year treasury yield is likely to remain near 3.7% in the short term. Most CRE lenders also expected a rate cut at this meeting, leading to a decrease in lending premiums across the property type and lender spectrums in recent weeks. CRE cap rate spreads over lending costs are expanding as a result, and the Mortgage Bankers Association’s forecast shows CRE lending is likely to rise moving forward. These factors should aid deal flow in the weeks and months ahead.
Long-Term Interest Rates Not Expected to Reach 2019 Level; But CRE Set to Enter a New Chapter
The Fed is likely to proceed with additional rate cuts at the final two meetings of 2024. The current CME Group predicts year-end rates to land between 4.25% and 4.50%, in alignment with the Federal Reserve’s dot plot. In the near term, the upcoming presidential election is creating some uncertainty. However, by the end of 2025, the Federal Reserve, Wall Street, and the 1-month term SOFR curve all expect the overnight rate to be between 2.75% and 3.50%. Confidence that rates are headed downward should aid deal flow and reduce the gap between buyer and seller expectations. If the long-term rate is near 3.00%, investors who plan on waiting for pre-pandemic financing conditions may need to rethink their investment strategies.
The decision to cut the federal funds rate 50 basis points rather than 25 proved to be controversial with media pundits and analysts, as it signals the economy may not be as strong as Federal Reserve officials had previously believed. At the same time, lower borrowing costs on commercial real estate loans will aid deal flow, and cheaper debt for credit card borrowing and auto loans will enable consumers to spend a higher portion of their income on products that support CRE space demand, especially within the retail and industrial sectors. Reduced debt burdens for consumers will also support additional household formation as borrowing costs decline, bolstering demand for apartment and self-storage facilities.
