The Fed is poised to implement more hawkish policies, so “be ready for rate hikes.”
Parsing the minutes of last month’s Fed meeting had many commercial real estate experts reading between the lines of what might happen to the sector in the short term, particularly as many within the Fed are advocating a 50 basis point increase in the overnight rate.
Ultimately, the Fed stuck to a 25 basis point uptick, but “the minutes suggest that one or more 50 basis point increases could be appropriate if inflation pressures remain elevated or intensified,” said Marcus & Millichap’s John Chang in a recent video.
“That suggests the Fed could raise the overnight rate by more than 200 basis points this year.”
The Fed is also actively discussing a balance sheet reduction, or quantitative tightening.
“During the pandemic, the Fed used quantitative easing to keep long term interest rates down. They were buying $120 billion in Treasuries and mortgage-backed securities each month…and in two years, they doubled their balance sheet,” Chang said. “And now, they’re going to start reversing that.”
He explains that by using quantitative tightening, the Fed can push up long term interest rates, reducing the chance of a yield curve inversion. The two-year Treasury already pushed into the 10-year rate a few weeks ago, causing a brief inversion. But that flipped as soon as the Fed minutes were released last week indicating that they’ll likely use quantitative tightening.
Chang says that while the minutes didn’t provide specific timing or guidelines, it did suggest reducing the Fed balance sheet by up to a proposed limit of $95 billion per month, with most of that being through the natural maturation of Treasuries and mortgage-backed securities.
For investors, this means that the Fed is worried about inflation, and “they’re going to implement more hawkish policies,” Chang says. “Be ready for rate hikes.”
Those increases could be up to 2.5% this year, according to some estimates. And while quantitative easing will be used to “theoretically reduce” a recession risk, the 10-year Treasury could still get pushed to 4% by the end of the year.
Chang notes that the probability of a recession in the next two years is “elevated but it’s not a foregone conclusion,” pointing to strong wage and employment growth in the first quarter.
“Those are all positive forces supporting economic growth,” he says. “For now investors should really focus their strategies on inflation risk and be prepared for interest rates to rise substantially. But remember—investment real estate is one of the best places to be in economic cycles like the one we’re in.”
