Capital Ideas: Is the Fed Ready to Commit to a Cut?

Update: The Federal Reserve announced today to hold the Fed Funds Rate at 5.25 to 5.5 percent, and tentatively signaled a rate cut for September.

“The question will be whether the totality of the data, the evolving outlook and the balance of risks are consistent with rising confidence on inflation and maintaining a solid labor market,” said Fed Chair Jerome Powell at a press conference after the announcement. “If that test is met, a reduction in our policy rate could be on the table as soon as the next meeting in September.”

There is widespread consensus that when Federal Reserve Chairman Jerome Powell steps to the podium today at the FOMC meeting he will announce another hold on interest rates while signaling a long-awaited cut for September.

Inflation has been coming down fairly steadily toward the Fed’s 2 percent target, and the labor market is tightening. The Fed, however, has been highly cautious about committing to cutting the Fed Funds Rate, which it has held at 5.25 to 5.5 percent since last summer after an extended series of hikes. So if Powell even hints strongly at a cut for the Sept. 17-18 meeting, it will be a big relief for commercial real estate.

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CBRE’s “base case” is a quarter-point rate cut in September, another in December and then four cuts in 2025, according to Richard Barkham, CBRE’s global chief economist & global head of research..

However, given the progress on inflation, a July rate cut isn’t “off the table,” Barkham said.

“There are some signs the consumer is weakening,” he noted. “Every positive for inflation, when interest rates stay the same, increases the real interest rate. That’s not the same as broad financial conditions, but it does have an impact. It’s sort of a mild-level tightening.”

And while the Fed has promised to do what is best for the economy regardless of politics, if it waits until September, it risks criticism from former President Trump, Barkham noted. Trump has already stated that he does not want to see rates cut now.

Essentially, Barkham said, whether or not you think a July rate cut is justified depends on your view of the economy. If you are a “glass-half-full person” you see consumer suffering, a significant reduction in inflation (down to 2.6 percent in June from 9 percent two years ago), a weakening job market and the risk of keeping interest rates too high for too long, and you think it would make sense for the Fed to act now.

If you are a glass-half-empty person, however, you see an economy whose strength still needs controlling, and an inflation rate that is near the Fed’s target rate but not there yet, and you think it’s better for the Fed to wait until the next meeting.

Real estate ramifications

The Fed’s aggressive tightening campaign has depressed CRE investment and finance activity, and hurt values. Meanwhile, some sectors, namely CBD office, are still facing pandemic-related fallout. Whether it comes now or in September, how much difference will a quarter-point decrease make for CRE?

According to Bryan Reid, an executive director at MSCI Research, in a research piece, the wait for interest rate cuts and the “disappointment” resulting from forecasted cuts that didn’t materialize has “softened” investor sentiment. A rate cut could start turning that around.

“A single rate cut on its own would not be a panacea, but could still act as an important signal for the industry,” Reid wrote in an email. “It will take time for monetary policy easing to play out and flow through to the commercial real estate markets, meaning that recovery is unlikely to be V-shaped.

“Deals that are on the margins would be the first to benefit from a lower-rate environment. However, in the more depressed parts of the market, like lower quality CBD offices, the gulf between buyers and sellers or borrowers and lenders remains wide, and will take longer to bridge.”

Barkham agrees that the a cut in the Fed Funds Rate is important for improving overall sentiment and jumpstarting transactions. A spike in inflation in Q1 “derailed” a revival for investment activity, he said, but he remains hopeful for a Q4 revival. The capital markets for office, of course, will take longer to return.

He noted, however, that the 10-year Treasury, which was at 4.2 yesterday, is a more important variable for CRE interest rates.

“The Fed funds rate may not feed through too much into investor activity, but if it persuades the market that we’re now firmly on the trajectory of downed interest rates, that would cause 10-year Treasury yields to come in just a bit quicker, and that would be very good for real estate investment activity,” Barkham said.

The Fed’s nod would also be key. “The cut is not that material economically, but it is the Fed putting a blessing on the view that we’re through this inflation,” he said.

We’ll be tuning into the Fed’s announcement this afternoon to find out which glass Fed Chair Powell is drinking from.

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