The Fed has become more dovish on rates, essentially changing its policy from one where it was likely to raise rates two or three times in 2019 to a more neutral position, and capital markets have gained confidence from that shift. “December and January were tough months for the economy and the commercial real estate business, because consumer confidence tanked and business confidence tanked along with the stock market,” says Spencer Levy, chairman of Americas research and senior economic advisor at real estate services firm CBRE.
The rebound in the stock market has strengthened both consumer and business confidence. “We would expect that as rates stay low, that confidence is going to remain,” adds Levy.
Impact on CRE
The 10-year Treasury has dropped by nearly 75 basis points since November to hover between 2.45 and 2.55 percent this month. CBRE expects the 10-year Treasury to top out just shy of 3.00 percent this year.
“I think we’re going to have about the same amount of transactions this year as we had last year, because the capital markets remain deep and liquid,” says Levy. In addition, while certain parts of the commercial real estate market may be near the peak, there is still a lot of momentum and opportunities that exist in newer markets like Nashville, Tenn., Orlando, Fla. and Kansas City, notes Levy.
One question is how the Fed position on rates and the recent decline in the 10-year Treasury could impact cap rates. Overall, cap rates have been on a plateau for the past couple of years, moving only about 20 basis points. Even with the recent dip in the 10-year Treasury, there is not a lot of room for cap rates to move lower, notes Bitner. People generally don’t have the risk tolerance that would be needed for rates to compress further, he adds.
Will the Fed cut rates?
JLL’s outlook for this year is that the Fed will likely remain neutral on rates through 2019. Core inflation could accelerate a little as the year progresses, but likely not enough to trigger a rate increase, notes Severino. “At the same time, I don’t see the economy deteriorating enough where the Fed would have to cut rates,” he says.
What is interesting is that the Fed Funds Futures market and the equity market both reacted negatively to the recent Fed decision as both expected the Fed to cut rates. Those expectations to cut rates don’t appear to make a lot of sense when the economy is growing at a rate that is above trend and unemployment is at a 50-year low, notes Severino.
“I think the Fed has been very dovish, but at the same time, they have been careful to make sure the market understands they are not immediately planning to cut rates,” says Bitner. However, that has not deterred growing sentiment that a rate cut may be in the cards for later in the year. According to CME FedWatch, expectations for a Fed rate cut rise to 26 percent for the September meeting, 42.2 percent for October and 60.1 percent for the December meeting. Growing sentiment in favor of a rate cut is due to concerns about trade tariffs and elevated recession risk.
Looking out over the 12- to 18-month horizon, Severino believes it is more likely that the Fed will raise rates again before they make any moves to cut rates. “I’m not saying they will raise rates necessarily; I just don’t see as much risk to the downside of the economy as I see a chance that the Fed think rates need to be higher going into the next downturn,” he says. Either way, the Fed is likely close to the end of its tightening cycle, he adds.