Pascale’s Perspective

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    Yield Curve Partial Inversion Roils Markets, What Happens If and When It More Fully Inverts?

    Pascale’s Perspective

    December 5, 2018

    On Monday, the US Treasury “yield curve” partially inverted as the 5 year T yield dropped below the 3 year T yield.  A typical “classic” inversion occurs when the 10 year yield drops below the 2 year yield, that is the most scrutinized relationship on the range of treasuries. Stock markets tumbled. (Dow dropped 800 points yesterday) as this added to uncertainty. An inverted yield curve is a classic harbinger of recessions (every recession since the 70’s).  Other macro economic concerns helped fan the flames (Brexit, mixed signals regarding the China/US “cease fire” on trade, etc). This is the first inversion in a decade, so it’s a major uncertainty. The major question facing markets: Is this “old school” indicator still valid in the “new normal” era of post Great Recession metrics of massive central bank accommodations, and stubbornly low inflation? Or “are things different this time?” We are again in uncharted territory. The Fed is still holding massive amounts of long dated Treasuries as it is now in its second year of the long slow unwind of its $4 trillion balance sheet. Markets seem to be counting on a very gradual sell off, keeping the long yields down. But most importantly, the lower 10 and 30 year bond yields are a product of reduced growth and inflation expectations for 2019, 2020 and beyond. Potential causes: the effects of US tax cuts fade, Italy weakening the Eurozone, continued trade disputes, etc. Many major economic groups are lowering growth forecasts for the next few years. Inflation is still spotty and not steady, note that oil prices again dropped today (after rising from lows) as the long awaited OPEC production cuts may be “off”. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Markets Rally as “Neutral Rate” Is Closer Than We Thought

    Pascale’s Perspective

    November 28, 2018

    Fed Chair Powell’s speech today sent stock markets up 2% and immediately halted this morning’s market “correction”.  The big change was Powell’s remark that rates are “just below” the neutral rate. Remember, the neutral rate is the rate the Fed is aiming to reach. The neutral rate is neither stimulative nor restrictive to the overall economy. Markets have been on edge as they feared that the Fed was on an unshakable path of continued rate hikes well into 2019. This sentiment was based on recent Fed statements and the “dot plots” produced at each FOMC meeting. It was assumed that there were four rate hikes on the horizon, one in December 2018 and 3 more in 2019. Today’s comments by Powell immediately changed that consensus to one in December and one in 2019. No doubt, the December 2018 dot plot will be closely watched. So it seems the Neutral Rate is 2.75%. It was once thought to be 3.25-3.50%. A lower neutral rate means a weaker global economy. Perhaps the “new normal” post recession world economy will require some accommodative policy after all. Today’s developments are an example of the “contrarian” economic news cycle: bad news becomes good news, (a grimmer economic outlook leads to lower interest rates in the future and markets cheer).  Powell also stressed that future policy is “data dependent” and not “set in stone”.  He also indicated concerns on the horizon: trade disputes/tariffs, Brexit, Italian bonds, and the IMF has lowered growth projections. Plus, today’s housing report showed new home sales falling to a 3 year low with inventory spiking. Corporate spreads are volatile and widening (pushing some Life Co loan spreads up also). The 10 year T hit a 2 month low of 3.04% today. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    “Normal” Inflation Continues But Oil Prices May Put the Brakes On

    Pascale’s Perspective

    November 14, 2018

    Today’s major data points can be interpreted as a look to both the present and the future, and forward looking markets are acting accordingly. This morning’s CPI report showed consumer prices rising at their highest level in 9 months, keeping the “inflation is back” narrative alive. But a closer look reveals that 1/3 of the increase is due to gasoline and other energy components. With worldwide oil markets plunging, the near future may see a cooling of inflation. Oil prices often impact interest rates, as markets view oil demand as a bellwether of global growth. So today saw Treasury yields drop, the 10 year is at 3.12%, after hitting a recent high of 3.25% earlier in the month. CMBS and other Fixed Rates: CMBS bonds stopped their slide (spreads had been widening), a cutback in supply as we approach year end helped. CMBS spreads for full leverage loans are still in the 200 range (about 190-210 over the Swap). Life companies at lower leverage are anywhere from 130-180 over the Treasury. So all-in coupons range from 4.50 to 5.25%, depending on quality and leverage. Stay tuned.  By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Gridlock in Washington, Wages Finally Pop, Trade Tensions Remain

    Pascale’s Perspective

    November 7, 2018

    Equities rallied today on the election results. Traditionally, Wall Street likes divided government and gridlock as that provides more certainty as the chances of major legislation being passed are diminished. Treasury buyers were nervous about the chances of another major tax cut increasing the already huge supply of government bonds. Fed Watch: Last weeks employment report confirmed that we are finally “here”.  Years of ultra-accommodative monetary policy is helping to produce significant wage gains. Anecdotal evidence suggested that even with the tight job market, employers had been increasing everything except wages (perks, benefits, bonuses, etc). Employees finally have pricing power on wages.  Last week’s report showed healthy gains of over 3.0% in line with the Fed’s “mandate” to put the average American in a position to succeed. A rate increase in  December is a virtual certainty. A breakthrough in US China trade talks could unleash yields further upward, today the 10 year sits at 3.21% about 6 bps below its recent high. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Market Volatility Driving Yields Downward

    Pascale’s Perspective

    October 24, 2018

    Stock markets worldwide are in a fear-driven, bumpy ride. This has brought bond yields down in a flight to quality. Markets are always watching what is coming next. The fear is that companies are experiencing “peak earnings” and that tariffs and other factors are taking their toll (nascent inflation, labor shortages, etc). Caterpillar’s earnings spurred a major selloff this week as they indicated margins are being cut due to increasing costs partially related to tariffs. Also, new home sales dropped, has housing peaked also? This seems not to be supply/demand driven but buyers are reeling from peak sales prices and higher interest rates. This begs the question in the post crisis economic world: can the economy thrive as ultra low interest rates go away? Geopolitical concerns: (1) Saudi Arabia and Turkey: tensions are rising between two major global economic powers; (2) Italy: populist government submitted a budget rejected by the EU, setting up a showdown. The EU is very concerned about Italy’s debt load becoming unsustainable. Note that an economic collapse/default in Italy would have serious worldwide repercussions. Italy’s economy is the 4th largest in Europe and 10 times the size of Greece’s economy (and the possibility of a Greek default caused major consternation a couple of years ago). Interesting that the Italian 10 year bond is trading at 3.61%, only a 0.50% premium to “ultra safe” US Treasuries; (3) China: remember that China’s growth was the only bright spot in the years after the financial crisis, now, the economy is sputtering despite regulators moving to increase liquidity. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Rising Rates Affect on Consumers, Fed Minutes Indicate Resolve

    Pascale’s Perspective

    October 17, 2018

    Increasing rates are supposedly the solution for an overheating economy. Rising rates are affecting the housing markets (negatively) and apartment metrics (positively in a contrarian way). Higher rates are slowing down the home refinance market to a crawl and also putting pressure on buyers and sellers. (higher rates = less loan proceeds of course). Today a Freddie Mac study indicated higher mortgage rates are turning some would be buyers into renters (at least until prices go down), thereby increasing occupancy and rents for apartment owners. Of course many apartment owners are bemoaning the increase in fixed and floating rates for their acquisitions and perms. Today’s Fed minutes indicate the committee is united (last month’s increase was unanimous) and convinced more hikes are in order. This is a significant message to markets that the Fed is not bowing to pressure from the executive branch. The 10 year T hit 3.20% again today after a week of huge market volatility. In other contrarian news, the Sears bankruptcy will be good news for many retail owners as many of the affected Sears (or Kmart) locations involve rock bottom below market rent for good infill retail locations. Savvy and well capitalized operators can repurpose the space. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Wall Street Correction, Is This Part of “Normalization”?

    Pascale’s Perspective

    October 10, 2018

    Last week’s comments from Fed Chair Powell have resonated with the markets. He said that we are a “long way” from neutral on interest rates and that the “really extremely accommodative low interest rates are not appropriate anymore”. This is a vote of confidence in the strength of the US economy, so it’s good news, right? Also, note that the Fed has indicated that they may increase rates above the neutral rate if necessary in order to restrain inflation. It seems that there is some technical support for 10 year rates above 3.00% (the yield did not “snap back”, it is staying high partly due to continued record supply). Many accused the Fed of inflating asset bubbles with years of low rate and accommodative policy. Well then, now those assets may be “marked to market” and we may be seeing the “real” values of stocks and other financials. Note that during much of today’s plunge in stocks, both stocks and bonds were selling off (which is unusual). However, there was some “flight to quality” bond buying at the end of the day, the 10 year yield dropped to 3.16% as traders noted that tomorrow’s Dow futures indicate a triple digit drop. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Formula For A New 7 Year High for the 10 year T

    Pascale’s Perspective

    October 3, 2018

    Interest rates are front and center today as the 10 year yield broke through a critical key technical level and is now up to 3.20%. The yield has risen 40 basis points in the last 45 days. The rate has not been above 3.12% since 2011. A perfect storm of factors is fanning the flames: (1) The new NAFTA agreement removes a major uncertainty for US growth, and markets seem to have accepted continued rocky US-China trade relations (for now); (2) The mid September expiration of a special tax benefit for pension funds purchasing Treasuries has had an effect on demand, buying from these major purchasers has slowed, and it seems like this anomaly held rates down in August and September as they loaded up before the deadline; (3) Continued good news on the US economic front, today it was the ISM non-manufacturing index hitting 61 vs a 58 estimate, a post recession high. We may be entering a “new” reality, or is it the return of the “old” normal of pre-recession metrics with treasury yields in the 4-5% range. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Fed Increases Rates and Signals December Hike Is On Schedule

    Pascale’s Perspective

    September 26, 2018

    Today’s rate increase was well telegraphed and expected, the “action” was in the dot plot and commentary as usual. The quarter point increase brought the Fed Funds rate to 2.25%, a level last seen in mid 2008. With all of the recent coverage of the 10 year anniversary of the Lehman bankruptcy and worldwide economic crash, it’s interesting to see today’s increase and commentary as a return to normalcy. For the first time in nearly a decade the Fed statement did not include the term “accommodative” to describe their position on interest rates. The economy finally does not need “accommodation” and is moving towards the all important “neutral rate” (which is estimated to be somewhere around 3.00%). Dot plot: In addition to the December rate hike (which is becoming an annual holiday tradition since 2015), there are three increases set for 2019 and one in 2020. This would put the rate above the neutral rate and into “restrictive territory” for the first time in many years. Interestingly, the Fed sees Median GDP outlook for 2018 now above 3.0% with 2019 at 2.5%, 2020 at 2.0%, and 2021 at 1.8%. This is a classic “soft landing” for a hot economy, this is what Fed policy is supposed to produce. Speaking of the Fed mandate, there was an interesting moment in the press conference where Fed Chair Powell said that their aim is to create an environment “where everyone has a chance to succeed” but he also said there are “limits to what the Fed can do”. This is a sign that normalization is close. The statement included the usual assessment that “risks to the economic outlook appear roughly balanced” (which sounds a lot like the classic refrain at many real estate conferences where the outlook is described as “cautiously optimistic”). Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    10 Year Treasury Above 3%

    Pascale’s Perspective

    September 19, 2018

    The 10 year treasury yield is above the key psychological and technical level of 3%. Factors include continued US economic growth seemingly unaffected by trade disputes, ECB discussing an end to their longtime bond buying program, and supply demand dynamics.

    David Pascale, Senior Vice President at George Smith Partners, joined RealCrowd on a podcast to discuss how the Federal Funds Rate impacts real estate.

    Mr. Pascale joined George Smith Partners more than two decades ago, leaving behind a successful career in intellectual property rights management.  Mr. Pascale has directly overseen the placement of nearly $4 billion capital into commercial real estate. He has an expertise in virtually every aspect of commercial real estate debt placement with distinct specializations in CMBS, bridge loans, credit tenant leases. He has worked extensively on retail, multifamily, hotel, office, and mixed use transactions. With a background in law, Mr. Pascale also brings loan document expertise and is able to explain and negotiate deal points and structure.  Click here to listen to the podcast or read the full transcript.

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    Thoughts on 10 Years Since The Crash and Great Recession

    Pascale’s Perspective

    September 12, 2018

    The Lehman Brothers bankruptcy in September 2008 was the culmination of a chain of events that brought markets worldwide to their knees, prompting governments and central banks to institute unprecedented measures (TARP, Massive Stimulus, Quantitative Easing, Regulation and then Deregulation). The commercial real estate market was devastated: credit froze, property values plunged, tenants failed or renegotiated leases, vacancy spiked, transactions of all types virtually stopped (buying/selling, leasing, refinancing). As many of us recall, the only financing available for years was government (Fannie, Freddie, SBA). But underwriting was very conservative and spreads were wide, private lenders (hard money at big rates for conservative transactions). The main culprit of the crash was excesses in the residential financing market: ridiculously loose underwriting standards allowing unqualified buyers to chase hyper inflated home prices and their mortgages to be packaged, insured and sold as investment grade securities. Commercial lending had its own issues with excess as the typical 2006-2008 CMBS loan structure was 80% LTV (or more), 10 years interest only, sub 100 spreads, and income included some pro-forma aspects (future lease up). Markets slowly responded: 2010 saw the first post-crash CMBS activity (with much more stringent underwriting), regular bank lending came back in 2011, construction lending picked up in 2012-2013.

    As of today, all sectors of the Capital Markets are extremely active and liquid. Unregulated debt funds (also known as hedge funds, private equity) are very active in the commercial real estate lending markets. CMBS is back and thankfully underwriting has been restrained compared to pre-crash levels. New regulations involving risk retention and originator reps have winnowed down the number of originators to well capitalized banks and funds. Residential lending standards have tightened, but the general housing market is approaching bubble levels (mostly due to supply/demand imbalances, not pre-crash style over building). The hope is that when the next downturn in prices comes, the increased equity required for borrowers will not lead to a contagion in foreclosures. The “Too Big to Fail” Banks are now bigger and more regulated (but the political appetite for bailouts is gone, so they better not fail). The worldwide central banks (Federal Reserve, ECB, Bank of Japan, Bank of Britain) are trying to bring the world back to the “old normal” after years of stimulus. Massive liquidity has not led to inflation yet. The questions are: where will the next crisis come from and will the financial system be able to survive it without a 2008 style collapse?

    “Turmoil on Wall Street and in the credit markets as Lehman Brothers declares bankruptcy, Merrill Lynch has been sold, AIG has been propped up by the US Government”.  To read the full FINfacts “Market Update” from September 17, 2008 click here.  Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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    Treasury Yields Spike As Economy Shrugs of Trade Tensions, A Harbinger of Things to Come?

    Pascale’s Perspective

    September 4, 2018

    Yesterday’s positive ISM manufacturing report was significant, the index hit a 14 year high (61.3% vs expectations of 57.9%). This comes on the heels of last week’s report that 2nd quarter GDP rose at a 4.2% rate, the best since 3rd quarter 2014. The data indicates that US Companies are expanding unfazed by the constant headlines regarding trade disputes. The trade tensions have been a major factor in “flight to quality” purchases of Treasuries. This has resulted in a downward pressure on yields, keeping them below the levels that are expected for this level of economic expansion in the US (remember Jamie Dimon’s recent remarks that the 10 year yield should be 4% or 5%?). Another factor point to a possible run up in yields this fall: on September 15, a special extension for pension funds to purchase Treasuries and deduct the contribution at last year’s lower rate expires, so a major buyer may slow purchases. With record supply spurring frequent and large auctions of debt and the Fed continuing to pare down its balance sheet of Treasuries, we may see the yield curve return to a more normal form with higher yields at the long end. The 10 year is sitting at 2.90%, watch for the next few key levels of 3.00% and then 3.15%. Will this week’s employment report (Friday) continue this narrative? Stay tuned.