Pascale’s Perspective

Tuesday’s release of October CPI indicated prices were unchanged for the month – the first time since July 2022. The previous month saw a 0.4% increase and market analysts were expecting a 0.1% increase.  Core CPI has now climbed to 4% for the year, the lowest yearly increase since September 2021. Energy prices were down month over month. Food price increases moderated significantly as annual food inflation of 3.3% is the lowest since June 2021. This is significant as the Fed has been concerned about inflation becoming “entrenched” with consumers growing to expect daily needs expenses to climb. These trends are definitely mitigating that concern (for now). Treasuries saw their biggest rally since the March flight to quality in the wake of the regional bank failures. This was a welcome “bullish” rally that saw the 10-year T drop from 4.65% to 4.42% in about 10 minutes. Rates jumped about 10 bps yesterday even after a PPI report (manufacturers’ prices) DECREASED by 0.5% last month (the lowest since April 2020 during the pandemic, analysts were expecting a 0.1% increase). The rates jumped due in part to some profit-taking after the big rally Tuesday.

Markets instead focused on revised retail sales numbers that showed a 0.9% increase in September. Retail sales actually dipped 0.1% for October. This actually fits in with the booming 3Q GDP numbers that aren’t expected to last into 4Q. Today’s initial jobless claims report of 231,000 was 9,000 more than expected. Bond markets feeding on the “contrarian” news cycle (economic bad news is good news) rallied again today with the 10-year now at 4.43% (60 bps below the 10/23 high).

What about the Fed? Fed futures markets reacted positively to this week’s data – markets are now convinced that rate hikes are “done” and rate cuts are coming: the chances of no increase at next month’s meeting are now 100% (up from 85% last week) and they show a 68% chance of a rate cut in May 2024 (up from 35% last week). UBS analysts made news last week predicting 275 bps of rate cuts in 2024. That’s an outlier; note that Goldman Sachs’ projections call for 0.25% rate cuts in each quarter starting in late 2024. One thing for certain is that the Fed will keep “talking hawkish” until the job is done. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

The 10-year treasury market started the week strong after last week’s big rally. The treasury held auctions of 3- and 10-year treasury notes that showed strong demand, especially considering the volume was larger than last month’s auctions. The 10-Year was sitting at 4.50% Thursday morning (down over 50 bps from the recent high). Then came Thursday’s $24 billion treasury auction of 30-year bonds. It did not go well. Primary dealers (money center banks) stepped in to purchase 25% of the issuance- meaning there weren’t enough bids from the market to clear all the bonds. The auction also was disrupted by a hacking/ransomware attack at the Industrial and Commerce Bank of China’s US Division. This was followed by Fed Chair Powell’s remarks: Fed officials are “not confident” rates are high enough to finish the battle with inflation and that the inflation battle “has a long way to go.” Perhaps he is being overly hawkish after last week’s drop in yields after the Fed meeting as he worries about overconfidence. The 10-Year Treasury spiked to 4.63% in hours and now sits at 4.65%.

Moody’s has cut the US Credit Rating Outlook from “stable” to “negative – citing polarization in Washington as driving large deficits (note that the government is 7 days away from a shutdown unless an emergency bill is passed).  Moody’s did affirm the US’s top rating of Aaa. If Congress and the White House can’t help, who can? Will the Fed be forced back into Quantitative Easing (buying Treasuries)? Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

Wednesday’s unanimous Fed decision to keep rates unchanged was significant. This marked 2 consecutive meetings with no rate increase – the first “double pause” since early 2021 (before the current hiking cycle). Fed Chair Powell delivered the usual “warnings” that the Fed stands ready to increase rates if inflation perks up (aka “policy firming”). But, the comments seemed obligatory, more of the usual “Hawkish signaling.” There’s a growing consensus that if there is no increase at the next Fed meeting, they are “done” for this cycle. The bond rally started in the morning as Treasury Secretary Janet Yellin released the long awaited funding schedule for the next round of Treasury sales. Markets had been apprehensive in recent months about supply issues as growing budget deficits have expanded debt issuance. Markets cheered the release as the auction levels were lower than feared – spurring a “relief rally” as the uncertainty was eliminated. Powell’s “dovish tilt” at the meeting continued the rally. And don’t forget “the data” – this week has seen more signs of a softening economy: lower than expected job creation, a drop in manufacturing activity, productivity increases (lowering wage pressure), and an unexpected drop in labor costs. Today’s release of the October jobs report indicated a cooling jobs market: 150,000 jobs were created, less than half of the previous month’s gain. Significantly, the economy saw less broad based hiring as healthcare, government, and leisure/hospitality accounted for nearly all of the increases. This means that several sectors of the economy saw near zero job growth. The overall narrative is now focused on the Federal Reserve’s commitment to pausing rate increases as the economy cools with possible rate cuts occurring in mid-2024 (see chart above on future rate expectations yesterday and today). Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

Yesterday’s 3Q GDP report indicating 4.9% annual growth, the strongest since 2021.   This indicates a strong consumer….but for how much longer?  Spending rose at a 4% annualized increase in Q3 while income gains lagged well behind that pace.   Savings rates are falling.    Initial jobless claims for last week came in higher than expected – the strong labor market is propping up consumer spending.  Treasury yields actually dropped yesterday as traders focused on the jobless claims (forward guidance) as opposed to 3Q GDP (the rear view mirror)  The 10 year dropped from 4.96% to 4.85%, settling at 4.83% at today’s closing.   Today’s PCE report release (the Fed’s preferred inflation gauge) showed a 0.3% monthly increase in core inflation and a 0.4% “headline” increase.   Of course, 0.3% monthly increase translates to 3.6% annually, still well above the Fed’s 2% target.   The report was within expectations and is not expected to change the Fed’s “no increase” stance at next week’s meeting.   It does show some worrisome inflation “stickiness”  as the path from 3.5% to 2.0% may be a slow grind…stay tuned…..

This week started with a flight to quality as markets reacted to conflict in the Middle East and potential escalation. The 10 Year began trading Tuesday after the long weekend and immediately dropped from its previous close of 4.80% to 4.65%, as markets opened. The mid-week economic reports drove trading on Wednesday/Thursday. First off, PPI (wholesale prices) was up 2.2% annually with core up 2.8% (slightly higher than previous months). Notably, goods inflation outpaced services – is this signaling the long awaited cooling in services employment/costs that are so closely watched by Fed officials? Speaking of Fed officials, Philly Fed President Patrick Harker’s comments in Delaware gained a lot of attention: ‘I believe that we are at the point where we can hold rates where they are.’ Wow. Of course, I think it is assumed that his (prepared) remarks had the blessing of Fed Chair Powell. Harker also nodded at higher treasury yields, noting that the higher fixed rate index is “doing our work for us.” Perhaps the recent run up in Treasury yields is acting as a substitute for the contemplated rate increase in one of the final two Fed meetings this year. This changes the “higher for longer” narrative to “high for longer”- aka we are already there at the top. It’s way too early to spike the football or assume raises are over. And it seems even if the Fed is done raising, it’s a long way from “even thinking about thinking about” cutting. To paraphrase Chair Powell’s comments about raising rates in June 2020 vs Thursday’s CPI was slightly hotter than expected at 0.4% monthly/3.7% annually (0.1% above expectations). With core up 0.3%/4.1%, exactly at expectations, markets took it as a “win” as it won’t spur the Fed to unexpectedly hike. Again, the “controversial” shelter cost component was a huge part of the increase, a possible lagging indicator. Friday saw a continuation of the “peak yield narrative” rally along with flight to quality. The 10 Year ended at 4.61%. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

This week’s data and treasury market reaction are significant for 2 reasons: (1) It’s been 2 weeks since headlines regarding the banking crisis and (2) Employment reports this week may be indicating loosening labor demand. In the last year, the Fed has become increasingly concerned about job openings vs unemployed workers as the usual survey data (JOLTS, etc.) showed a ratio as high as 2 to 1. As major corporate layoff announcements have been occurring multiple times a week and real time data from private job listings (indeed.com, Zip Recruiter, etc.) show plummeting job postings, many analysts feel that the Fed was looking at lagging data. The phrase “zombie job postings” and reports of skewed survey results imply that the official data is lagging. Monday’s data indicated continuing contracting in manufacturing (ISM). Tuesday saw job openings (officially) fall 700,000 to below 9.9 million- the lowest in 2 years and a lower than expected job creation number. Today’s jobless claims continued the narrative with higher applications both now and upwardly revised over the past few months (based on updated methodology). Will the Fed possibly realize that they have already raised rates enough to loosen the labor market? Tomorrow’s monthly major unemployment report might shed more light. 10 Year treasuries rallied down to 3.29%.

As systemic banking issues have receded from the headlines, the issues are not solved. The Real Estate Roundtable’s recent letter to the FDIC and the Federal Reserve highlights the issues and suggests some solutions. It notes that recent interest rate moves by the Fed have stressed bank balance sheets as treasuries and MBS are now worth less. There is $1.45 trillion in looming commercial and multifamily debt maturities in 2023-2025- banks and thrifts hold just over 50% of total CRE debt. The letter requests the establishment of a TDR (troubled debt restructuring) program that will encourage regulators to allow loan modifications during times of economic instability. This will avoid Banks being “forced” into foreclosing and/or putting sponsors into default due to restrictions on their ability to modify loan terms. Banks are also asking for increased deposit insurance which will put them on equal standing amongst depositors with the “TBTF” money center banks. The combination of increased depositor confidence and balance sheet flexibility could be part of a solution. Stay tuned…

The Silicon Valley Bank and Signature Bank collapses set off a week of wild volatility, market fear (risk-off), massive new rescue facilities from governments and money center banks, and the dust hasn’t settled. The events have also sharpened the divide between the “Too Big To Fail” money center banks and the regional banks. The TBTF banks have more stringent capital requirements and are in better shape to withstand volatility. The latest attempt (announced today) to stabilize First Republic Bank involves 11 major banks depositing $30 billion in FRB as a sign of confidence. This is on top of Sunday’s announcement of the Bank Term Funding Program (BTFP) which allows banks to borrow against their portfolio of secure bonds (Treasuries/MBS/Fannie and Freddie Securities) at par (the original price) and not today’s mark to market value (less than the original price due to rate increases). This is a critical facility as the Fed’s rapid rate increases have left many banks in a potentially illiquid position. Banks bought Treasuries in 2019-2022 while prices were high and yields were ultra low. Depositors poured money into banks during this low rate environment. The spike in Treasury yields over the past year drained deposits out of banks and into Treasuries, Money Market Funds, etc – and left Banks in a cash poor position while holding devalued collateral. This week has also seen a $50 billion rescue facility implemented by Switzerland’s central bank for Credit Suisse, a major international bank twice the size of SVB. Today has been the calmest day in markets since the SVB collapse last Friday…

What about next week’s Fed Meeting? Next week’s Fed meeting will present a conundrum for Powell and friends. Today is the one year anniversary of the first rate increase of this cycle of hikes. The Fed has spent a year tightening financial conditions, draining liquidity from the system, etc. Their intent was to pressure Main Street (employers, consumers, retailers, etc.), but their measures are now putting pressure on the financial system. Will the “cracks in the system” possibly spur the Fed to pause the increases at next Wednesday’s meeting? Maybe the focus should be on a suspension of Quantitative Tightening. The Fed is selling/rolling off $95 billion of bonds a month. Remember that the Fed was purchasing $80 billion of bonds per month last March. The selling devalues bonds while draining liquidity out of the system. The recent data (CPI as expected, PPI deflationary) may give Powell enough breathing room to “talk tough and pause.” Another possibility: Acknowledge financial market stress (“We’re monitoring it closely”), raise rates 25 bps and stop QT completely (or even start QE again?). Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

This week, the 10-year treasury yield rose above the key psychological level of 4.00%. Hawkish statements by Fed policymakers indicate a resolve to not cut rates until 2024. Recent hotter-than-expected data(CPI, PCE, etc) has changed the narrative: inflation may be “stickier” than was assumed. This week also saw high CPI data from the 3 largest economies in Europe: England (10.1%), Germany (9.3%), and France (7.2%). This is driving up international bond yields. The latest market/futures/Fed talk consensus estimates are for 25 bp increases at the next three meetings and then (hopefully) a pause. That would put the Fed Funds rate, and SOFR, at around 5.40% at mid-year, aka the “Terminal Rate.” This month’s data is especially critical. The Fed is highly focused on labor/service costs and a(seemingly and stubbornly) tight job market as the main driver of inflation. This month’s data releases are critical (when aren’t they these days?) – Job openings 3/8, Employment report 3/10, CPI 3/14, PPI 3/15. The WSJ reported yesterday on signs of a cooling labor market in private-sector job postings. This trend has not yet appeared in official Labor Department data releases: the infamous “lagging indicators” may be at work here. Also, December and January data releases are skewed by “seasonal adjustments.” Therefore the March data releases (based on February’s data) may confirm some long-awaited “slack” in the labor market. As we approach the 1 year anniversary of the first Fed increase, the path forward remains murky. Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

The Federal Reserve raised the Fed Funds rate by 0.25% today as markets expected. The target range is now 4.50-4.75% as the Fed has increased rates in 8 consecutive meetings beginning in March 2021. The rate is the highest since October 2007. Recent data indicating a slowdown in inflation has raised hopes that “the pause” may be occurring soon, perhaps after the next Fed meeting in March. The accompanying statement with the increase retained the language “ongoing increases in the target range” disappointed markets by implying multiple increases are planned. Fed Chair Powell’s post statement presser was closely watched. He acknowledged the slowdown,  “And while recent developments are encouraging, we will need substantially more evidence to be confident that inflation is on a sustained downward path.” He also said its “premature” to declare victory. Of course, Powell’s intent is to seem hawkish until the moment he cuts in order to keep markets from “getting ahead of the Fed.” It’s also important to note that positive “Real Interest Rates” are now just being achieved. As inflation is at 4.4% (using the annual core PCE from December), the Fed just barely hit positive territory at 4.50-4.75%. The divergence between market expectations and Powell’s rhetoric is stark – markets expect a 0.25% increase in March, followed by a pause at the May meeting, and possible rate cutting by 4Q 2023. Powell has repeatedly insisted that the Fed is not cutting this year. He did throw doves a bone during the presser with 2 statements: he acknowledged that “the disinflationary process has started”  – boom! The 10 year Treasury rallied from 3.51 to 3.39% immediately upon this statement. Then he remarked that he said it is “certainly possible” that the Fed Funds rate stays below 5% – meaning one more 0.25% increase before the pause. Futures markets predict an 85% chance of a 0.25% increase in March, with 15% predicting no rate cut. May futures indicate a 63% chance of a pause or cut at that time. Stay tuned…

2022 began with the 30-day floating index at 0.10% (now 4.32%) and the 10-year T at 1.51% (now 3.69%). Federal Reserve policy has dominated the capital markets. Speculation on future moves by the Fed is a huge factor in decision-making by all players in commercial real estate. Transaction volume started strong as the momentum from 2021’s huge year carried into Q1 2022. Volatility kicked in on January 26 with the Fed’s unexpected announcement that balance sheet reduction (aka Quantitative Tightening) would be a major part of Fed policy in 2022 (along with rate increases). Many borrowers rushed to lock in rates as the Treasury hovered around 2.00% in January-March. Then the Fed put the hammer down with 25 and 50 basis point increases in March and May – followed by 4 consecutive 75 basis point increases. Sales and loan volume plummeted as buyers, sellers, lenders, and equity providers were unable to price assets with any certainty. Lenders and investors are hoping for more clarity coming into the new year. Securitized lending volumes and investor appetite for the paper has waned. CMBS volume declined over 35% from 2021 levels. As one major originator said, “Only borrowers that have to transact are in the market.” Many originators are pushing 5 year loans as borrowers are reluctant to lock in long-term. The floating rate CLO market is in limbo. Many originators have not been able to securitize and are holding unsold pools on warehouse lines. Life companies had large origination volume in the first half of 2021 during the rush to lock in rates, with a considerable drop-off in the 2^nd half of the year. Credit unions and banks are increasingly cautious. Optimism for 2023 revolves around the possibility of the Fed engineering a “soft landing” and the anticipation of the “pivot” to lower rates which will unleash capital on the sidelines and rally securitized markets. Lenders and buyers of secondary market paper will come into the new year with fresh allocations. The US economy is showing incredible resiliency in these challenging times (GDP, unemployment, consumer sentiment) although there are also indicators of a slowdown going into 2023. In the contrarian world of Fed watching, that may be welcome news. Stay tuned… Happy Holidays to All!

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

Today’s announcement of a 50 bp rate increase topped off a year of rate moves unseen in recent history. The Fed increased rates 7 times this year including 4 consecutive 75 bp increases. The increase to 4.25% – 4.50% puts it at the highest level since December 2007, when Fed Chair Bernanke cut rates during the financial crisis.

What’s next? Today’s dot plot of predictions from Fed officials shows a “terminal rate” of 5.1% (up from September’s estimate of 4.6%). So, that’s “how high?…what about “how long?” – the dot plot indicates no rate cuts for all of 2023, with 1.0% in cuts during 2024. Note that would put the rate in December 2024 right back to today’s rate. Futures market assumptions are more optimistic. They indicate a likely 25 bp increase in February and March 2023 with the longed for “Fed pivot” starting in the summer. It seems that the end of the tightening is within sight. However, the Fed will keep up the hawkish rhetoric until “the job is done” in Powell’s words. He keeps reiterating that “the historical record cautions strongly against prematurely loosening policy”; referencing Fed Chair Volker’s premature rate cuts in the early 1980s, only to have to hike rates again even higher than before. The 10 year Treasury is right at 3.50% with 30 Day Term SOFR at 4.32%. Regarding yesterday’s cooler than expected CPI report, it is significant to note that services costs remain high with job openings exceeding available workers. That issue still isn’t “solved.” Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners

Today’s release of the October PCE report indicated that the key indicator, month-over-month core price increases, rose 0.2%. That’s in contrast to April (0.7%), June (0.6%), and the last 2 months at 0.5%. It’s just one month and not yet a trend, but 0.2% annualized is 2.4%. That’s “in the range” of the Fed’s 2.0% target inflation rate. Coming on the heels of yesterday’s sort of dovish comments from Fed Chair Powell, the 10-year Treasury rallied down to 3.54% this morning. It’s now almost 80 bps below the recent peak of 4.32% (October 21). One year ago today it was 1.33%. Markets are cheered by Powell’s comment that “it makes sense to moderate the pace of rate increases.” This is being interpreted as a likely 50 bps increase this month, followed by a couple more increases in the 25-50 bps range. He also cautioned that “we have a long way to go in restoring price stability,” mentioning that the terminal rate would have to be held for longer than previously assumed. Futures markets are now predicting a terminal rate of around 4.90% (which implies another 100 bps of increases). Powell drilled down on the core issue: tightness in the jobs market. The three categories of goods and services that make up the index are goods, housing, and services – with services being the largest. Good and housing prices are moderating while services costs climb.

Tightness in the job market: The Fed is watching the job openings per unemployed person ratio closely. It is presently at 1.7 to 1 (down from a high of 2 to 1 earlier). The Covid pandemic exacerbated this ratio. Powell pointed out that the “participation gap” has led to a shortfall of 3.5 million workers in the labor force. Covid related deaths, lingering long covid sickness, early retirements, and other factors probably account for 1.5 million of that total. Labor participation stats in tomorrow’s jobs report release will be closely watched as usual. Bottom line: The Fed can’t increase the workforce so it’s going to concentrate on decreasing job openings by tightening financial conditions. Powell seemed to be speaking to critics of his policy in Congress when he responded to a question: “We don’t think the world is going to be a better place if we take our time, and inflation becomes entrenched.” Stay tuned…

By David R. Pascale, Jr., Senior Vice President at George Smith Partners