“Hawkish” Fed Pivot Provides Certainty, Markets Celebrate

When does a hawk look like a dove? For today, the answer is: when the hawk’s arrival has been well telegraphed and it’s talons aren’t as sharp as feared. Today’s Fed meeting and announcement marks a full pivot away from ultra accommodative policy to a tightening anti-inflation stance.

The headlines:

• The Pace of the Fed’s Tapering of Bond Purchases Is Doubling.
• Bond Buying is Now Scheduled to End in March 2022 (Not June). This means that interest rate hikes may begin in April. Speaking of hikes, the Fed’s “dot plot” now calls for 3 rate hikes in 2022 and another 3 in 2023 (bringing the cost of funds to about 1.6% from 0% as of today).

Powell spoke of the “dual mandate” regarding inflation and employment thresholds which need to be met in order to begin raising rates. The inflation part of the equation has been met. He indicated that “Rapid progress to maximum employment” is underway, giving more certainty to a rate increase in April 2022. More on inflation – the recent record CPI and PPI increases are further proof that “transitory” is no longer appropriate. Powell today said, “The risk of higher inflation becoming entrenched has increased”.

Stocks rallied on a “relief trade” as market volatility has been high since Powell’s November 30 Congressional testimony indicating that a pivot was imminent. Today’s statement and Powell’s remarks calmed markets, providing a level of certainty. Today is a case of, “sell the rumor, buy the news”. A Fed funds rate of 0.9% at year end 2022 is not being seen as a major impediment to economic growth and it gives “cover” to investors worried about asset bubbles. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

Last week’s release of the October PCE numbers continued the steady drumbeat of inflationary data. Some perspective: the PCE is the Fed’s preferred inflation gauge, the target rate is 2.0%. Since the Great Recession, the PCE has lingered below 2.00%, popping up to barely above 2.00% on a few occasions (2011, 2016, 2017). The July 2021 to October 2021 annual rates: 4.03%, 4.14%, 4.21%, 4.42%, 5.05%. “Transitory” inflation talk is in the rear view mirror. Not only that, inflation has “support”. Real consumer spending rose 0.7% last month alone. This indicates that higher prices are not dissuading consumers to purchase goods. Powell has been nominated for another term, markets seem to be happy with that as it means no major policy changes. However, Powell will need Senate confirmation. The release of Fed minutes last week showed some support for earlier than anticipated rate increases to reign in inflation. Powell may want to speed up the decline in monthly bond purchases ahead of his February hearing. Next month’s Fed meeting may feature a more hawkish Fed. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

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This week’s comments from Fed member Thomas Barkin are telling: “I think it’s very helpful for us to have a few more months to evaluate, is inflation going to come back to normal? Is the labor market going to open up?” He made it clear that more data is needed before raising rates. Now that the tapering of the Fed’s bond purchases has been quantified and announced, the next move on rates will be dependent on the direction of the economy. The Fed bought some time with the tapering announcement. The bond buying will be lowered over the next 6-8 months while the Fed is able to further gauge if inflation is transitory or more permanent. Regarding the labor market, the labor participation rate is increasingly in the spotlight. Labor participation has historically been 63-64% since the Great Recession. It dropped to 60.2% in February 2020 during the “shutdown shock” and is back up to about 61.6%. More labor participation will help the inflation picture: worker shortages are affecting the supply chain, wage inflation is spiking, etc. Participation has been gradually rising in the last few months. This week, the 10 year Treasury hit 1.65% on a strong retail sales report. Today it dipped to 1.58% on a weaker than expected homebuilding report. Look for data driven ups and downs to be the norm for a while. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

George Smith Partners is working with a national balance sheet lender providing fixed-rate, long term permanent financing for Class A stabilized industrial and multifamily properties located in primary and secondary markets (excluding NY and CA). Lender services loans in-house. With loans from $25,000,000 – $50,000,000, pricing is Swaps + 1.40% floor, for 10-year terms. Pricing available for loans that go under application before year end.

The 10 year T jumped 12 bps today (closing at 1.57%) as inflation is increasingly being perceived as more than “transitory”. Breaking down today’s CPI report shows some more persistent inflation signals that will most likely continue into 2022. The headline number of 6.2% annually was the highest in 30 years. Analysts were expecting about 5.9%. The monthly number was 0.9% (expectations were 0.6%). Core inflation was also the highest in 30 years at 4.6% annually. Food and energy prices are up significantly. Shelter costs, driven by higher rents, increased 0.5% for the month. The shelter metric is another example of the “stickiness” of this wave of higher prices. Treasury Secretary Janet Yellin struck a dovish tone. She again said that policymakers expect price increases to settle down in 2022 (to acceptable levels of about 2.0%). However, she pointedly added that if inflation turns out to be “endemic”, the Fed “would have a role to play to keep it under control”.

St Louis Fed President Brainerd remarked last night that he sees two interest rate hikes in 2022. The Fed futures market is now predicting 2 rate increases for 2022 and a 44% likelihood of a 3rd hike. Not a great day for Treasuries as an auction of 30 year bonds went poorly pushing that rate to 1.94%. Inflation expectations as measured by the 5 year “breakeven” rate jumped to an all time high of 3.113% (the difference between the treasury yield and the inflation protected security of the same term. It is a key indicator of investor expectations of inflation) Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

George Smith Partners is working with a capital provider funding permanent debt to 75% LTV. With a strong appetite for Multifamily, Office, Industrial, Retail, Self-Storage and Mixed-Use properties the Lender offers fixed rates starting at 3.20% for 5-year loans in 9 Western U.S. states for transactions up to $25,000,000. The Lender has non-recourse and interest-only options available along with aggressive underwriting down to a 1.15x DSCR.

Today’s Fed meeting announcement and subsequent presser by Fed Chair Powell confirmed that the tapering of monthly bond purchases has begun. The muted market reaction is a testament to how unsurprising the well telegraphed announcement was to investors (Dow and S&P up slightly, 10 year T yield jumped 6 bps to 1.60%). Pick your metaphor: “the punch bowl is not being taken away, it’s just less full”, “the Fed didn’t put the brakes on, it just eased off the accelerator”. Highly accommodative monetary policy is still in place: Fed Funds rate is at zero, billions of dollars of MBS and Treasuries are being purchased every month, the Fed’s balance sheet is at nearly $9T of bonds that they have no intention of selling anytime for years.

What is changing? Powell no longer refers to inflation as purely “transitory” and that supply/demand imbalances are persistent. Everyone is looking for clues on when rate increases will occur. Note that Bank of Canada, Bank of England, Bank of Australia are all aggressively raising rates to combat inflation. Powell pointedly remarked that, “Our tools cannot ease supply constraints” and that “the dynamic economy will adjust to imbalances and inflation will decline to levels much closer to our 2.0% longer run goal”. This is being interpreted as highly dovish and the Fed may not need to aggressively raise rates. The risk is waiting too long to raise rates (while other major banks increase) which could lead to runaway inflation and multiple rate increases in a short period. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners

George Smith Partners is working with a capital provider offering up to $30,000,000 for construction and bridge financing on multifamily, industrial, office, and retail properties in the Western US and Texas/Oklahoma. Rates start at 3.25% over SOFR with a 0.25 SOFR floor. With terms up to 5 years IO at 65% LTV or 2 years IO and 70% LTV this lender offers non-recourse for multifamily properties. All other commercial real estate is recourse or partial recourse.

George Smith Partners identified an equity provider seeking to invest in pre-leased, fully entitled retail and industrial construction projects nationwide. With equity contributions up to $5,000,000 and the ability to go up to 100% of cost, this equity provider has a hold period of 12-24 months.

In the wake of last week’s Fed announcement (tapering bond purchases) and continued “sticky” inflationary data, a future path is becoming clearer. What’s next? Fed plans on decreasing monthly bond purchases from $120 billion (now) to zero (June/July 2022). If inflation is still persistent, expect the Fed to start raising rates in Q3/Q4 2022. How much? Recent “dot plots” and comments from Fed officials suggest an eventual target rate of 1.75%. Call 1.75% the “near term neutral rate”. So that means about 6 quarter point rate increases. Note that the post Great Recession high point was 2.50% in 2018. The CME futures index shows a 50% probability of an increase by June 2022, 60% by July, 73% by September, and 60% expect two increases by December.

Fixed Rates: As the Fed buys fewer Treasuries, Mortgage Backed Securities and signals rate increases; Treasury yields are expected to rise to attract more private buyers. Less buying of MBS may impact loan spreads.

Floating Rates: LIBOR and its likely successor, SOFR, are both expected to fluctuate in nearly lock step with the Fed Funds overnight rate (the “headline” rate that leads the Fed meeting announcement). Of course, floating rate borrowers would see increases in their monthly debt service.

However, this is “the plan” and plans can change based on market conditions and/or unforeseen disruptions. As the stock market hits another record high today during the “perfect storm” of low rates and high consumer demand, it’s not hard to imagine that a “mark to market” may occur across many asset classes. As the pandemic’s impact has been unprecedented in the era of the modern global economy, the recovery is uncharted territory. Central bankers will have their hands full in navigating it. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners