“Wait’ll Next Year”… Volatile Year in Capital Markets Draws to A Close…

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

George Smith Partners is working with a capital provider offering fixed rate financing up to $75,000,000 with rates starting at T + 2.00%. Funding up to 70% LTV, they lend on all major asset types, both stabilized and near-stabilization. This program is full term interest only and the lender underwrites to the IO rate. 5 – 30 year terms are available with flexible prepayment options across all primary, secondary, and some tertiary markets. This capital provider also has bridge financing starting at SOFR + 2.75 and construction proceeds up to $750,000,000 starting at SOFR + 3.75.

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

George Smith Partners is working with a capital provider financing ground up construction with rates starting at 5.75%. With the ability to go up to $10,000,000 in proceeds, this Lender has non-recourse and interest only options with 2-, 3-, and 5-year terms. Lending in the Western states, with a focus on California, they have a strong appetite for multifamily, industrial and low-rise office.

After last week’s big rally on CPI, Tuesday’s PPI added to the “inflation has peaked” hopes. Core PPI rose 5.4% annually and was actually flat month over month (vs expectations of 7.2% and 0.3%), and well off the March 2022 highs. The services component declined by 0.1%, the first decline since November 2020. Consumer durable goods (apparel, electronics) prices continue to soften as inventories pile up. Retailers indicate that consumers are downsizing and/or changing buying habits towards more value oriented. Many are predicting lower-than-expected holiday sales (while travel demand is strong). Interestingly, consumer credit card balances saw its highest annual jump in 20 years. This could be a sign the red hot consumer demand over the past few years is unsustainable: pandemic savings are running low and credit card rates are rising with the Fed increases. Signs that the job market may be slackening: the seemingly non-stop hiring by big tech has abated with layoffs by industry leaders. Weaker demand and job market slack are critical to cooling off price pressures.

Fed officials are making it clear that the “job is not done” – Yesterday morning SF Fed President Daly remarked that “a pause is off the table.” But “slowing rate hikes” is on the table. The consensus is based on comments and futures markets: a 50 bps increase on December 14, followed by 25 bps at the February and March meetings. A pause at that point would put the “terminal” Fed Funds rate at 4.75%. Daly indicated that the target is “4.75-5.25%.” Then what? The Fed intends to hold that rate for a while and let the cumulative effects of the rate hikes take effect. Daly also pointed out that as the inflation rate declines, the delta between a stable Fed funds rate and inflation will increase and (hopefully) further diminish price pressures. Keeping up the narrative: Before the December meeting, we will get October PCE, November jobs, and CPI. Stay tuned…

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

This morning’s October CPI report: Core CPI increased 0.3% for the month (0.5% expected), overall CPI is 0.4% (0.6% expected). Annual CPI is at 7.7% (7.9% expected and down from the June high of 9.1%). Relief rally: 10-Year Treasury dropped to 3.84%, down from a 4.12% opening; a big intraday move and below the psychologically significant 4.00% level. It’s interesting to note that the major fixed and floating rate lending indices are converging – 30 Day Term SOFR is 3.79%. The Dow jumped 850 points within hours. Fed futures “softened”:  85% chance of a 50 bp increase at next month’s meeting, 15% chance of a 75 bp increase. Yesterday it was 56% for 50 bps, 44% for 75 bps. One report does not “fix” inflation, but markets are ultra sensitive to trending data and anticipation. The rally is big as it assuages the fear that has emerged in recent weeks regarding the great Fed questions regarding the eventual terminal rate or peak rate: “How high and how long? Recent comments by Fed Chair Powell and other officials suggested the terminal rate may need to be 5.00% or higher to tame inflation. Today’s report provides a “hopeful path” to a lower peak and shorter time there.

Inside the numbers: Prices for “core goods” (homes, used cars, appliances, apparel) have been softening for months, while services costs have spiked. Today’s report indicated medical services prices fell 0.6%, benefitting from the “annual reset” methodology employed by the Labor Department. Another lagging indicator that should start showing softer price increases is shelter. Zillow, CoreLogic, RealPage and Apartment List have all indicated apartment rents (for new leases) softening nationwide over the past 2-3 months. It will take a couple more months for that to be figured into CPI, which counts “renters at large”- aka all tenants. Markets don’t want a repeat of the optimistic rallies as core CPI dropped steadily from April to June, but then leveled off in July and spiked in August and September- which sent rates soaring. Therefore, next month’s CPI report release on December 13, followed by the year’s final Fed meeting the next day is looming very large. Stay tuned…

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

George Smith Partners recently went into app with a capital provider financing land acquisition with pricing just over 6%. The balance sheet lender can provide financing on all major asset types, provided that the property is within its geographic footprint of NV, UT, OR, and ID. Financing up to $15,000,000 with no prepayment penalties, loans can close in less than 30 days. Interest only options are available.

George Smith Partners is working with a capital provider with a clean balance sheet providing permanent fixed-rate debt financing up to $10,000,000. With multifamily rates starting at 5.60%, this portfolio lender offers loan terms from 3 to 10 years with step-down prepayment options. For 3 year loans, the lender’s prepayment penalty is open after 2 years. Financing only in California, this capital provider can go up to 75% of value on multifamily, self storage, warehouse, industrial, office, and retail (anchored and unanchored).

First off, a 75 basis point increase for the 4^th straight meeting put the Fed Funds rate at 3.75% – 4.00%, the highest since 2008. Prime Rate is 7.00%, 30-Year fixed rate home loans are about 7.30% and 30-Day Term SOFR is 3.79%. Markets rallied on “dovish” comments in the initial statement: “In determining the pace of future increases, the Committee will take into account the cumulative tightening…. (and) the lags with which monetary policy affects inflation.” Many economists note that Fed actions take time to work through the economy. A scenario where the Fed watches and waits while lagging indicators catch up could forestall economy-crushing excessive rate increases, aka the “soft landing.” Hopes of “the pivot rally” jumped as the 10-Year Treasury yield dropped to 3.98 from 4.06 and the Dow rallied over 300 points in 30 minutes… until Fed Chair Powell’s remarks and responses to questions. His opening remarks seemed like a direct response to domestic and international pressure on the Fed to ease off on rate increases. He reiterated that the Fed’s number one job is price stability and that a sustained healthy labor market depends on that stability. The irony in that statement is that fighting inflation will require more slack in the labor market, i.e. higher unemployment. It’s as if the Fed needs to “break employment to save it.” The phrase that really moved markets was: “It’s very premature to think about pausing”, which he repeated for emphasis. Powell recognized that conditions have already tightened in housing, business investments, and other rate-sensitive sectors. He noted that goods prices should have come down faster and that prices for services are rising significantly. Yesterday’s ADP report for September indicated robust hiring continues in the services sector – especially hospitality and leisure.

Future Direction: Powell indicated that the Fed might “slow the pace” of rate cuts in December and February. But the data point that really shook the markets was his response to the big questions which are: “How high?” and “How long?” – regarding the “terminal rate” or peak and how long before the next rate cut. It seems like the answers are “higher” and “longer.” Powell said that there is now “significant uncertainty” amongst Fed policymakers about the “ultimate level” for the Fed Funds rate. This follows recent comments by Fed President Kashkari that a “terminal rate” in the 5% range may be needed to battle core PCE inflation. Recent assumptions had the terminal rate at about 4.6% and hopefully peaking for a few months. Powell and the Fed are now setting expectations for a longer battle. Rhetoric such as “Some ways to go” and the recent mantra “Restrictive territory… for some time” drove the message home.

In the weeds: Powell discussed employment metrics he is closely following: job quits, vacancies and labor participation. The Fed is watching for any sign of slack in the labor markets. He also discussed softening rental rates and the inherent housing cost lag in the CPI statistics. CPI continues to count rental costs based on all lease payments, not just newly signed lease costs. This may understate the effect of Fed rate increases on housing costs for months. He noted that this lag is considered when reading the data. The rallies dissipated into negative territory as markets digested Powell’s remarks – the 10-Year jumped to 4.11% and the Dow dropped 1.5%. Stay tuned…

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

The 2 Year Treasury and the 10 Year Treasury inverted in July and have remained “out of balance” to this day. That inversion is often seen as a harbinger of a recession. Today, the 3-Month Treasury is higher than the 10 Year Treasury – this has occurred only 7 times since 1967. Markets may be saying that the Fed has raised rates too fast, without allowing for enough lag time to gauge the effects (which can be felt for up to a year after any given rate hike). This week has seen earning disappointments from tech companies as companies pull back on advertising. The Case-Shiller index indicated home price gains are dropping at the fastest pace on record as mortgage payments average 75% higher than last year. The Fed’s demand destruction strategy is “working.” Recent quotes from Fed policy makers indicate some concern over raising rates too quickly over the next few months. Bonds have rallied – after hitting a multiyear high of 4.32% last Friday. The 10 Year is down to 4.00% as of tonight’s close. The latest hopes are quantified in the futures markets – a 75 basis point increase is nearly assured at next week’s Fed meeting (94% probability), but the December meeting futures show a 63% chance of a 50 basis point increase, and 37% at 75. This Friday’s PCE report looms large as the final major inflation data point before next week’s meeting. Stay tuned…

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

A perfect storm is continuing to hit treasury prices and therefore yields are rising. Markets study every data report hoping for some sign that inflationary pressures are easing/slowing/peaking, hoping for a “pivot” from the Fed. Recent economic data hasn’t provided that hope. The supply/demand metrics in the Treasury market are strained: record debt issuance and major buyers (Japan, China, Pension Funds) are buying less or sidelined. Also, most importantly, we are seeing heretofore untried Quantitative Tightening from The Fed. The central bank regularly purchased $80 billion per month during several extended periods since 2010, but is now selling Treasuries. The Fed was still purchasing Treasuries into March of this year. The process is now picking up as it took months for those recent purchases to “settle” – now the Fed is selling up to $95 billion per month. In fact, the Fed recently sold $37 billion in one week.

“Bid to cover” ratios are dropping in recent auctions, indicating fading demand. There are signs that liquidity in the Treasury market itself is starting to dry up, causing the normally calm Treasury Secretary Yellen to recently comment on her concerns. Recent Data: Last week’s CPI report continued the recent narrative that price increases are pivoting from goods to services. This is more concerning to the Fed as labor is a critical component of services. Example: travel is especially inflationary due to pent up demand for leisure combined with the return of business travel/conventions. Airline ticket prices and bookings are skyrocketing and the industry estimates there is a shortage of about one million workers in the segment. Note that apparel and appliances are seeing price and demand declines. Many retailers are overstocked as supply chains loosen and demand softens. Fed Speeches: Neil Kashkari referenced CPI reports in comments this week. He indicated that perhaps “headline” CPI has peaked but he is more concerned about core inflation (excluding food and energy). He indicated the Fed was resolute in its determination and if core inflation lingers into next year, commenting “But if we don’t see progress in underlying inflation or core inflation, I don’t see why I would advocate stopping at 4.5%, or 4.75%.” This caught markets attention – as the previously assumed “terminal rate” was about 4.25%-4.50%, and he’s talking about 5.0%. Fed Pivot Watch: Powell has made it very clear that the Fed is willing to tolerate unemployment and significant losses in stock markets without “blinking.” But recent developments like the British gilt crisis and Treasury market liquidity may be early indications of systematic financial risk which would (hopefully) be intolerable to the Fed. Stay tuned….

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