May 25, 2022
Yes, that is correct. Today’s release of Fed committee notes from the May 4th meeting indicated a resolve to “do what it takes” to tame inflation. Usually a Fed announcement like “we judged that 50 basis point increases would likely be necessary at the next couple of meetings” would trigger major volatility in stock and bond markets. Today, however, stock markets rallied and bond markets held firm. Why? Recent quarterly earnings reports by Fortune 100 corporations and plummeting stock markets have shown inflation is hitting the bottom line hard. Remember, 2021 featured trillions of dollars in stimulus, the lowest interest rates in modern history, and some “transitory” inflation. The punch bowls have all been pulled from the table and the lights are on, reality is setting in. A return to normalcy is predicated on inflation being brought down to the Fed target of 2.0% (most recent reading: 6.6%). The Fed notes indicated unanimity on the rate hiking plan. Markets are cheering the determination and resolve (although some believe it should have been shown earlier).
Bottom Line: The “next couple of meetings” means 50 basis point increases are guaranteed for the next two meetings: June 15 and July 27. Futures markets are at 90% on both of those moves – that puts the Fed Funds target rate at 1.75% after the July meeting. What next? The traditional August break with the next meeting on September 21. So, the Fed will have almost 2 months to gather data and gauge the effects. The September increase may be 25 basis points (futures markets are at 67% for the smaller increase). Again, the Fed invoked their willingness to go “above the neutral rate” (2.4%) into restrictive territory, if necessary to battle inflation. The next few inflation readings will be very closely watched, starting with this Friday’s release of the April 2022 PCE (the Fed’s Preferred Inflation Gauge). Over the next few months, that along with CPI/PPI will be critical as markets watch for signs that inflation is peaking or retreating. Interesting “coincidence” – a Fed Funds rate above the neutral rate would put it at 2.75%, exactly where today’s 10-Year Treasury is at (down from 3.20% on May 6); with 30-Day SOFR at 0.98% and 30-Day LIBOR at 1.01%. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
May 18, 2022
Today’s stock market tumble was the worst trading day since June 2020. Yesterday, Fed Chair Powell’s comments were straightforward, including “there could be some pain” as the Fed moves to tame inflation with rate hikes. The proverbial “soft landing” in times of fiscal tightening is very elusive. So Powell indicated that he is now hoping for a “softish landing” that will be “a little bumpy, but it’s still a good landing.”
Today’s stock drop stemmed from a capitulation by investors that inflation may seriously affect financial conditions. Earnings reports from Target and Walmart indicated that inflation is affecting corporate America’s “bottom line”. This realization after Powell’s comments yesterday contributed to the sell off.
More from Powell: “Financial conditions have tightened quickly”, he seemed pleased as it will slow down inflation. Stocks are being “marked to market” based on rising interest rates and inflation. The same process is happening in the CRE capital markets as debt costs, leverage levels, risk spreads and equity expectations are in flux. There’s plenty of capital but lenders are in the process of “pricing discovery” as conditions change rapidly. Many lenders indicate that today’s volatility will hopefully lead to conditions settling in a few months. Most certainly some adjusting of asset prices and cap rates will have to occur for transaction volume to increase to last year’s levels. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
May 11, 2022
After last week’s fifty basis point Fed increase on Wednesday and 10 year Treasury spiking to nearly 3.20% on Friday, markets were closely watching today’s release of the April CPI report for signs of relief. The Fed’s hawkish stance on inflation has magnified the significance of any indications of moderating price increases. The good: annual CPI dipped from 8.5% (last month, the highest since 1981) to 8.3% (still very high). Markets were hoping for 8.1%. The Not So Good: Core CPI rose 6.2% (estimates were 6.0%), monthly gains were higher than expectations: 0.3% headline (estimate 0.2%) and 0.6% core (estimate 0.4%). The market’s reaction was schizophrenic. Treasury yields initially jumped from about 3.00% to 3.08% before closing at 2.89%. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
Treasury Yield Volatility – Peak Inflation? Risk Spreads Widen, SOFR/LIBOR Indices Spike on Hawkish Fed Expectations
April 27, 2022
The last few weeks have seen major volatility in financial markets with stock market selloffs, climbing VIX index, oil price swings, and whipsawing bond yields. The 10 year yield marched up to 2.95% last Monday before dropping to 2.73% yesterday morning. Global slowdown fears tied to the Ukraine war, Chinese demand ebbing due to Covid breakouts/shutdowns in key Chinese cities, interest rate spikes, consumer confidence drops due to inflation are all contributing to uncertainty. The yield curve has been inverting, steepening and partially inverting over the past few months. Today the 10 year is at 2.83%.
This week, all eyes will be on the release of the March PCE report on Friday. Markets will be looking for indications that inflation has peaked – hoping that the monthly increases in PCE and core PCE are below the February numbers. The prospect of “stagflation” is a major “fear factor” (stubborn inflation, high interest rates, stagnant economic growth). The Fed meeting and commentary next week seemingly has been telegraphed and received by markets – a 50 basis point increase is expected (futures markets show 97% probability).
Note that markets now expect three consecutive 50 basis point increases (May, June, July). Signs that inflation is peaking and possibly decreasing in the coming months may temper these hawkish expectations. Term SOFR rates (floating rate lenders’ preferred loan index) have increased from about 0.21% (March 1) to 0.70 (today). New fixed rate CMBS loans are pricing at about 4.80-5.25%. Banks winning loans as they are able to compete with lower rates and simple rate locks. Bank loan proceeds may be slightly less and involve some level of recourse. Fannie and Freddie are locking rates anywhere from the mid to upper 4’s depending on leverage and affordability metrics. Life companies are able to lock rate early and price in the 4.50-4.75% range for higher quality properties, especially apartments and industrial. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
April 11, 2022
The 2 year/10 year Treasury yields are “back to normal”, but rates continue to rise. Some technical aspects are pushing yields up: new auctions in 10 and 30 year Treasuries are set for this week and a huge debt sale by Amazon.
Treasuries: Markets were prepared and had priced in a hawkish, tightening Federal Reserve. Tightening was assumed to be a series of interest rate hikes up to the “Neutral Rate” of about 2.50%; while keeping the balance sheet steady with the intent of rolling off maturing securities in the coming year. Recent Fed speeches and meeting minutes have significantly raised the bar on the level of tightening being planned. A half point increase at the May 3-4 Fed meeting is now the default scenario (futures are at 79% probability). Treasury yields are spiking as the market prices in hawkish new revelations from the Fed:
- Possible “overshooting” the neutral rate, ie. raising rates about 2.50% to about 3.50% putting the Fed Funds rate into “constraining” territory for the first time in decades
- “Quantitative Tightening” (QT, the opposite of QE) – QT will involve shrinking the Fed’s balance sheet at a rate of $95 billion per month ($60 billion in Treasuries, $35 billion in MBS).
The last period balance sheet reduction (2017-2019) averaged about $30 billion/per month and was mostly “runoff” of maturing treasuries. This round is expected to include outright sales of longer term treasuries starting this summer. Why so sudden? Maybe it’s “buyer’s remorse” or an attempt to “turn back the clock” as the Fed is being highly criticized for continuing to purchase bonds throughout 2021 and into March 2022.
Tomorrow’s CPI report is expected to indicate very high price increases as the effects of the Ukraine conflict are in the report’s scope. Interesting news regarding the Amazon debt sale: Amazon is pricing a 40 year fixed rate bond at 130 over Treasuries. Will other corporations rush to sell bonds before yields spike further? Tomorrow’s March CPI report is expected to be very high as the effects of the Ukraine conflict exacerbated already escalating prices. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 30, 2022
Many of the pandemic era economic metrics are unprecedented and the recovery is no exception. Huge demand combined with supply shocks not seen in generations stoking inflation. The Fed’s aggressive rate hike stance is pushing short term Treasury yields up (1 month to 3 year terms), while investors are buying 5 – 30 year bonds, betting on slowing growth. The 3 year bond is at 2.49%, higher than the 5, 7, and 10 year bonds. The highly watched 2 and 10 year bond spreads inverted yesterday for the first time since September 2019 (and the 2 year and 30 year very briefly inverted).
Floating rate expectations are climbing: 30 day term SOFR sits at 0.31%, the forward curve indicates expectations of it hitting 2.37% by year end (8 x 0.25% Fed increases). The German 10 year Bund which was in negative territory at the beginning of this month is now at 0.66%, further eroding the “relative value” trade in the US Treasury. The inverted yield curve is often a predictor of a recession (average time from inversion to recession: about 18 months). Or,is this just a bet that the Fed increases will slow growth but not push us into recession? Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 22, 2022
Powell’s Monday remarks shook up markets as he continued to channel his “inner Volcker” (80’s reference). He referenced the Fed’s dual mandate as he remarked that inflation is “much too high” and the labor market is “strong.” Translation: It’s our mandate to raise rates aggressively. He followed that up by indicating that raising rates more than 25 basis points at a “meeting or meetings, we will do so” Market Assumption: Look for 50 basis point increases in May and June. A full 1% increase in a 2 month period hasn’t been seen in about 30 years. He admitted that the Fed “widely underestimated” upward price pressures (remember “we believe that base effects from the pandemic shutdown are distorting inflation statistics and it will smooth out within 6 months”?). It’s also noteworthy that he did not rule out raising rates above the so called “neutral rate” for a period in order to cool off inflation. The neutral rate is considered to be the rate that would be neither stimulative nor restrictive, is now about 2.5% (note that it was 4.2% in 2012). The Fed funds rate was 2.50% during much of 2019 before plummeting to 0% in March 2020. The yield curve is flattening as the 3, 5, 7, and 10 year treasuries are bunched within 4 bps of each other. This may be signaling a prediction of slowing growth as the “soft landing” unicorn may be elusive. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 16, 2022
Today’s Federal Reserve meeting and accompanying announcement was expected – the first increase in 4 years of the Fed Funds rate. The quarter point increase today will be followed by six more increases throughout 2022 according to the accompanying statement and “dot plots”. That would bring the overnight rate and the index for floating rate loans up to 1.75 – 2.00% by year end. Stocks rallied on the news as markets welcome some action on inflation. The Fed is searching for the (elusive) “soft landing” whereby rate increases cool inflation without choking growth. It is looking like a tough challenge with little historical precedent: a supply shock, high commodity prices, wage inflation, pent up demand following massive stimulus. The prospect of recession or “stagflation” (low growth, rising prices) is feared as a possible outcome. The Fed committee also predicted three rate increases in 2023 to end up at the so-called “neutral rate” (or “terminal rate”) now pegged at around 2.50%. The 10 year T hit 2.25% today, a high last reached in May 2019. Look for SOFR (the leading floating rate index) to increase, today the 30 day SOFR is at 0.33% and is expected to increase in nearly lock step with the Fed Funds rate. The Ukraine invasion and global uncertainty continue to contribute to volatility in credit spreads. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
March 1, 2022
The Ukraine conflict and subsequent sanctions are roiling financial markets. The exclusion of Russian banks from the SWIFT global payment system triggered a flight to quality as investors bought treasuries and sold off risk assets. The 10 year T is at 1.73%, down from 2.03% last week, pre-invasion. Markets are now betting that the US Federal Reserve’s rate to increase plans for 2022 may be slower than previously anticipated. Example – the probability of a half-point rate increase this month has almost vanished. A quarter point increase is fully “baked in”. Speaking of Fed and inflation, last week’s PCE core inflation index (the Fed’s preferred metric) jumped 5.2%, a new 38 year high. Today, oil prices (West Texas Intermediate) closed at $105 a barrel, the highest since August 2014. The coordinated release of 60 million barrels of oil from the US and other world powers today did not help prices (note: that is about a half day’s worth of global consumption). The SWIFT exclusion makes it difficult for Russian oil to be sold, not to mention Russia’s standing as an international pariah. Supply chain issues are also being exacerbated. Fed Chair Powell speaks to Congress tomorrow and will try to balance inflation hawkishness with sensitivity to market disruptions. Many lenders are cautiously quoting new loans but we are hearing that it’s “difficult to know how to price right now”. CMBS spreads have increased about 40 bps in the last few weeks (AAAs up from the 60s to the 100s over Swaps). CLO (floating rate) spreads were already gapping out early in the year due to the LIBOR-SOFR transition, but now have widened further. The question is, will this all “settle down” or escalate? Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
February 23, 2022
Geopolitical tensions are high over a potential incursion/attack on Ukraine by Russian forces. A massive humanitarian cost is being predicted based on estimates of casualties and displaced refugees. Financial markets are on edge, stock prices are dropping while bond yields remain fairly steady. The immediate effect of an escalating conflict in Ukraine will be a spike in energy prices. Supply chains already under stress will suffer further disruption. These factors will further exacerbate and lengthen inflation worldwide. The Federal Reserve is now expected to raise rates steadily throughout 2022. There are 7 meetings remaining in 2022 (March, May, June, July, September, November, December). Markets are expecting a quarter point increase at each meeting. Expectations of a half point increase in March are ebbing due to the increased uncertainty in the Russia/Ukraine situation. The futures market indicates 70% chance of a quarter point and 30% chance of a half point. Seven rate increases would bring the Fed rate to 2.00%, close to the 2.25-2.75% predicted “neutral rate” that policymakers feel would be appropriate for “normal” economic conditions (which has not been reached in well over a decade) Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
February 16, 2022
We were back in person for the annual MBA (Mortgage Bankers Association) CREF Conference in San Diego. Nearly all the GSP producers attended and met with numerous lenders of every strata of the capital stack. The overriding narrative: 2021 was a banner year and everyone has increased their allocations for 2022. As one GSP producer commented, “Everyone wants to lend more money and they can care less that interest rates are going up”.
Bridge lending is very competitive. Multifamily is the preferred asset class and will be priced tightly. Several lenders will quote retail, office and even hotels. Some lenders are increasing minimum deal size to bulk up production, but niche lenders remain in the lower loan amount space. Expected rate increases during 2022 will stress metrics on underwriting. Sponsors and lenders will have to evaluate rate risk going forward. Rate caps are getting more and more costly.
Yes, hotel loans are again being quoted by lenders looking for yield. They will be focused on sponsorship expertise and balance sheet strength. Extended stay has thrived during the pandemic.
CMBS lenders are looking to better last year’s post Great Recession record high issuance. In the fixed rate space, we talked to some secondary life companies getting more aggressive on loan proceeds to win business, filling in the space between the more conservative “big name” life companies and CMBS.
The Mezzanine, Preferred Equity, JV Equity markets for bridge and construction are very liquid. Many are offering pay and accrue structures to win business.
Product types: Rental SFR pools continue to mature as a “buy and hold” asset class. More lenders are getting into this space with acquisition/bridge and perm financing options. Other “secondary” product types are thriving including manufactured housing, student housing and self storage.
Bottom Line: It’s a good time to borrow in a highly competitive capital markets environment and fix your rate or hedge before rates go up. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 26, 2022
Today’s Fed meeting announcement started with a “mission accomplished” and continued on with “the hammers”. First off, another reminder that the Fed’s “dual mandate” has been met: “With inflation well above 2% and a strong labor market, it will soon be appropriate to raise the federal funds rate”.
How soon? Fed Chair Powell indicated that asset purchases are dropping to $30 billion in February and ending in March, so that’s his way of saying be ready for a March increase.
How much? The consensus seems to be a quarter percent (the first increase since Dec 2018). But, Powell also said “there’s quite a bit of room to raise interest rates without threatening the labor market”. Of course this will increase interest payments on home loans, credit cards, car loans, commercial real estate loans, etc. as the Fed is determined to remove liquidity from the system. This is leaving some room for a bigger increase in March.
The “third hammer” that markets have been watching is balance sheet runoff. The Fed also released a special statement regarding its planned approach for “significantly reducing the size of the Federal Reserve’s balance sheet”. It expects this process to commence after the increase in the federal funds rate has begun. So again, when? This could be as early as April. The big question is how much and how fast? Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
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