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
January 18, 2022
The 10 year Treasury yield spiked to 1.86% today as new assumptions for the Fed are being “priced in”. The 2 year Treasury (most sensitive to Fed moves) has jumped to a 2 year high of 1.00% (up 80 bps since September). The early January predictions of 3 or 4 rate hikes this year now seem “dovish” this week.
Major factors include continuing high CPI numbers combined with:
- Predictions of extended supply chain disruptions resulting in shortages/higher prices for oil, raw materials, computer chips, consumer staples, etc; and
- A very tight labor market with “sidelined” workers that will demand higher wages to return to work.
Markets are now pricing in a 0.50% rate hike in March (the first 0.50% rate hike since May 2000). Consumers, businesses and Congress are clamoring for action on inflation. It looks like the Fed will want to make a “whatever it takes” statement with a rare “double hike” in March (as soon as the monthly bond buying has ended). Fed governors are calling for as many as 5 rate increases in 2022. Also, the 10 year T is spiking on the “relative value trade” as the 10 year German Bund is climbing out of negative territory for the first time since May 2019. So the 10 year at 1.86% is now right where it was on 12/31/2019, the day of the first Covid alerts and before the unprecedented fiscal and monetary stimulus of the past two years. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
January 12, 2022
Consumer prices rose 7.0% for 2021 according to the December CPI report released early this morning (core prices rose 5.5%). That is the highest rate in 40 years, all the way back to the Volker era. Fed Chair Powell has expressed concern that inflation may become “entrenched.” Via speeches, interviews, and Fed minutes released, the Fed committee members have laid out a path for 2022 and beyond. The December unemployment report at 3.9% indicated that there is a “labor shortage” according to Fed officials. This is very significant as it means that both the inflation and employment “test thresholds” have been met (the so called “dual mandate”).
The 10 year T barely moved today as the big CPI numbers are not expected to change policy assumptions that are “priced in”. The 10 year closed out 2021 at 1.51% before a big spike last week, sending the yield as high as 1.81% on Wednesday. This spike was attributable to markets being surprised by the release of Fed minutes indicating that balance sheet runoff, aka QT (Quantitative Tightening) may occur this year. This was a surprise to markets. The Fed had already telegraphed the first two stages of policy tightening: tapering bond purchases (set to end two months from now) and raising the Fed Funds rate. The general assumption was that the “runoff” of the Fed’s balance sheet would not occur until 2023. The knowledge that the Fed may be a net seller of MBS and Treasuries this year was a jolt. The act of selling bonds removes liquidity from the system and will put additional upward pressure on rates. The consensus amongst major bank economists and the future markets is the following: Bond purchases end in March, then 3 or 4 rate hikes this year (March, June, September, December). That will bring the Fed Funds rate to 1.00-1.25%. This is halfway to the Fed’s “terminal rate target” which is now 2.50%. Balance sheet run off may start as soon as September, but definitely by December. Stay tuned. By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
December 15, 2021
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 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
November 29, 2021
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
November 17, 2021
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
November 10, 2021
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
November 3, 2021
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
October 20, 2021
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