June 29, 2022
The treasury yield curve is indicating near-term rate hikes and long-term economic slowdown. The 2-Year is 3.04%, 5-Year is 3.14%, and 10-Year is 3.09% (41 bps below its recent high). The markets are betting against the “soft landing” unicorn, as continued hawkish comments by Fed officials indicate that fighting inflation is the priority. Higher unemployment and/or slower growth could be collateral damage. Markets are “treading water” in anticipation of tomorrow’s PCE Report – the Fed’s preferred inflation gauge. The critical component will be the Core PCE monthly increase. Last month’s increase was 0.3%, and the analyst consensus for this month is 0.4%. The report will be the major market mover as we enter the 2nd half of 2022.
Capital Markets Update: Market dislocation is occurring throughout capital markets as securitized lending (both fixed and floating) is slowing. Bond buyers are demanding higher yields, and some lenders are reluctant to clear their inventory and take losses. Some lenders are hitting the pause button on new originations, which then puts increased pressure and demand on lenders still active. New CMBS “full leverage” fixed-rate loans are pricing between 5.75% – 6.25%. “Full leverage” in this case is low leverage, as cap rates have yet to widen accordingly. We are seeing regional banks step up with rates in the low to mid 5’s with the ability to rate lock early. In the bridge lending space, active lenders are extremely busy as some competitors are on the sidelines. This is not a 2008-style “meltdown” as Bank balance sheets are strong and there is liquidity in the marketplace. It is a period of “price discovery” and uncertainty about asset values and the direction of the economy. Stay tuned…
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
June 22, 2022
Markets are whipsawing back and forth between worrying about stubborn inflation, recession, or both- stagflation. The conundrum is partially a result of Fed policy. Remember, the Fed’s toolbox consists of “hammers not scalpels.” The central bank is not able to fine-tune or tweak sections of the economy. Instead, it’s interest rate increases are macro-monetary policy moves that affect capital markets, personal finance, consumer behavior, etc., on a large scale. Much of today’s inflation is due to a massive supply shock, as manufacturing and logistics underwent disruption due to COVID. So, the Fed’s “hammer” is to create a demand shock by raising interest rates. Example: Existing home sales volume is plummeting as mortgage rates spike (the 30-year fixed mortgage rate has spiked to over 6.00%, up from about 3.10% last year). Also, there are signs that gas prices have actually dropped slightly in recent days. Markets are looking at this as “good news and bad news” as high prices and increased interest rates are causing consumers to curb purchases. The 10-year Treasury hit 3.50 on June 14 on the narrative that inflation was possibly out of control. Today, it is at 3.16% on slowdown fears. No matter what, the focus will be on the data over the next couple of weeks. This week will include jobless claims and consumer sentiment. Next week will include durable goods and Thursday’s big PCE release. Stay tuned… By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
June 15, 2022
“Seinfeld” was a must-see show on TV and “Forrest Gump” was packing cinemas back when Fed Chair Greenspan raised rates by 0.75% in November of 1994. Today’s rate increase was expected after last Friday’s CPI report of 8.6% overall, with a 6.0% jump in core inflation. The news broke Monday and was confirmed by many bank analysts. This led to a huge jump in the 10-Year Treasury from about 3.04% (Friday morning) to as high as 3.50% (Yesterday). Stock markets plunged with the Dow losing about 10% of its value in the last week.
Today’s Fed announcement and press conference by Fed Chair Powell, while hawkish, actually calmed markets. Why? It was a case of “Sell the rumor, buy the news.” Stock markets rose and the bond market rallied – the 10-Year dropped to 3.29%. Markets see a Fed that is determined to fight inflation and Powell provided more clarity on the future. Markets were in free fall largely due to the uncertainty of monetary policy going forward. Today, Powell and his colleagues helped assuage those concerns with the following comments: (1) The planned increase at next month’s meeting will be “50 or 75 basis points” (so a 75 bp increase is not “for sure”), (2) “75 bp increase is a large one, and I do not expect moves like this to be common”, (3) Predictions from the Fed: the Fed Fund’s target rate for year end 2022 is 3.4% (note that this estimate was 1.9% in March) and 3.8% for year-end 2023, before tapering down to 2.4% – the neutral rate. The Fed Funds rate is at 1.50% – 1.75%, 30-Day SOFR is 1.48%, and 30-Day LIBOR is 1.50%. Sign of the Times: “Collars” are back. Interest rate caps are now also being offered with a “collar” that can alleviate costs. The cap purchaser also “sells a floor” to the cap provider by agreeing to pay a minimum interest rate if rates drop. Stay tuned…
By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
June 8, 2022
Today’s $33 billion auction of the 10-Year Treasury Bonds saw tepid demand. Bids were submitted for 2.41x the amount offered – the last six auctions have been averaging 2.50 times. Investors are in a wait-and-see mode as they are anticipating this Friday’s CPI release. Recent data shows that inflation is peaking (good news), but the question is what is on the other side? A stubborn plateau or a downhill? The core CPI report (excluding food and energy) is expected to drop to 5.9% – after April’s rate hit 6.2% (with a 0.6% month-over-month gain). Wage growth will also be in the spotlight. Recent data indicates that more expensive “large goods,” such as autos, appliances, and furniture are experiencing slower price gains on softening demand. However, the services sector is still suffering from high demand and a shortage of workers. The European Central Bank is set to announce new projections for growth and inflation. This week’s meeting may see a commitment for their own 50 basis point hike. France’s central bank is describing the potential move as “normalization but not tightening.” The US Fed meets next week and has communicated their intent to raise the Fed Funds rate by 50 bps, followed by another 50 bps in July. The September meeting is the subject of speculation, hence the focus on Friday’s CPI and the accompanying commentary at next week’s meeting. Stay tuned… By David R. Pascale, Jr. , Senior Vice President at George Smith Partners
June 1, 2022
One of the most prominent features of capital markets over the past several decades has been the “Fed put.” A put provides insurance against asset prices falling below a certain level. The idea is that the Fed will raise rates to combat inflation, but if there is a significant decline in the stock market, the bank will drop rates. Besides interest rate policy, the Fed has implemented quantitative easing since 2008. QE is the direct purchase of long-term Treasuries and other securities, which brings down long-term interest rates and provides a buyer of last resort. An example of the Fed put was in 2010, when the bank began a second round of quantitative easing while the market was still struggling with the effects of the recession.
Recent developments raise the question of whether the Fed put still exists in the current market. The S&P 500 is down 15% this year, the 10 yr Treasury has increased by nearly 1.50%, and the GDP print for Q1 was -1.4%. Many expect that GDP growth will be negative in Q2, meeting the technical definition of a recession. Yet, the Fed has stuck to its stated intention of raising rates until there is a significant decrease in inflation. The magnitude and pace of increases have only increased at successive Fed meetings. The minutes from the most recent meeting indicate that the Fed is willing to go further and faster and may keep rates above the “neutral” level of 2.5% for some time.
Additionally, the Fed has started to remove liquidity from the market by ending quantitative easing. Per CNBC, “Starting on Wednesday, the Fed will begin reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities by a combined $47.5 billion per month for the first three months. After this, the total amount to be reduced goes up to $95 billion a month… The reduction will occur as maturing securities roll off the Fed’s portfolio and proceeds are no longer reinvested.”
The question now becomes whether the Fed will stick with these policies if they result in a recession, a rise in the unemployment rate, and a slowdown in the housing market. In the short term, it appears that the Fed will continue to hike rates, but this may change as the market evolves.
By Matt Kirisits, Vice President at George Smith Partners
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