Analysis: The Fed’s Slowdown Provides Breathing Room to a Market That Needs It

As featured in ConnectCRE.com March 22, 2023

The Federal Reserve’s 25-basis-point increase in the federal funds rate on Wednesday was widely expected; now the question is where the Fed—and the market—goes from here. Among commercial real estate economists and finance experts, the consensus calls for some much-needed breathing room amid a tight lending environment that is likely to remain so.

“I expected the 25-bp hike largely because the market had already priced it in,” D. Scott Lee, co-founder – president, advisory services group at Tauro Capital Advisors, told Connect CRE. “No increase would have caused a reaction.  

“That said, I expect no further increases for the next and possibly three meetings,” Lee continued. “There is pressure not to exacerbate the regional banking deposit issues and inflation moderation has been making positive movement. The market would like to see how this trend proves out. “

Mike Madsen, VP, acquisitions and economics at RealSource Properties, had a similar take. “What a difference a few weeks can make, and this might not be the last time we say that this year,” he said. “March may be the last time policymakers hike the fed funds rate in 2023.”

He continued, “It doesn’t make much sense to continue to raise rates while the FDIC is pledging to cover all deposits as needed for market stability, which is in jeopardy due to increasing rates too late and too rapidly for the banking system to handle. However, with the turmoil in the global banking system and the 2% target for inflation nowhere in sight, interest rates may remain volatile over the next several months.”

At Avison Young, chief economist Dr. Nick Axford said the Fed’s decision for a 25-bp rate hike “must have been a very close call, given the banking sector turbulence over the past two weeks. The decision reflects the priority being placed on continuing to tame inflation in the face of tight labor markets.”   

However, Axford added, “we now expect rates to peak at a lower level than previously anticipated, given that banks will become more cautious in their lending, which will slow the economy and accentuate the decline in inflation that is already underway.”

Henry Stimler, executive managing director at Newmark, noted that while the quarter-point increase had been expected, “what everyone was really tuned into was the comments by Fed Chair Jerome Powell. The market is reacting to what it believes is an ‘end in sight,’ subtly implied by Powell’s comment that there would be just one more by the end the year – which is good news for lenders because the market needs some stabilizing news. So, overall, no great shock and some light hopefully at the end of the tunnel.”

Nonetheless, Stimler added, “due to the regional banking issues we experienced earlier this month, financial conditions have tightened more than the market indicates. By adding this dampening effect, we will see a net-neutral impact on inflation. With the market thinking continuous rate hikes are coming to a close, and this is where rates will be for the foreseeable future, we finally have a level. That sense of stability is going to help more transactions get done.”

Avatar Financial Group president TR Hazelrigg IV and JLL chief economist Ryan Severino focused on the impact of the Fed’s actions to date. “The Fed’s aggressive rate hikes have significantly compressed the spread between private money and conventional rates resulting in an explosion in demand for alternative financing,” said Hazelrigg.

As a result, he added, “many borrowers are choosing to pay what is now only a slightly higher rate for bridge financing to avoid steep prepayment penalties associated with more conventional loans. The wisdom being: pay a little more now but exit as soon as rates drop.”

Severino cited the Fed’s ‘third mandate” of financial stability, beyond its dual mandate of price stability and full employment. There, Severino noted in a commentary on JLL’s website, the Fed’s actions suggested the phrase “move fast and break things,” and the central bank contributed to something breaking. 

“The Fed’s aggressive hiking strategy contributed to recent banking issues,” wrote Severino. “That does not absolve individual banks from responsibility, but clearly the rapid increase in rates played a role.”

From a real estate perspective, Axford said, “This tightening of credit conditions will further restrict the availability of debt for refinancing of existing loans, which could force more disposals into a market where a significant amount of capital is awaiting the right opportunity to deploy. When the tide turns, we believe it could do so quite quickly.

“Those with equity to invest and with no immediate need to secure debt finance could see further openings in the market, and fewer competitors with sufficient conviction to act, in the months ahead.”