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The Federal Reserve usually speaks as one. But it’s a big organization with many individuals, including those with their own reputations and areas of responsibility. And some have been coming out to question how many, or if any, interest rate cuts will be on the table for 2024 at all.

Neel Kashkari, president and CEO of the Federal Reserve Bank of Minneapolis, is the most recent voice wondering what degree of cuts might be possible. He wrote about the multiple factors that were making any prediction difficult. Disinflation has “stalled,” underlying economic demand has remained strong, and monetary policy is “much tighter” than before the pandemic.

In a discussion at the 2024 Milken Institute Global Conference in Los Angeles, California, replying to questions from New York Times’ economic reporter Jeanna Smialek, he said, “Inflation seems to have gone sideways while economic growth has remained resilient. It’s led me to question is monetary policy having as much downward pressure on demand as I would have otherwise expected.”

He pointed to the housing market, which has remained “remarkably resilient” given 30-year mortgage rates up to about 7.5%. He acknowledged questions about whether the so-called neutral interest rate — the short-term interest rate when the country sees full employment and stable inflation — might be higher than what the Fed has expected. It’s a point that Vanguard has raised.

If the neutral rate was higher than Fed estimates, “Instead of two feet down on the brakes, maybe only one, or possibly not much at all,” Kashkari said.

There are multiple scenarios he offered going forward, “the most likely” being that “we stay put for an extended period of time, until we get clarity on is disinflation in fact continuing, or has it, in fact, stalled out.”

If disinflation starts again or the country sees “marked weakening in the labor market,” there might be interest rate cuts this year, Kashkari said. “Or if we got convinced eventually that inflation is embedded or entrenched now at 3% and that we need to go higher, we would do that if we needed to.” “That’s not my most likely scenario, but I can’t rule it out.

Back in January, Christopher Walker, a Fed governor, notedthat economic news at the time was good.

“But will it last?” Walker asked. “Time will tell whether inflation can be sustained on its recent path and allow us to conclude that we have achieved the FOMC’s price-stability goal. Time will tell if this can happen while the labor market still performs above expectations. The data we have received the last few months is allowing the Committee to consider cutting the policy rate in 2024. However, concerns about the sustainability of these data trends requires changes in the path of policy to be carefully calibrated and not rushed.”

 

Source:  GlobeSt.

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The pressure that banks are feeling from CRE loans has become a regular observation by the Federal Reserve, Department of the Treasury, Federal Deposit Insurance Corporation, other regulators, economics, financial analysis, investors … pretty much everyone paying attention.

But there’s an odd twist according to a new analysis by economist and economic policy advisor Miguel Faria e Castro and senior research associate Samuel Jordan-Wood at the Federal Reserve Bank of St. Louis.

“Given the negative outlook on certain segments of CRE, one would expect that more-exposed banks have experienced worse market performances,” the two wrote. “We found that while CRE exposure has not mattered much for bank stock returns since the 2007-09 financial crisis, the correlation became significantly negative in 2023.”

The analysis started with an examination of the relationship between commercial real estate exposure as a share of total assets on one hand and total assets in billions of dollars, on a natural logarithm scale. Something immediately obvious is that the largest banks have a relatively small exposure in CRE loans as they represent 10% or less of their assets. But smaller to medium banks had high exposures, in some cases topping 60%.

They found that those banks with high exposure to CRE loans tended to have “relatively fewer liquid assets on their balance sheets, lower capital ratios (that is, more leverage), a larger share of their liabilities in the form of deposits, and a larger share of their assets in the form of loans.”

They then moved beyond a correlation analysis and used regression to look at the connection between CRE exposure and bank returns.

“From 2007 to 2008, the beta coefficient was statistically significant and negative, implying that banks with higher CRE exposure had lower stock market returns, all other variables equal,” they said. “Since the 2007-09 financial crisis affected not only residential real estate but also CRE, it is natural that more-exposed banks performed worse during that time. Our analysis reveals that while the correlation had been mostly inactive since then, it again became significantly negative in 2023.”

So, it seems to be another way banks are currently feeling negative effects from CRE exposure. Not just in concern over asset values and regulatory pressures, but in actual earnings.

 

Source:  GlobeSt.

 

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Wednesday’s Consumer Price Index numbers were higher than expected, sending Wall Street into a swoon about what it could mean.

For starters, it’s just about a given that, following this latest evidence that prices are not declining as fast as had been expected, the Fed will delay implementing its promised rate cuts. But some prominent voices are wondering about a worse case scenario: that the Fed might actually start raising rates. If this were to come to pass, simply put it would raise havoc in commercial real estate. GlobeSt.com has heard repeatedly over the last few months that transactions were resuming in part because the market believed that the Fed was done raising rates, introducing some much-needed certainty into forecasts.

Former Treasury Secretary Lawrence Summers is one of these voices.

“You have to take seriously the possibility that the next rate move will be upwards rather than downwards,” Summers said on Bloomberg Television. He said such a likelihood is somewhere in the 15% to 25% range.

The odds still do favor a Fed rate cut this year, “but not as much as is priced into markets,” he said.

Also, Federal Reserve Governor Michelle Bowman said earlier this month that it’s possible interest rates may have to move higher to control inflation.

“While it is not my baseline outlook, I continue to see the risk that at a future meeting we may need to increase the policy rate further should progress on inflation stall or even reverse,” she said in a recent speech to the Shadow Open Market Committee in New York.  “Reducing our policy rate too soon or too quickly could result in a rebound in inflation, requiring further future policy rate increases to return inflation to 2 percent over the longer run.”

Bowman is a permanent voting member of the Federal Open Market Committee.

JPMorgan Chase CEO Jamie Dimon has also floated the possibility that rates could increase in his letter to shareholders. The investment bank is  preparing “for a very broad range of interest rates, from 2% to 8% or even more,” he wrote.

These voices, though, are in the minority. Right now, most analysts have coalesced around the theory that rate cuts will be delayed this year.

Less than 24 hours after the CPI was released, Wall Street economists began revising their outlooks. Goldman Sachs and UBS now see two cuts starting in July and September, respectively, while analysts at Barclays anticipate just one reduction, in September, according to the Wall Street Journal.

Others are even more pessimistic about the timing.

“The lack of moderation in inflation will undermine Fed officials’ confidence that inflation is on a sustainable course back to 2% and likely delays rate cuts to September at the earliest and could push off rate reductions to next year,” Kathy Bostjancic, chief economist at Nationwide, said in a research note that was reported by The Associated Press.

Right now the Fed’s official expectation is that inflation continues to move down albeit in an uneven trajectory. If this is true, then rate cuts are still likely this year.

However, Wall Street worries that inflation has stalled at a level closer to 3% and if the evidence bears this out in future reports, it is conceivable that the Fed could scrap cuts altogether.

One indicator that does not bode well for rate cuts this year is the so-called supercore inflation reading, which besides excluding the volatile food and energy prices that the core CPI does, also strips out shelter and rent costs from its services reading.

Supercore accelerated to a 4.8% pace year over year in March, the highest in 11 months, according to CNBC.

Tom Fitzpatrick, managing director of global market insights at R.J. O’Brien & Associates, told the publication that if you take the readings of the last three months and annualize them, the supercore inflation rate is more than 8%.

All this said, the Fed has promised it would cut rates three times this year and that is a hard promise to unwind. The upheaval a rate hike would cause would give the institution a black eye even worse than its promises a few years ago that the creeping inflation in the economy was transitory.

 

Source:  GlobeSt.

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According to Newmark, there is now a $2 trillion maturity wall of CRE loans facing banks over the next three years. A dizzying sum.

But the statement raises a question. When the size of the oncoming wall — or wave or lava flow, or whatever to call the coming flood — is mentioned, is anyone really sure of the size?

CRED iQ’s database at middle of December 2023 showed “approximately $210 billion in commercial mortgages that are scheduled to mature in 2024, with an additional $111 billion of CRE debt maturing in 2025. In total, CRED iQ has aggregated and organized a total of $320 billion of commercial mortgages slated to mature within the next 24 months.”

In February 2024, the Mortgage Bankers Association said that 20% of commercial and multifamily mortgage balances were to mature this year.

“Twenty percent ($929 billion) of the $4.7 trillion of outstanding commercial mortgages held by lenders and investors will mature in 2024, a 28 percent increase from the $729 billion that matured in 2023, according to the Mortgage Bankers Association’s 2023 Commercial Real Estate Survey of Loan Maturity Volumes,” they wrote.

Even discussions can be misleading. Take the Financial Times article. The headline is, “Banks face $2tn of maturing US property debt over next 3 years.” The immediate question becomes how much of banks’ portfolios are coming due? But to get there, it’s critical to see what the total holdings are.

According to the Federal Reserve’s “Assets and Liabilities of Commercial Banks in the United States,” also known as H.8, thetotal of commercial real estate loans, including multifamily, held by banks was $2,985.5 billion during the week of March 20, 2024. Given the timelines of loans, most frequently five-year cycles, a 20% turnover annually is a realistic estimate. But a $2 trillion count would be two-thirds of all bank loans, which doesn’t seem plausible.

GlobeSt.com contacted Newmark for some clarity. The firm responded with information from David Bitner, Newmark’s executive managing director and global head of research. Here are his points:

  • “The $2T figure should indeed refer to ALL CRE loans (including 5+ unit multifamily).”
  • “Bank maturities are the largest share of near-term maturities, which is a large part of why we focus on them.”
  • “Debt fund and CMBS/CRE CLO debt is also front-loaded.”
  • “Data comes from Mortgage Bankers Association latest Loan Maturities report (released in mid-February).”

So, the pool of loans is much larger than those held only by banks. Even with the “extend and pretend” treatment lenders seeking to keep losses off their balance sheets, eventually reality sets in. In one sense, it won’t matter who holds the loans. As accounting standards eventually force lenders to write off clear losses, the result would be a large exercise in mark-to-market, lowering the value of many if not all CRE loans.

That would hurt the total asset values of many banks, which is the condition that led to the closures of Silicon Valley Bank, First Republic Bank, and Signature Bank last year. As Gosin told the FT, such a result would force some banks “to liquidate their loans or find other ways to reduce their weight in real estate,” whether by finding ways to increase capital, offload the risk, or further reduce the amount of CRE lending they do.

 

Source:  GlobeSt.

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A drumbeat for stagflation as a possible scenario for the US economy is growing louder.

Last week, strategists from the Bank of America wrote that the macroeconomic picture is “flipping from goldilocks to stagflation,” which they defined as growth below 2% and inflation of between 3% and 4%. Inflation is higher in developed and emerging markets, while the US labor market is “finally cracking,” wrote Michael Hartnett.

JPMorgan Chase’s Marko Kolanovic raised similar concerns in February. A halt in inflation’s downward trend, or price pressures broadly resurfacing “wouldn’t be a surprise” given outsized gains in equities, tight labor markets and high immigration and government spending, he said, according to Bloomberg.

Between 1967 to 1980, stock returns were nearly flat in nominal terms as inflation came in waves, with fixed-income investments significantly outperforming while stock returns were nearly flat in nominal terms. Kolanovic sees “many similarities to the current times.”

“We already had one wave of inflation, and questions started to appear whether a second wave can be avoided if policies and geopolitical developments stay on this course,” he said in his note, adding that inflation is likely to be harder to control as stock and cryptocurrency markets add trillions of dollars in paper wealth and quantitative tightening is offset by Treasury issuance.

Recent economic reports back up these analysts: The February Consumer Price Index came in at a higher-than-expected 3.2% year over year. Retail sales reported on Friday rose 0.6% from January to February, falling short of projections expecting 0.8% growth.

The Wall Street Journal highlighted these developments but ultimately dismissed the idea of stagflation taking hold in the US economy. So have the equity markets,

Barclays Plc strategist Emmanuel Cau wrote in a note that was reported in Bloomberg.

“With the Fed so far endorsing current market pricing of three cuts starting in June, investors continue to see the glass half full on the soft landing narrative,” he said.

This week the Federal Open Market Committee will meet and the minutes it releases will show how Fed officials’ thinking changed from recent bad data on inflation.

One sign doesn’t bode well for Fed watchers hoping for rate cuts to happen sooner than later.

More than two-thirds of academic economists polled by the Financial Times believe that the Federal Reserve will be forced to hold interest rates at a high level for longer than markets and central bankers anticipate. Respondents to the FT-Chicago Booth poll think the Fed will make two or fewer cuts this year with the most popular response for the timing of the first cut split between July and September.

“The Fed really wants to cut rates. All of the body language is about cutting. But the data is going to make it harder for them to do it,” Jason Furman, an economist at Harvard University, who was one of 38 respondents polled this month, told the FT. “I expect the last mile of inflation to prove quite stubborn.”

However, there is one viable theory for rates in June. Vincent Reinhart, a former Fed official who is now chief economist at Dreyfus and Mellon, told the FT that politics will play a role in the timing this year.

“The data say the best time to cut rates is September, but the politics say June,” said Reinhart, who did not participate in the poll. “You don’t want to start cuts that close to an election.”

 

Source:  GlobeSt.

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Federal Reserve Chair Jerome Powell said Thursday he expects to see some banks fail due to their exposure to the commercial real estate sector, which has declined significantly in value following the shift to remote work.

Powell said the banks that are in trouble with falling office space and retail assets are not the big banks, which were designated as “systemically important” in the aftermath of the 2008 financial crisis. That episode, which resulted in a taxpayer bailout of the financial sector, was also triggered by unsound real estate assets.

Rather, the banks at risk of failure now Powell identified as smaller and medium-sized.

“This is a problem we’ll be working on for years more, I’m sure. There will be bank failures,” he said during a Thursday hearing on the Fed’s monetary policy in the Senate Banking Committee.

“It’s not a first-order issue for any of the very large banks. It’s more smaller and medium-sized banks that have these issues. We’re working with them. We’re getting through it. I think it’s manageable, is the word I would use,” he said.

Powell didn’t go into detail about the specific regulatory actions regarding commercial real estate exposure that are now being undertaken by the Fed, which is both the federal currency issuer and one of the primary bank supervising agencies, though he did say he had identified the banks most at risk.

“We are in dialogue with them: Do you have your arms around this problem? Do you have enough capital? Do you have enough liquidity? Do you have a plan? You’re going to take losses here — are you being truthful with yourself and with your owners?” he said.

Commercial real estate investment trusts, known as REITs, have taken a hit over the past few months. Alexandria Real Estate Equities, Boston Properties, Kilroy Realty Corp., and Vornado Realty trust are all in negative territory since the beginning of the year.

Powell described the decline in value of commercial real estate as a result of remote work following the economic shutdowns of the pandemic as a “secular change” in the economy.

“In many cities, the downtown office district is very underpopulated. There are empty buildings in many major and minor cities. It also means that all the retail that was there to serve those thousands and thousands of people who work in those buildings, they’re under pressure, too,” he said. 

While the decline of commercial real estate values could put some banks out of business, Powell expressed confidence that the Fed and financial regulators would be able to contain the fallout and prevent a broader crisis. Thirty-four U.S. banks have failed since 2015, according to the Federal Deposit Insurance Corp. (FDIC), which insures deposits at regulated banks.

 

Source:  The Hill

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“Bad” doesn’t adequately express the last few days for New York Community Bancorp.

As the close of Thursday, shares were down 44.6% after the bank revealed a 2023 Q4 loss of $252 million rather than the Q3 $207 million gain. Markets remembered that there are still significant concerns about commercial real estate and its loans.

New York Community had acquired much of the deposits and loan assets from failed Signature Bank, and it added a $552 million provision for future credit losses, plus $185 million in net charge-offs, plus cut dividends by 70% to bolster capital.

Despite repeated assurances from the Federal Reserve and the Treasury department that banks are fundamentally sound, real-time results for banks have become reminders to markets that all is apparently not well.

The problems facing New York Community were more than Signature. A New York co-op loan that wasn’t in default nevertheless is now up from sale because of “a unique feature that pre-funded capital expenditures.” There was also an “additional charge-off on an office loan that went non-accrual during the third quarter, based on an updated valuation.”

Even worse, all this was unanticipated by investors because the bank had not prepared markets for the bad news.

From a market view, compounding all this was that the acquisitions from Signature and 2022’s acquisition of Flagstar Bancorp boosted New York Community’s total assets to more than $100 billion. That put the institution, as it noted, “firmly in the Category IV large bank class of banks between $100 billion and $250 billion in assets and subjecting us to enhanced prudential standards, including risk-based and leverage capital requirements, liquidity standards, requirements for overall risk management and stress testing.”

Moody’s placed the bank on review for a downgrade

But there was compounding news from elsewhere in the world, as the Wall Street Journal reminded. Azora Bank of Japan saw shares drop 20%, “the maximum allowed on a single day under stock-market rules, after it said losses in its U.S. office-loan portfolio will likely lead to a net loss for the year ending in March.” The annual loss will be the first in 15 years and its president will step down April 1. And then, Deutsche Bank “increased loss provisions in its U.S. commercial loan book nearly fivefold from 2022’s fourth quarter to 123 million euros, equivalent to $133 million.”

Concerns about conditions in CRE might push banks into restricting lending even more, which would reduce available financing and make the industry more dependent on alternative funding sources, like private equity, with significant higher financing costs than commercial banks.

Or as Morgan Stanley’s Mike Wilson put it to Bloomberg: “It’s not a systemic issue. It’s a weight on credit growth [and] the companies that are reliant on that kind of funding are going to see that’s a paperweight for them.”

 

Source:  GlobeSt.

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Listening to discussions about what will happen with interest rates in 2024 is like walking into an open house at The Oxford Union of the namesake university. Debates to the right and left with the audience voting on the most compelling argument.

One of the loudest collective voices in the rate debate are the money markets, and they’re nowhere near as optimistic as those cheering a soft landing of the country’s economic airplane, according to Reuters. Financial markets are expecting interest rates to remain high for an extended period of time — 3% for years — with inflation still higher than the Fed wants and government spending driving new heights of public debt.

The former means the Fed could limit cuts and the latter will mean more U.S. borrowing at higher yields to attract buyers. The yields, especially for the 10-year, create an attractive place for investors to put money with relative safety, boosting the rates other outlets must get to provide risk-adjusted returns and compete as investment opportunities. In other words, don’t expect the decade of near-zero rates to return.

“Traders have in recent weeks doubled down on bets for steep rate cuts next year, encouraged by slowing inflation and a dovish shift from the U.S. Federal Reserve,” Reuters wrote. “Expectations that rates will drop at least 1.5 percentage points in the United States and Europe have boosted bond and equity markets.”

The Federal Reserve’s most recent collection of economic expectations show the projected federal funds rate range to be 4.4% to 4.9% this year, 3.1% to 3.9% next year, 2.5% to 3.1% in 2026, and 2.5% to 3.0% in the longer run.

The warnings aren’t coming only from money markets. There have been polar takes on the edge.

As Stephen Stanley, chief US economist at Santander, told the Financial Times, “You couldn’t draw up a more perfect economic scenario than the FOMC’s forecasts. If it happens, that would be tremendous. But there are only downside risks.”

As Jeffrey Gundlach — founder, CEO, and chief investment officer of Doubleline, and money management firm that is a big player in the bond market — told CNBC in an interview that when the yield level of the 10-year Treasury market goes below 4%, it sounds “almost like a fire alarm.” And the 10-year has been hovering under 4% since mid-December. If Gundlach is right and lower 10-year yields are portents of a recession next year, the Feds might raise interest rates as a way to drive down price hikes.

In other words, near-zero interest rates may be long out of play no matter how you look at current conditions.

 

Source:  GlobeSt.

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A lot of discussion in business and economic circles is around whether 2024 will bring a soft landing or some degree of recession. The optimists have been out in force for some time and are expecting a Federal Reserve rate cut as soon as the first quarter of next year.

But there are still those who think a recession could happen and that victory is far from clear. If that proves to be true, Yale School of Management’s Professor of Finance and Management Andrew Metrick says to prepare for some serious trouble for commercial real estate and the banks that hold the loans.

“Historically, for every one percentage point increase in the policy rate from the Fed, banks take 1% hits to their capital over the next eight quarters,” Metrick said in an interview with Yale Insights. From the zero-interest rate to the current baseline federal funds rate range of 5.25% to 5.50% has been a large and rapid leap. “If banks lose 5% of their capital, there are going to be a lot of banks in trouble.”

“If we manage to avoid a recession and get a soft landing, the banks will recover,” Metrick says. “Past commercial real estate downturns have been slow moving things,” he explained. “We spent 10 years after the global financial crisis working out a whole lot of problems.”

At issue is the deep intertwining of banks and commercial real estate. As Metrick notes, the banking system holds about $3 trillion in CRE loans on their book sheets, $2 trillion of which is held outside the largest 25 financial institutions. To date, the loans have performed because their interest rates have been low. Refinancing is drastically changing that.

If a soft landing skips and slides into a recession, the processing of CRE loans would kick into high gear because banks don’t typically sell them on as they do with residential mortgages. Under a 2016 change in accounting standards called Current Expected Capital Losses (CECL), “banks are supposed to take seriously what they think the probability is of something paying off in the future, even if it’s current,” Metrick says.

His “nightmare scenario” starts with banks as yet having to provision adequately for potential losses. In a recession, banks are even more reluctant to lend into commercial real estate than they have been. Many loans don’t get refinanced, and some bank somewhere becomes the “Silicon Valley Bank of commercial real estate” that suddenly fails. Congress investigates and finds that the bank not only failed to have reserved enough, but also didn’t warn shareholders.

“That next quarter, every accountant in the world is going to tell their banks, ‘I’m not going to be the one blamed if you fail.’ They’re going to get very tough on CECL, and what looked like a slow-moving downturn suddenly crystallizes as an expected value disaster that everybody has to put in their balance sheets at the same time,” Metrick says.

Many banks, maybe hundreds, now become insolvent, creating a wave of closures not seen since the very worst of the Global Financial Crisis.

“Not to leave you super scared, but you should be a little scared because I’m a little scared,” he says.

 

Source:  GlobeSt.

 

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To understand where interest rates might go, watching the actions of the Federal Reserve is important, of course, but so is monitoring yields of Treasury instruments. Whether bonds, notes, or bills, depending on the term, they have great sway.

Treasurys are considered safe investments, and so are one of those practical baselines for calculating risk adjusted returns. As the yields rise, so do interest rates.

But as is true with anything, trying to track every movement can become confusing.

For example, CBRE noted on Thursday, November 3 that the “recent bond market sell off has lifted the 10-year Treasury yield to nearly 5% and further dampened investor sentiment for commercial real estate.”

 

“Rather than inflation, a mix of short- and medium-term economic and political pressures is driving up bond yields,” they continued. “These include a stronger-than-expected economy with robust consumer spending, increasing term premiums, the surging government deficit and reductions in the Fed’s balance sheet (quantitative tightening).”

Based on such data and their analysis, CBRE said that it lowered growth expectations for CRE investment rate volumes in 2024. The projection had been +15%; now they are -5%.

“Our econometric models indicate that the rise in the 10-year Treasury yield to 5% or more, if sustained, will raise cap rates and lower capital values for commercial real estate,” they wrote.

And if they were correct that the 10-year would continue a strong upward pace, maybe the impact of higher interest rates would have such an impact. They might even be correct.

But this is where following short-term data flows can drive people to potentially make mistakes.

On Wednesday November 1, the 10-year dropped from the previous day’s 4.88% yield to 4.77%. Then on Thursday, it hit to 4.67%, and Friday closed out at 4.57%. Similarly, the 2-year yield went from 5.07% on Tuesday to 4.83% on Friday.

Econometric models can be wrong. Then again, they could be correct, look further out, and maybe yields will rebound in the long run.

But then, CBRE wrote that other than office, the “relative health” of CRE property types “makes forward internal rates of return (IRRs) increasingly attractive.”

“If the economy manages a soft landing and long-term bond rates ease, investment activity may surprise on the upside,” they wrote.

This is why solid hedging strategies make a great deal of sense.

 

Source:  GlobeSt.