‘Prisoners To The Next Data Release’: Economists Say Interest Rates Likely To Drop In 2024, But Probably No Time Soon
With commercial real estate transactions on ice amid elevated interest rates that opened a chasm between buyers and sellers, the big questions continue to be whether rates have peaked and when they might start to come down.
The answers are, respectively, probably and unlikely until late 2024 or even into 2025 despite indicators showing progress toward the Federal Reserve’s longstanding goal of 2% inflation, according to economists interviewed by Bisnow.
That means the commercial real estate market could remain in a frustrating holding pattern well into the new year or see a new era of “losers and winners” begin to take shape.
Economists said policy all depends on numerous factors that are difficult to reliably predict. But the consensus was nothing is moving rapidly soon.
“At this point, the most likely outcomes are either short-term rates don’t move next year or there’s maybe one cut,” said Xander Snyder, senior commercial real estate economist at First American Financial Corp. “But at the end of the day, we're all really just prisoners to the next data release, including the Federal Reserve.”
The Federal Open Market Committee next meets Dec. 12 and 13, with most economists, including those interviewed by Bisnow, saying they expect the Fed to keep the base rate steady at 5.25% to 5.5%, much as they did through the fall after hiking rates 11 times between March 2022 and July 2023.
The latest data release ahead of the December meeting showed progress toward the Fed's inflation goal as well as a persistently strong job market.
The consumer price index put the annualized U.S. rate of inflation at 3.2% this month, down from 3.7% in October, which was largely influenced by gasoline prices, Moody’s Analytics economist Nick Villa said. The core inflation rate, which doesn't include volatile food and energy prices, came in at an annualized 4% in October. That was down from 4.1% in September and 4.3% in August.
“So the labor market is still tight. Inflation is coming down. … That’s good news,” Snyder said. “But … the Fed has repeatedly said, ‘One month data does not constitute a trend.’”
The core inflation rate has been particularly sticky, said Sunny Wong, an economist and associate dean at the University of Houston’s Hobby School of Public Affairs.
“Four percent, in terms of U.S. history, is still pretty high,” Wong said.
For the past 10 to 15 years, inflation has hovered around 2% to 2.5%, he said, adding that 1991 was the last time the U.S. saw 4% core inflation. When interest rates will drop depends on how the market reacts to monetary policy, particularly whether it reduces inflation, Wong said.
Some projections show an inflation rate of 4.4% a year from now, which makes it hard for the Fed to lower rates when it wants to send a message that it is controlling inflation, he said.
“If this is the mindset that the public has about having high inflation in the next year or so, I think the Fed would still need to keep the rate at a higher level,” Wong said. “I would be surprised if they drop the rates in the first quarter of next year.”
But the Fed’s decision will depend on how the economy and banking systems function, he said.
Moody’s house view is that the Fed will hold rates steady through the end of the year. The second half of 2024 could bring two 25-basis-point rate cuts, followed by a full-percentage-point cut in 2025, Villa said.
“The view is unchanged, and really, it's because we continue to see good disinflationary progress in the economy,” he said.
That means that an increase in activity and valuations in the commercial real estate sector will take time, likely at least until the middle of 2024, Villa said.
“Even beyond, I think 2025 will be more promising than 2024,” he said.
The data doesn’t give the Fed any ammunition to cut rates right now, Snyder said, though he added that the Fed’s own projection also anticipates a 50-basis-point decline in rates next year. The Fed’s projection from September is that rates will be in the 4.5% to 5.5% range by December 2024.
“There’s a strong case to be made for there not being any rate cuts,” Snyder said.
A strong job market, inflation still double what the Fed is targeting and nearly 5% GDP growth in the third quarter doesn’t give much reason to cut rates, he said.
If rates don’t come down, commercial real estate prices will likely fall to offset the higher carrying costs of interest expenses, Snyder said.
“There will be losers and winners,” he said. “If they're prudent buyers and diligent about prices they pay, then the opportunity may well come along in the next year or two to get in at a low basis on solid property at the beginning of a new business cycle.”
The best period to compare this interest rate environment to is the savings and loan crisis of the 1980s because of how banks have been squeezed by fixed-rate securities, Snyder said.
“During that period, prices declined. Commercial property prices declined [for] 16 consecutive quarters at the end of the 1980s, early 1990s,” he said.
The stickiness of inflation was also seen in the ’80s, when inflation rates were over 14%, Wong said.
The consumer price index rose by at least 3.8% annually for six years starting in 1980. The Fed jacked up interest rates aggressively in response, Wong said. The interest rate peaked at 19.63% in October 1981.
“I think that’s why the Fed learned their lesson before, and they’re trying to not keep it at this level for so long,” Wong said. “They want to find ways to go down.”