Fed's Interest Rate Hikes May Be Almost Done, But Lending Will Still Get Tougher
Despite the stunning failures of two banks this month and widespread anxiety over the potential for systemic contagion, the Federal Reserve isn't changing course on raising its key interest rate — for now — in what amounts to a mixed picture for real estate.
The Fed signaled Wednesday it could be at the beginning of the end of a series of rate hikes that have spiked the cost of borrowing. But those holding commercial real estate mortgages could be in for a painful interlude as lenders pull their purse strings even tighter.
The Federal Open Market Committee raised the target range for the federal interest rate by 25 basis points to 4.75% at its Wednesday meeting. The FOMC didn't change its year-end projection for the interest rate of a shade over 5%, according to the committee's internal survey of its members.
The FOMC cited improving job growth over the past few months and inflation remaining well over its target range of 2% in justifying its decision while acknowledging the elephant in the room.
"The U.S. banking system is sound and resilient," the announcement read. "Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is uncertain. The Committee remains highly attentive to inflation risks."
In the five weeks between the FOMC's previous rate hike and Silicon Valley Bank's collapse, inflation numbers had been above expectations, leading the Fed to anticipate increasing its aggressiveness toward interest rates this year, Fed Chair Jerome Powell said at a press conference on Wednesday.
Even though he stressed multiple times from the podium that the Fed, combined with the Treasury Department and the Federal Deposit Insurance Corp., has the resources and willingness to guarantee virtually all deposits across the banking system, Powell said that the stress in the banking sector has already created tighter lending standards and likely will continue to do so.
"Such a tightening of financial conditions would work in the same direction as rate hikes," Powell said. "In principle, as a matter of fact, you can think of it as being the equivalent of a rate hike, or perhaps more than that. Of course, it's not possible to make that assessment today with any level of precision whatsoever."
The consensus among economists in the immediate aftermath of the FOMC's announcement is that the banking crisis led the Fed to take a more dovish stance in general toward interest rates, Bloomberg reports.
"It's possible that monetary policy will have less work to do," Powell said at the press conference.
But the Fed's base projections do not call for any cuts before the end of the year, with Powell once again cautioning the finance industry against betting on lower rates.
The FOMC’s decisions are always subject to heavy scrutiny and prognostication from the banking and finance industries, so much so that most commercial real estate financing deals “bake in” the trajectory of the federal interest rate over the term of a loan.
Though a majority of published predictions accurately forecast a 25 basis point hike, the suddenness and recency of the public loss of confidence in banks had some predicting the Fed would keep its interest rate flat this month, Bloomberg reported ahead of the announcement.
More than the rate hike itself, commercial real estate investors likely took special note of the Fed’s base projections for the rest of the year, which include only one or two further hikes and no cuts. Even with debt remaining more expensive than it has been for years, a more predictable market could shake loose some liquidity, CoreLogic Chief Economist Selma Hepp told Bisnow.
“The market is reacting to what it believes is an ‘end in sight,’” Newmark Executive Managing Director Henry Stimler said in an email. “[That] 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.”
Ultimately, the reason banks are likely to tighten lending standards without further pressure from the Fed is not because of the high-profile bank runs from mid-March, but because of what initially sparked them.
Banks’ long-term investments, including commercial real estate mortgages, lost considerable value in the past year as interest rates rose, and will lose a little more with the latest rate hike — the downside, or duration risk, inherent to such investments, Hepp said.
“I think the duration risk exists for many other banks,” she said. “It’s just maybe that they managed it better or didn’t over-position themselves into longer assets. And we still don’t know which banks have tapped into the new [Bank Term Funding] program. The indications are that quite a few banks have tapped into it, which gives a hint that the problem exists.”
U.S. banks borrowed a total of $300B in the first week of the emergency Bank Term Funding program alone, PBS reports.
Banks with especially high exposure to long-term investments, as SVB had, have billions of anticipated losses on their balance sheets waiting to be revealed by new appraisals, Hepp said. Any bank in that situation will simply have less money to lend, regardless of its underwriting standards.
“At the very least, I think it’ll lead to an extended period of tightening,” Hepp said.
UPDATE, MARCH 22, 6:30 ET: This story has been updated to include reaction from CoreLogic Chief Economist Selma Hepp and Newmark Executive Managing Director Henry Stimler.