Displaying items by tag: fed
Worries of a Crisis in Commercial Real Estate
There are increasing concerns that a crisis is brewing in commercial real estate (CRE), as over the next couple of years, $2 trillion in CRE loans will need to be refinanced. Previously, there were hopes that macro conditions would soften, leading to lower rates and a more favorable lending environment. Instead, inflation has proven to be more resilient than expected, and expectations of Fed dovishness have been dialed back.
In addition to high rates, major challenges include decreasing demand for offices and rising vacancies, a stricter lending environment, and balance sheet woes at regional banks, which traditionally account for a large share of CRE lending. However, there is significant variance within the CRE market. Areas like data centers, hotels, and industrial buildings continue to show strength, while retail and multifamily exhibit more mixed performance.
If conditions worsen, there is a risk of spillover effects on the broader economy, including decreased lending activity due to losses at banks, lower tax revenue for local governments due to more vacancies and lower property values, and subsequent declines in hiring. However, the consensus continues to be that there won’t be a full-blown crisis as the sector is sufficiently diversified and continues to have strong credit performance despite adverse conditions.
Finsum: Investors should pay attention to the CRE market given the refinancing cliff and challenges posed by higher rates and a stricter lending environment.
Institutional Investors Increasing Exposure to Long-Duration Bonds
The first five months of 2024 have featured above-average volatility for fixed income due to inflation continuing to run hot and increased uncertainty about the Fed’s next move. Despite these headwinds, institutional investors have been increasing their allocations to long-duration Treasuries and high-quality, corporate bonds.
One factor is that there is increasing confidence that inflation and the economy will cool in the second half of the year, following a string of soft data. As a result, allocators seem comfortable adding long-duration bonds to lock in yields at these levels. Many seem intent on front-running the rally in fixed income that would be triggered by the prospect of Fed dovishness. According to Gershon Distenfeld of AllianceBernstein, “History shows pretty consistently that yields rally hard starting three to four months before the Fed actually starts cutting.”
For investors who believe in this thesis, Vanguard has three long-duration bond ETFs. The Vanguard Long-Term Bond ETF is composed of US government, investment-grade corporate, and investment-grade international bonds with maturities greater than 10 years. For those who prefer sticking solely to bonds, the Vanguard Long-Term Treasury ETF tracks the Bloomberg US Long Treasury Bond Index, which is composed of bonds with maturities greater than 10 years old.
Many allocators are adding duration exposure via high-quality corporates given higher yields vs. Treasuries. These borrowers would also benefit from rate cuts, which would reduce financing costs and boost margins. The Vanguard Long-Term Corporate Bond ETF tracks the Bloomberg US 10+ Year Corporate Bond Index, which is comprised of US investment-grade, fixed-rate debt issued by industrial, financial, and utilities with maturities greater than 10 years.
Finsum: Interest is starting to pick up in long-duration bonds following softer than expected economic and inflation data, which is leading to more optimism that the Fed will cut rates later this year.
Central Banks Creating Opportunities in Bond Markets
The federal reserve is holding steady with interest rates, at least at the current time, but other central banks around the globe are cutting and other hiking, creating opportunities in fixed income. While this is certainly adding a level of depth to portfolio management that hasn’t been present often in the last decade, high yields indicate great returns in fixed income.
According to Goldman Sachs investors should consider upping their exposure to high quality fixed income, emphasizing active management due to unpredictable US monetary policy. Despite expectations of rate cuts, recent inflation data suggests a "higher for longer" environment, meaning higher rates may persist.
As a result, US equities may still be attractive, but some investors are shifting towards fixed income to capitalize on strong yields, particularly in high-quality investment-grade bonds and structured products.
Finsum: Active investors continue to have an edge with disparate monetary policy actions around the globe.
Change in Rate Outlook Impacts Private Real Estate
Entering 2024, the consensus was that the Federal Reserve would be cutting rates in the back half of the year in response to falling inflation and a slowing economy. This has major implications for private real estate, given that trillions of dollars in loans are maturing over the next couple of years.
Yet, economic data and inflation have been more resilient than expected. Now, rate cut odds have narrowed, while there is some chatter that the Fed may have to tighten further. Currently, the Fed continues to signal that its next move is to cut rates, albeit later and to a lesser extent than previously thought.
Still, this is likely to be uncomfortable for many borrowers, as many are holding onto properties based on the belief that rates will be lower, leading to more favorable selling or refinancing conditions. This is especially the case for those exposed to floating-rate debt.
According to Richard Mack, the CEO and co-founder of Mack Real Estate Group, “People are paying to hold assets, but unless rents rise quickly, eventually asset prices will have to adjust to rates instead of hoping and anticipating rate decreases. In essence, you have to pay to wait and see what kind of recovery transpires, which is different from past cycles where interim cash flow paid you to wait for appreciation.”
Finsum: Many were confident that conditions for real estate would improve as the Fed eased policy in the second half of the year. Now, many borrowers are likely to face increased stress as rate-cut expectations have been scaled back.
Rate Cuts Could be Delayed Into 2025: PIMCO
Earlier this year, PIMCO cited expectations that the Fed would start a series of rate cuts as one of its reasons to be bullish on fixed income. The asset manager is revising this view given the lack of progress on inflation and now sees rate cuts being delayed until the end of the year or even into 2025.
Following the latest FOMC meeting, PIMCO sees the Fed pursuing a policy similar to the 1990s, when the Fed held rates and allowed inflation to trend lower over time. Fed officials seem wary of the downside risks of further tightening and are willing to concede higher inflation in the near term.
Despite a recent uptick in inflation, the Fed seems content to hold rates at steady levels. During his press conference, Chair Powell remarked that monetary policy was restrictive and that rates could be lowered if the labor market weakened. He added that a rate hike was ‘very unlikely’ and that the inflation in resurgence could be temporary due to seasonality and noise.
While fixed income rallied following the FOMC meeting, PIMCO expects FOMC members to raise their inflation forecasts from 2.6% to 3% for core PCE at the upcoming meeting. The firm also sees an increased risk of no rate cuts this year if inflation data comes in closer to 3% than 2%.
Finsum: Following the latest FOMC meeting and hot inflation data, PIMCO is lowering the odds of a Fed rate cut in 2024.