The Problems are the Path: Investors are Almost Alway Wrong on the FED

Investors, home buyers, and agents are convinced the FED will lower rates later this year. However, their record is not that great!

Whether the investor is a Wall Street Titan, a Commercial Real Estate Investor or Speculator or an individual investor in stocks and bonds or real estate, they have been caught offside in both directions while making their decisions on the Path of Interest Rates over the past years.

Let's take the commercial bets on office buildings.  No one expected a major shift in employees working from home as a result of the Pandemic. The shift created massive vacancies in office buildings across the United States and major world centers.  Office building owners felt it wise to take additional loans on properties before the pandemic, planning to refinance at lower rates in the future.  It did not work out well for them.  The FED raised rates to combat inflation and vacancies created a fall in income that put properties at risk.  Offices were not the only victims of improper planning on interest rates and the FED. Apartment owners expected rates to remain low or go lower and also borrowed. Speculators saw great opportunities in remodeling and renting out new apartments or home at higher rents or resale prices with *Due On completion loans.  The loans were cheap.  Unfortunately, when the loans came due the rollover rates were not cheap.

*Due On clause in loans on real estate are what lenders put in to get their money back.  In residential properties the Due On Clauses have been mitigated by legislation.  Not so in Commercial Loans.  If a commercial borrower remodeled or developed a property with a construction loan or some variation of it.  They have a Due On Clause that states once occupancy or completion permits are issued by Planning Departments the Loan is Due and Payable.  Some loans may have a rollover clause to a new loan at market rates.  Other loans will have a repayment demand within a specific time frame. 

The FED has not complied to the plans of lower rates.  While the forecasters claimed a cut in rates in March 2024, maybe 3 rate cuts for 2024, no 7 rate cuts. The FED said NO.  The FED also indicated that rates may remain up for well after March 2024.

On a daily or weekly basis reports do not indicate a softer economy.  It is becoming evident that the savings of Americans have created a cushion that allows growth to continue at a steady pace.  Home owners have refinanced their mortgages at sub 4% rates, put more into cash savings instruments and accounts. That has created a resistance to the thought of selling and moving. The result is no resale of existing homes. Inventories of homes for sale are at historic lows.

Wall Street made bets in the future markets that rates would drop.  Mr. Powell said, not yet and maybe not so soon as you thought.  So now those waggers on lower rates have shifted to May 2024.  At some point those waggers unwind and rates move up and bonds sell off.

The economy keeps moving along as the employment numbers were above expectations and another blockbuster for the economy moving forward. Moving forward with the economy is INFLATION.  The Federal Reserve Bank of Atlanta has now forecasted inflation for the first quarter of 2024 at 3.4%  This is no where near the FED target of 2%.  Rates will remain higher for longer than expected all pointing out the inability to forecast.

Near the end of 2023 and the early days of 2024 a decline in rates from the high of 2023 unleashed a wave of borrowing by highly rated U.S. companies with issuance of debt at near records for 2024. That does not bode well for the belief of lower rates in the future.  The "in the know" U.S. Corporations are borrowing at the present higher rates.  They must foresee higher rates in future than lower rates.

While U.S. Corporations are borrowing the Banks are not.  The recent survey by the FED of loan officers show fewer banks are tempering their willingness to lend.

The U.S. budget deficit is increasing.  The increasing deficit is financed by U.S. borrowing and issuing new debt.  The debt has higher interest rates. The higher interest rates keep rate on all loan high.  The increase in debt and higher rates create a larger Federal deficit.  High interest rates feed on themself.

What is at stake?

The prospect of higher rates for a longer period than expected could upend the Bond Market.  The decline in the Bond Market will create higher yields, with the higher yields will come a decline in the stock market as investors are willing to take on secure returns and sell their stock positions and speculative investments which pay capital gains.  More and more commentators are questioning the value of stocks and whether the advance has gone beyond fundamentals into risky bets based upon concepts of technology developments yet to be proven in growth and earnings.

The prospect of higher rates will create issues on valuations in the home residential market.  Higher mortgage rates will put first time home buyers back into rentals or back to Mom and Dad.

The Biggest Risk is the Bond Market!

As time passes and rates remain high debt will have to be refinanced. If the financing rates are too high for the the party needing to pay off the debt, the only recourse is to sell the underlying asset.  Should a Bond Market sell off occur, more assets will be discounted.  New Housing Developments will sell off their inventory and fail to take on new projects in face of high rates.  There will be some buyers in real estate who will take on property in discounted markets, even if rates are high to finance their purchases.

The risk that lies ahead is for the highly leveraged private equity, commercial real estate or lenders as regional banks. This could end up being a slow burn as as delinquencies mount, notice of defaults become more common and with that Foreclosures.