March 16, 2016
- The Fed kept interest rates unchanged for the second time this year
- Financial markets are playing a larger role in policy, but the Fed will not overreact
- Additional rate hikes are still likely in 2016
- Investors are confident in the long-term prospects of U.S. commercial real estate
- No immediate impact on lending rates to commercial real estate is expected, but less volatility should slowly narrow credit spreads
To the surprise of few, the Federal Reserve declined to raise interest rates this week, leaving its target range unchanged at 0.25%-0.50%. This was a widely expected result given the significant market volatility in January and February, and was signaled by the dovish tone of Federal Open Market Committee (FOMC) members in recent speeches.
The changes to forward guidance were dovish, signaling a "lower for longer" rate path. The updated interest rate projections imply that the FOMC now anticipates fewer increases in 2016—it expects two hikes instead of four, a meaningful revision from its December projections. The policy statement also explicitly pointed out risks associated with global economic and financial developments.
Rather than commit to a predetermined timeline, data dependence will dictate how quickly the Fed moves. However, it is becoming more difficult to evaluate that data. The Fed must react to credit spreads, stock prices, yield curves and other financial indicators, but how much weight each variable is assigned is not clear. Further complicating the equation is the divide among FOMC members about the extent to which financial disturbances are impacting the real economy.
Financial markets seem uncertain as well. Ahead of today's announcement, futures markets were pricing more than a 50% chance that the next rate hike would come in June; those odds were virtually 0% just a month ago. Renewed volatility would likely contribute to more gradual rate increases.
The Fed's overall game plan has not changed. The decision to delay a rate hike now is a risk-management play—better to wait and see how the next few months unfold, than to make a costly mistake. Employment continues to make significant gains, including a positive surprise of 242,000 new jobs in February, and inflation is finally making real progress toward the 2% objective—particularly in the services sector and in wages. Hawkish Fed officials are concerned that the U.S. economy may overshoot on inflation—indeed, there was one dissenting vote to raise rates 25 bps in March.
Against this "lower for even longer" backdrop, U.S. commercial real estate remains a favorable long-term investment; the market has proven to be less fickle in sentiment than the broader financial markets. CBRE surveys conducted near the height of market volatility in late January and early February indicated that the vast majority of institutional investors expect to maintain or increase acquisitions in 2016. That said, the prices they are willing to pay may be at an inflection point. The Moody's/RCA Commercial Property Type Index declined in January for the first time since 2010.
Holding rates steady is the Fed's attempt to calm market volatility. Although holding rates will have minimal impact on short-term base rates (LIBOR) or the long-end of the curve, a period of less volatility could compress credit spreads, improving borrowing conditions in commercial real estate.