Many experts have been more bullish in their approach to increases to the Federal Funds rate in 2018, forecasting a total of four rate hikes for the year. And after the administration passed tax reform at the end of last year, experts again forecasted an increase in the Federal Funds rate, saying it could cause the Fed to actually speed up rate hikes.
Today however, Fed Funds futures are forecasting the chances of four rate hikes in 2018 at 37%, down from the previous 40%.
This decrease in confidence for four rate hikes is due to minutes from the Federal Open Markets Committee’s May meeting which revealed a more dovish approach to raising rates. The minutes showed that while the Fed still holds that the economy warrants gradual increases to the Federal Funds rate, in several Districts, contacts expressed concern about the possible adverse effects of tariffs and trade restrictions, including the potential for postponing or pulling back on capital spending.
Now, that probability remains effectively unchanged as most still expect to see a rate hike next month (June). Traders in the Federal Funds futures market currently see more than a 90% chance of a June rate hike.
The spread between the 5-year and the 10-year Treasuries is the tightest it has been since the summer of 2007, resulting in all-in commercial real estate borrowing costs that are nearly indistinguishable at different terms. A year ago the spread was about 50 basis points – today that spread is around 15 bps. The result has been borrowers opting for longer-term money because there is no real savings benefit to taking out a five-year loan, regardless of the deal at hand. For shorter-term deals, if in five to seven years the borrower chooses to sell the property he’ll still have three to five years remaining on the loan term. The advantage/disadvantage of the original loan depends on where interest rates are at the time of sale. There could be a substantial cost or impairment to the value of the real estate because of the remaining liability of the loan.
This is all made possible due to a flattening of the yield curve. Aside from the economic implications of a flat or inverted yield curve, the market (bond) is going against the Fed. While the Fed has raised the short end, the market has failed to fall in step by bidding up the long end. The back room dialog says that the Fed is raising rates too high too fast, and will chock off growth in GDP forcing an economic slowdown/recession, which in turn will force the Fed to then reduce rates to bail the boat.
Who’s right, the market or the Fed? We don’t know, but history gives the nod to the market.
For our part, give us your exit strategy and your opinion on the matter, and we’ll get you a loan reflective of your plans and outlook.
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Michael Green is a Commercial Loan Originator for the Counsel Mortgage Group®, LLC.
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