Trade Wars Put Downward Pressure on Interest Rates

ATLANTA–“An accommodative stance.” That’s how Marcus & Millichap describes the Federal Reserve’s approach to interest rates as trade wars continue to wage and “weigh on the economy.”

In its latest Financial Markets Research Brief, the firm explains that, given weaker inflation and slowing economic indicators—along with ever-escalating global trade tensions—“the Fed reinforced its willingness to cut rates and even let inflation rise above the two percent level going forward, a notable shift in its historical policy framework designed to increase future flexibility.”

The Fed’s decision to ease rates, of course, bodes well for the continuation of the economic upcycle, as David G. Shillington, president of Marcus & Millichap Capital Corp., explains: “Given that core inflation remains very low, it’s believed that the economic stimulus created by a rate cut could extend the duration of our current expansion and do so without the risk of creating undue inflationary pressure.”

But it’s nothing the market hasn’t seen before. In fact, as the brief explains, “Rate cuts during an ongoing expansion would echo similar steps taken during the mid-1990s, when Fed officials responded to softening data by trimming rates three times.”

And as the Fed goes, so goes Wall Street. “It appears that Wall Street has reacted to the more dovish position of the Federal Reserve as it relates to interest rates,” says Shillington.

And already, the impact is apparently being felt, reflected in stock prices that, says, the MMCC president, “have already benefited from investors seeing the potential for lower capital costs in the coming months.”

Taking the discussion to its logical conclusion, the ripple effect for borrowers is also clear. “Those investors with existing, floating-rate debt will see an immediate reduction in their interest costs and an improvement in their cash flow,” says Shillington. “These lower rates should also create a stimulus to transactional sales volume as the buyers of real estate properties will benefit from lower interest costs.”

With the 10-Year Treasury hovering around the two-percent region, the brief sees primary markets as the principle beneficiaries. The reasoning there is that lower interest rates will boost market liquidity, “as many economic metrics, including low unemployment and stable wage growth, still favor additional acquisitions,” it explains.

“The spread between US Treasuries and cap rates narrowed significantly as long-term rates continued to rise throughout last year,” Shillington adds. “This spread reached a low point in October of 2018, when the 10-year hit 3.25 percent. This phenomenon was particularly true in primary markets and in the multifamily industry, where cap rates tend to be the lowest.

“If rates had continued their upward trend,” he continues, “cap rates would have eventually risen, resulting in a deterioration in real estate values. Now that long-term rates have dropped back to around two percent, the gap between Treasury and cap rates has widened again. This suggests a more stable period for real estate valuations.”

But, in a sense, all bets–or many, at any rate–will be off if the trade wars escalate. Shillington sees a real risk to the economy at large. “As prices for imported goods rise, so do production costs, which are often passed on to consumers,” he says. “These higher prices could negatively impact demand, and sales could slow. The ripple effect of lower consumption could mean a slowdown in economic activity.”

Taking that scenario to the extreme, retaliation and tariffs placed on US goods would impact employment and GDP growth. “The impact of slowing job growth due to lower domestic consumption, reduced manufacturing or reduced exports would most certainly impact the real estate industry that relies on job growth and wage inflation to drive occupancies and rents.”

Of course, that’s in the extreme. For now, the real estate market can ride the wave of the Fed’s “accommodative stance.” But, as the research brief suggests, vigilance is called for: “The impact of previously announced tariffs on consumer goods in the coming months should be closely monitored for risks of slowing consumption and economic growth.”