Powell Has Spoken: Here We Go With Interest Rate Hikes, Stock Market Volatility

It didn’t take long for Wall Street to hear word from the Federal Reserve’s meeting in Jackson Hole, Wyoming. And major indexes all dropped multiple percentage points by end of day.

“Restoring price stability will take some time and requires using our tools forcefully to bring demand and supply into better balance,” said Fed chair Jerome Powell Friday morning. “Reducing inflation is likely to require a sustained period of below-trend growth. Moreover, there will very likely be some softening of labor market conditions. While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”

“Powell telegraphed that the September rate hike could be in the 75-basis point range, and that the Fed will continue tightening until they are convinced the price stability is in range,” said Quincy Krosby, chief global strategist at LPL Financial, in a statement.

So, people in CRE, if they didn’t believe what they Fed had been saying or hoped that somehow things were going to get better sooner, need to reconcile themselves with the likelihood of even higher financing costs.

However, there may be something for the industry to take out of likely developments.

“Given that Powell and the Fed continue to say that they are taking inflation seriously, and effectively that they will do whatever it takes to bring inflation back down to previous levels, the stock market is pretty convincingly saying that it doesn’t believe them,” noted Chris Zaccarelli, chief investment officer for Independent Advisor Alliance in an emailed statement. “If the Fed is going to raise interest rates until the US enters recession, then the stock market needs to be down 20-30% from its prior peak, as that is the minimum that markets drop, on average, for an NBER [National Board of Economic Research]-determined recession.” And the major drops on Friday still weren’t close to that.

Either stocks will continue to trade “in defiance of what the Fed is trying to tell it,” as Zaccarelli put it, or there will be far greater stock value slides coming. That could be perversely good news for CRE. There are many who will hold their stocks because that’s likely the sensible thing to do. If the cash isn’t needed today, don’t sell because eventually shares will be back up again.

But there will be many investors who either panic or think there’s more profit to be made in other asset classes, like commercial real estate. That could cause an additional flood of capital into the sector, pushing prices higher, and cap rates even lower. The danger will be that the decisions are based on the anticipations of higher rents protecting investment value. But can they keep going higher? Given the state of the economy and race up that residential and commercial rents saw in recent times, that may be more optimistic than realistic.