The Federal Reserve stands at a pivotal juncture as it deliberates on its interest rate policy for 2024. In the wake of tumultuous economic shifts brought about by the pandemic, the Fed faces the delicate task of balancing robust economic recovery against inflationary pressures that appear to be subsiding.
Interest rates were left unchanged at a range of 5.25% to 5.50% by the Fed at its policy meeting ending 13 December 2023. As the markets well know, the Fed indicated that rates are likely at or near their peak and could be cut in 2024 if inflation continues to fall towards the Fed’s 2% target.
Billions if not trillions of dollars are now riding on when, or worst case if, this will happen.
Ryan Severino, chief economist and head of U.S. research at BGO, says the Fed is “done” with rate rises and he doesn’t anticipate another rise unless inflation rebounds but he doesn’t expect an imminent reduction in rates either. “There might be bumps in the road, but my forecast and those of other economists don’t see inflation rebounding. But I don’t think [the Fed] will start cutting rates straight away; they will be more cautious, to make sure inflation is in the rear view mirror,” he says. “My sense is that unless things slow to a greater rate than I anticipate, they would like to hold the line in the first half of next year and see how the economy holds up.”
All this sparks hopes the commercial real estate market may finally move on from its ‘wait and see’ approach that has stymied deal flow throughout much of the past year.
“The Fed has made substantial progress in slowing the rate of inflation, with CPI being only 1% above the Fed’s target. Assuming the Fed continues their pause, investors are preparing to step back into the market as cap rates are expecting to fully top out in 2024, especially when the Fed begins dropping serious hints at lowering rates,” says Spencer Gray, CEO of Gray Capital, a syndicator, owner and operator of multifamily apartments.
Aaron Jodka, director of research, U.S. capital markets, at Colliers, says there is still ambiguity from the Fed but once there is a clearer direction, “a lot of buyers and sellers will come off the sidelines” which will boost volumes in 2024 relative to 2023.
“As the year progresses, we expect to see some interest rate reductions which will be beneficial to the real estate markets. The Fed is leaving the door open about interest rate increases, and while we don’t expect that will be needed, we’re waiting for things to change. Once we see that transition, that will be a really good sign for commercial real estate investment,” he says.
A rate-cutting scenario, even if distant, would unlock even more stunted capital. “There is a note of caution out there, but if things break the right way, this could be a much better cycle for returns than people are anticipating. Two reasons: because people have gone through such an abrupt adjustment over the last 12 months, people are more hesitant to put their hand back in the oven and get burned, but also, looking at the last couple of business cycles, there’s more leeway for the Fed to cut than before the pandemic,” says Severino.
“I don’t think we will see a point where the Fed is compelled to cut the rate to zero because that reflects the world going off the rails again. But if they do cut, that puts wind in the sails of investors and increases the probability that we could get some good outcomes over the next two years.”
Going into 2024, interest rate policy remains contingent upon a multitude of variables, making concrete predictions difficult.
The Fed’s vigilant monitoring of inflation dynamics will heavily influence its policy decisions. While some inflationary pressures were expected during the recovery phase, the persistence of these pressures and their potential impact on long-term price stability remain key concerns. Should the Fed interpret these pressures as persistent, a more aggressive stance on interest rate hikes could be on the horizon.
Employment figures, consumer spending patterns, and business investments will be pivotal in determining the pace and magnitude of interest rate adjustments. A robust labor market recovery coupled with sustained consumer and business confidence might prompt a quicker normalization of interest rates.
Domestic as well as global economic factors may also come into play. The Fed will consider how international events, trade dynamics and geopolitical issues might influence domestic economic conditions and, consequently, the interest rate trajectory.
“The GDP growth/recession story will be the determining factor,” says Jodka. “Wild cards like geopolitical tensions, war and natural disasters, things of that nature that you really cannot predict, that will potentially dictate interest rate movement.”
Some have thrown cold water on the idea that inflation and therefore rate rises are moving into the rear view. In an interview with the Financial Times, former Treasury secretary Larry Summers said: “I think it’s premature to judge that we have landed softly, because if you look at underlying inflation rates, depending upon your measures, some of them are still running well above 2 percent. If inflation is currently at 2 per cent, it’s not clear that it won’t go back up again. And it isn’t clear that the landing has been soft in the sense that there are a variety of problems — declining flows of credit, inverted yield curves, aspects of consumer behavior, rising evidence of credit strains — that raise the possibility that the landing won’t be soft, if there is one. So at this point, we may soft land on the aircraft carrier, but the landing may be hard, and we may overfly.”
As the Fed contemplates its interest rate policy for the coming year, clear communication and forward guidance to financial markets and the public will be paramount. Transparent communication regarding the rationale behind policy decisions and the Fed’s outlook on economic indicators will help manage market expectations and mitigate uncertainty.
“The Fed changing some of their tone would make a big difference in the comfort level of commercial real estate investors,” Jodka says. “There are still challenges to find capital from a debt perspective. A lot of banks are out of the market. We have a lower LTV situation and higher debt coverage ratios, and it’s harder to get leverage as a real estate buyer these days. Despite what the Fed says, there’s still a capital need. Uninvested capital is at a record high, looking for a value add.”
The Fed’s ability to respond adeptly to evolving economic conditions while maintaining stability will play a key role in shaping the course of the US economy and global financial markets. For now, all eyes remain fixed on the Fed, awaiting cues that will influence the path of borrowing costs, economic activity and dealmaking throughout 2024.