The Fed’s Delicate Interest Rate Balancing Act

The Federal Reserve and interest rates are the key forces driving the commercial real estate sector at the moment as the market waits for what appears to be an impending rate reduction.

“I hope they get on with it so we can put this chapter behind us and move on to other significant trends affecting commercial real estate,” John Chang, SVP of research services at Marcus & Millichap’s, said in a research video.

But the Fed has a delicate balancing act to perform when deciding how to adjust rates, he noted. It has to keep inflation under control but also keep people employed – essentially maintaining the economy in the ‘Goldilocks Zone,’ meaning don’t let it get too cold or overheated. Chang said the Fed may be fearful of making the wrong decision, which could result in waiting too long and ultimately oversteering interest rates.

In the years following the Global Financial Crisis, the Fed was very cautious about raising interest rates. When the pandemic hit, the Fed was decisive about dropping interest rates to zero and funneling stimulus into the economy. When inflation started to surge in 2021, the Fed was once again very slow to take action, recounted Chang.

“The Fed didn’t start to raise rates until March of 2022 and by then, they missed their window and they had to hit the brakes really hard,” said Chang. “Now it looks like inflation is making steady headway toward the Fed’s 2% goal, but rather than initiating small, measured steps, the Fed has once again held back.”

Meanwhile, other indicators are leaning toward a possible recession, including flat retail sales and modest contraction in both the ISM manufacturing and nonmanufacturing indices. Consumer sentiment is trending down and the unemployment rate is drifting higher.

“I fear the Fed will once again miss the opportunity to take measured steps, and instead they’ll get caught behind the eight ball and have to oversteer the economy by making big rate cuts in the face of a sputtering economy,” said Chang.

Rather than several rate cuts this year, he said he expects one rate cut in September and possibly another by the end of the year depending on unemployment. If unemployment starts to increase rapidly, the Fed may have to oversteer with a 50 basis point reduction. However, Chang said CRE investors should be encouraged that the inflation cycle is playing out.

“It looks like a soft landing is still in play,” he said.