Bold Prediction: The Fed WILL Do a 25+ BPS Cut... But RE Borrowing Rates Will Rise

[Scott Trench]

Ready for some nerdery? 

I believe that the Federal Reserve is going to cut rates by 25-50 bps at it's September meeting (no emergency cut), but that 30-year fixed rate mortgage rates will rise to upper 6s low 7s around the same time, and Commercial borrowing rates, including for multifamily, will increase as well. 

Here's the bet: 

- "Unemployment" is not about to shoot up. This is important, because the only way the Fed gets aggressive about rate cuts is in the face of skyrocketing unemployment. Immediately after the weak jobs report, we saw unemployment applications come in way below projections.

The economic pain people and businesses are facing in 2024 is real. But, unemployment, as measured by the US Census is unlikely to explode. Why? Two Reasons: First, because 50M people in this country either work gig jobs or are illegal immigrants, when they lose their jobs or have their hours scaled back, it doesn't show up on official unemployment stats. Second, when Boomers lose their jobs, they often simply retire, and they are an enormous generation. 

 - Core Inflationary pressures remain high. A rate cut in September is more symbolic and a signal to markets that the Fed is cautiously optimistic that they've tamed inflation than actual dovish Fed Policy. We have 10,000 boomers leaving the workforce each day, and this will continue for years. There are not enough Gen Z-ers to replace them, and that puts pressure on (legal citizens) wages, partially offset by immigration. Oil prices remain a huge X factor, and housing prices (at least with respect to rents) are being held back by the most supply EVER being built and coming online here in 2024. Supply won't abate until at least middle of 2025, but when it does, inflationary pressure on rents will be very high indeed, especially if I'm right and rates stay high.

- The Yield Curve will begin to normalize (uninverting): Even as the Federal Funds Rate begins to drop, the yield curve will finally begin it's march towards normalization. Even if the Fed lowers rates by a full 100 bps over the next 12 months, to 4.25%, the 10-year, in a normalized environment, should be at 5.5% (+125bps over the FFR). While it won't get all the way to 5.5%, it will creep towards 5%, and occasionally tick past it, with high volatility. Yield curve has been inverted for nearly 2 years now. It won't stay that way forever, so enjoy it while it lasts...  

- US Treasuries, with each passing year, are "less safe", putting upward pressure on yields: Regardless of the election outcome, neither party is about to solve the budget deficit. US Treasuries will not see their credit rating improve, and will, within the next 12-24 months get another (small) downgrade, inching up treasury yields. We aren't in "US is going to default and is an inherent credit risk" at 6X national debt to tax revenue ratio, but we are getting close to "let's be wary" territory for creditors. Imagine a $185K income earner ($100K after tax) having a $600K mortgage. Not crazy, but if that mortgage becomes $650K, $700K, $800K, you begin to feel a little apprehensive and need more interest in return for incrementally higher risk. 

So, even as the Fed lowers the Federal Funds rate, and as we see the spread between the 10-year treasury yield and the 30 year mortgage rate shrink, upward pressure on the 10-year from longer-term foundational pressures will see mortgage rates tick up or or at least hold steady.

While this is neutral/slightly negative news for home buyers, it is very bad news indeed for our friends in the commercial real estate world, who are really seeing the best case scenario for the 10-year right now. I think this is your moment, friends in the multifamily space, and that if you let it pass, you might not get better terms.

It can, and, I believe, will, get WAY worse for borrowers in the multifamily and CRE spaces.

[Chris Seveney]

Quote from @Dustin Tucker:

I'm going to go out on a limb, and say the dumb money keeps buying treasuries like they are going out of style, which continues to push the rate lower.  The fed's cut will be too late and they will be playing catch up, as defaults and Job Layoffs continue to mount.  Additionally, we will see the unemployment rate tick up another .5%, to 4.9+ maybe even over 5%.  

 I do not disagree. I think one thing people need to understand is in the US the ten-year treasury is competing against the mortgage-backed securities and while the ten-year is impacted by interest rates, its not the only factor and amount of spending we do also impacts it.

they auctioned off 30-year today and it went really bad as no one wants our long-term debt and it sold for 4.3%

10-year notes recently traded for 3.96% but again very weak demand - which I believe means yield prices may continue to move up, which means interest rates are not going down dramatically anytime soon - so that fed 25 or 50bps drop is not going to have your mortgage lender dropping rates suddenly the next day...

Now the spread between the 10 yr and 30yr mortgages historically is closer to 1.75 but recently has been between 2-3% due to yield curve. So that is one area where there could be some movement, but again, if people are thinking they are going to see a 4 in the interest rates anytime soon, I do not see it. I do not think we will even see a 5 within the next 12 months and if we do, then that is because of some pretty harsh economic data and that $500k home is now back to $400k.**

**I am not a financial advisor or guru, I was just a dumb civil engineer who learned that you cannot push on a rope and dirt and water  = mud.