Interest Rate Market Perspective – January 2016
January 14, 2016
In the middle of December 2015, the Federal Reserve raised the Fed Funds rate by a quarter of a point (0.25%), the first Fed Funds rate increase in almost a decade. While only a modest increase, it represents the end of a period of an extraordinary “easy money” policy. The Fed Funds rate had been targeted at 0% since December 2008 (originally reduced as part of the emergency stimulus to the financial crisis).
“The economic recovery has clearly come a long way, though it is not yet complete…. with the economy performing well and expected to continue to do so, the Committee judged that a modest increase in the federal funds rate target is now appropriate, recognizing that even after this increase monetary policy remains accommodative.” Fed Chair Janet Yellen after the FOMC Meeting 12/16/15
As discussed in an article on the Fed Funds Rate Lift-Off (Interest Rate Market Perspective, June 2015), the Fed Funds rate is an overnight interest rate for financial institutions — the rate at which banks lend money to other banks. As such, a Fed Funds rate increase directly affects interest on adjustable rate mortgage loans (ARM loans) and other debt that’s based on short term rates like LIBOR (such as bridge loans, repos and margin loan).
An increase in the Fed Funds Rate doesn’t directly impact longer term bond and mortgage rates. Treasury bond yields and long term mortgage rates fluctuate depending on the expectations for inflation which is, in turn, influenced by the health of the economy. Indirectly, Fed policy and its opinion influences inflation expectations and long term bond and mortgage rates.
Coming out of this last meeting, the Fed indicated that its expected target Fed Funds rate will be about 1.375% by year-end 2016 – four (4) 0.25% increases during 2016. The Fed is projecting the Fed Funds at 2.40% by the end of 2017 and 3.50% by year-end 2018. The Fed also indicated that interest rate policy “remains accommodative” and they expect the economy to warrant “only gradual increases” over the next few years. With inflation at about 1.20%, it’s still well below the Fed’s target of 2%.
With its words and action, it seems that the Fed has maneuvered through lift-off of the Fed Funds rate without much concern. In response, the bond market is basically unchanged. 10-year Treasuries were trading at 2.27% as of the close of business on 12/15/15 before the Fed announcement. Since then, the 10-year Treasury has traded between 2.09% and 2.30%.
Looking forward, there is a good argument that interest rates will remain low and the Federal Reserve’s ability to raise the Fed Funds rate aggressively is limited in 2016. The capital markets continue to grapple with:
– Uncertainty of the global economy (weakness in the economies of China and other developing countries);
– Sustained low crude oil and commodity prices and its impact on the creditworthiness of high yield bonds (for corporations and countries dependent on oil and commodity production).
Further, with aggressive Fed Funds rate increases, there is concern that the US dollar value may get too strong, exacerbating the economic problems for oil/commodity exporting countries and making US exports less competitive.
To the extent project owners and borrowers are looking to stay ahead of any rise in long term interest rates, I would keep an eye on fundamentals that have the potential to reignite inflation. Another way of saying it, “Watch what the Fed watches.” The Fed (and the bond market traders and investors) key-in on the economic data released almost every day. The economic data includes the unemployment rate and non-farm payroll report (published the 1st Friday of every month for the previous month), US GDP, PPI and CPI inflation, economic reports from Europe and Asia, just to name a few. Understanding that the interest rate markets have benefited from sustained low crude oil and commodity prices, if this trend would reverse, it will get reflected in higher interest rates.
Greystone’s core business is lending for project acquisition and refinance with loans backed by US Agencies (Fannie Mae DUS and Freddie Mac), CMBS conduit loans and FHA insured loans. With existing FHA loans, where the objective is strictly to lower the interest rate, a HUD IRR (IRR) Loan Modification allows borrowers to reduce their interest rate with little cost, limited documentation and a shorter approval period (2 months or so). For qualified borrowers, Greystone can “early rate lock” the interest rate on your new loan up front, as early as application – eliminating the interest rate risk during the underwriting approval period.