Where Fed Cuts Really Matter

After two long years, the first Fed rate cut came as collective relief to the market. To borrowers facing upcoming loan term expirations it offered hope of better refinancing terms, and the possibly of holding onto properties with large ballon payments due. To new borrowers looking to get back in the game, it could mean the end of the market’s freeze . But does this intial 50 bps cut really create immediate relief? The piece below from CBRE’s DSF West team dissects the heart of this question.

“How cuts could impact adjustable and fixed interest rates: The Federal Reserve’s interest rate cuts directly influence adjustable-rate mortgages tied to short-term rates like SOFR or Prime. However, fixed interest rates incorporate expectations of future Fed actions, the long-term economic outlook, and inflation forecasts, rather than just the outcomes of the next FOMC meeting. While the Fed’s decisions don’t directly impact fixed rates, which are based on long-term inflation expectations, economic indicators such as consumer spending and employment reports are more likely to affect these medium- to long-term fixed rates than Fed rate cuts.”

The factors oulined in the final sentence couldn’t be more important in today’s post-COVID world.

Inflation was at an all-time high, and appears to be subsiding. Yet no one really knows if the Fed has the issue under control. Historically speaking, putting the inflation genie back in the bottle tends to be a big challenge with flares up common once the original spike has subsided. While consumer spending and employment, the other focal points of the Fed’s economic assessment, appear in good shape, there’s also a few other factors affecting rates on the longer end like ballooning US gov’t debt, unpredictable political / fiscal policy and international buyer’s appetite for new treasury issuance. Which is to say more simply, many market forces contribute to long-term treasury yields.

With the long-end of the curve dictacting 30-year mortgage rates and fixed rate commercial loans, there’s an entire subset of borrowers who may see little to no benefit, at least initially, from the Fed’s early cuts. Banks, however, are the only institutions able to borrower overnight at the Fed Funds rates, so their cost of capital technically falls, which in turn could spur more lending. It’s a head-scratcher trying to understand how it all may play out.

The bigger point is recognizing that Fed Rate cuts, depsite their dominance of headlines, don’t necessarily mean relief to all, especially those hardest hit by rising rates over the last two years.