Fed Chair Powell, in his semi-annual testimony to Congress earlier this week, reiterated the Fed’s hawkish theme that the Fed will likely need to push rates even higher to address the inflation threat. The FOMC, at its meeting last week, released its updated dot plot showing that the median forecast among FOMC members is for a further +50 bp hike in the federal funds to 5.6% from the current effective rate of 5.07%.
The Fed has already raised its federal funds rate target by a total of 5 percentage points (500 basis points) to the current range of 5.00%/5.25% from the 0.00%/0.25% range that prevailed during the pandemic. The +500 bp rate hike seen thus far in the space of just 15 months is more than twice as large as the overall +225 bp rate hike seen in 2015/2018.
In fact, the Fed’s current +500 bp rate hike is the largest since the Fed Chair Volcker drove the federal funds up to 20% in 1980 and again in 1981 to combat runaway inflation. The CPI peaked at +14.8% in March 1980 and then started falling in response to the Fed’s draconian interest rate hike.
The FOMC, at its meeting last week, finally decided to take a time-out after ten straight rate hikes to gauge the lagged fall-out from its rate-hike regime. The Fed, in its recent comments, has stressed that monetary policy acts with long and variable lags, which means that the Fed and the markets have yet to see all the fall-out from the Fed’s sharp rate hike.
There is the distinct possibility that more banks and financial institutions will fall into insolvency in the coming months, not only from portfolio losses on their Treasury securities but also from bad loans to troubled borrowers, particularly in the commercial real estate sector.
Real estate data provider Trepp says that more than $1.4 trillion of U.S. commercial real estate loans will mature by 2027 and that $270 billion of those loans will come due this year. Citigroup reports that banks hold 54% of the overall $5.7 trillion commercial estate loans, and that small lenders hold 70% of those loans.
There are many commercial real estate owners who will be unable to refinance their loans due to high interest rates and high vacancy rates. Those building owners would then default on their loans and turn their keys over to the bank, putting a big hole in bank balance sheets that could spark new bank runs.
MSCI Real Assets reports that troubled assets in the commercial real estate sector climbed to $64 billion in Q1-2023, and that $155 billion of commercial property assets are potentially troubled. The report found that $23 billion of distressed assets involved retail malls, while $18 billion involved office buildings.
Fall-out from the Fed’s rate hikes has yet to fully hit the U.S. economy as a whole. There is a 65% chance of a U.S. recession, according to the median forecast by economists polled by Bloomberg. The consensus among economists is for U.S. GDP growth of unchanged in Q3 and a -0.4% decline in Q4, according to a Bloomberg monthly survey released today. That would just narrowly avoid the short-hand definition of a recession of back-to-back quarters of negative growth.
U.S. GDP growth is then expected to turn positive again in Q1-2024 but show a paltry annual growth rate of only +0.7% in 2024 after the expected weak overall pace of +1.2% in 2023.
On the date of publication, Rich Asplund did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
