June 15, 2016
- The Federal Reserve held interest rates unchanged for a fourth consecutive meeting.
- The result was no surprise; absent the poor May jobs report, it would have been a close call.
- Risk of persistently low inflation adds to cautious policy stance.
- The Fed noted several positive economic indicators including growth in household spending, the housing sector and reduced drag from net exports.
- “Lower for longer” monetary policy raises the appeal of U.S. commercial real estate investment.
The Federal Reserve left the target federal funds rate unchanged at 0.25-0.50% for a fourth consecutive meeting. Suspense surrounding a possible June rate hike vanished after a dismal May jobs report revealed that the U.S. economy added just 38,000 jobs. The economy has consistently underperformed Fed expectations this year, forestalling the board’s original plan to raise rates three or four times in 2016.
Earlier this year, it was global economic and financial market concerns that kept the Fed from moving; now the fear is that the U.S. economy’s slower job growth and low inflation are a direct consequence of the earlier macro worries. The result is a more cautious policy stance than many had predicted several months ago. If the employment data continue to show significant weakness, it is conceivable that we may not see additional rate hikes this year. However, the Fed is being careful not to overreact to a single month of poor job numbers, and most FOMC officials still anticipate two rate hikes in 2016. Janet Yellen and her colleagues have been overly optimistic recently about the U.S. economy, which is why financial markets are discounting that forecast.
Identifying where we are in the economic cycle is more important than determining the timing of the next rate hike. If we are at the end of the cycle, there should be no further rate hikes. That is not likely the case, however. Consumers—by far the largest sector of the economy—are in good shape. Hiring, income and housing gains, though not spectacular, are solid. Consumer confidence remains near its high-water mark, and spending is healthy. There is more to like than to dislike in the economic data.
The decline in inflation expectations may be more worrisome for the Fed than the May jobs report. The global economy has seen a downshift in inflation and interest rates, which, if it persists, can be a tricky situation for central banks to manage. The Fed will continue to favor inflation over deflation. This means a “lower for longer” trajectory for interest rates.
U.S. commercial real estate remains a favorable long-term investment, especially in the world of ultra-low interest rates. As investors seek the sweet spot of high yields and low risk, the Fed’s “lower for longer” policy should stimulate capital flows into these assets. Nonetheless, the Moody’s/RCA Commercial Property Type Index declined during the first quarter, and the historically low cost of long-term Treasuries indicates that investor sentiment remains uncertain. The real estate investment cycle as a whole likely has a few more years of growth, but risks and opportunities will become more nuanced.