As economy strengthens, Federal Reserve poised to raise rates again this year

October 16, 2017 By Paul McCormick – Senior Vice President of Investment Sales and Capital Service, Brett Campbell – Senior Analyst From Ariel Property Advisors
Paul McCormick. Photos courtesy of Ariel Property Advisors
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The U.S. economy was hindered by the havoc caused by hurricanes last month, with the country registering the first monthly job loss in seven years in September. While payrolls declined by 33,000 – marking the end of the longest stretch of job creation on record – the unemployment rate fell, reaching a new 16-year low of 4.2%, and worker’s wages improved.  

The devastating hurricanes distorted the jobs data and their impact on the economy should continue for a while. Nonetheless, the labor market remains a bright spot and there are significant pockets of strength in the economy that should keep the Federal Reserve on track to raise rates for a third time this year in December despite persistently low inflation.

Minutes from the central bank’s September 19-20 policy-setting meeting showed that while most Fed officials are leaning toward raising rates once more this year, they are continuing to debate whether a string of weak inflation readings indicates temporary weakness or a longer-lasting development. However, Fed Chairwoman Janet Yellen recently said in a speech that it would be “imprudent” for the central bank to wait for inflation to return to its goal of 2% before raising rates again.

Echoing New York City’s trend, Brooklyn’s real estate investment sales market continued to languish in the first half, with pricing metrics declining broadly following years of steady appreciation.

During 1H17, New York City’s biggest borough saw 570 transactions consisting of 756 properties, totaling approximately $3.58 billion in gross consideration, according to Ariel Property Advisors’ “Brooklyn 2017 Mid-Year Sales Report.” Compared with 2H16, dollar volume and transaction volume declined 11% and 8%, respectively, while property volume held steady.

Heightened expectations of a Fed rate hike later this year, as well as a slew of government debt auctions, weighed on Treasury bonds in recent weeks. Investors sought assets perceived as risker after a string of sanguine economic reports. The Institute of Supply Management’s monthly indexes of activity in the manufacturing and services sectors climbed to their highest levels in more than 10 years in September, and during the same month automobile sales surged to a 2017 peak.  

Gross domestic product rose 3.1% in the second quarter, sharply above the first quarter’s tepid 1.2% growth and the economy’s average of a little more than 2% a year since the recession ended in mid-2009. Forecasters expect between 2% and 3% growth in the third quarter and stronger output in the fourth quarter. Nevertheless, pockets of weakness persist in the U.S. economy, with retail sales a notable soft spot, and the housing market’s strength has shown signs of slowing.     

In a rare development, the U.S. is in sync with other major economies. In its recently released flagship report, the International Monetary Fund said the world economy’s acceleration this year has been more robust than earlier estimates. The IMF raised its forecast for growth to 3.6% this year and 3.7% next year, markedly above 2016’s growth of 3.2%.

Treasury Yields Trek Higher

Using a 6-month trailing average, Brooklyn capitalization rates are relatively attractive, standing at 4.59% in July, above Manhattan and Queens, which had cap rates of 3.65% and 4.44% respectively. In pursuit of higher yields, investors, both private and institutional, remain enthusiastic about Brooklyn.

The yield on the 10-year Treasury note has climbed since the Fed’s last policy-setting meeting, but remains below a two-year peak of 2.61% reached in March and 2.45% at the end of last year. Treasury bonds have mostly gained in 2017, indicating ongoing demand for assets perceived as safe havens amid geopolitical tensions and reduced expectations of a large fiscal stimulus package from the Trump administration that would bolster the economy.

As the Fed starts unwinding its $4.5 trillion portfolio of Treasury securities and mortgage bonds, Treasuries may come under pressure. This move should put upward pressure on rates and eventually lead to higher borrowing costs on consumer and business loans.

President Donald Trump is reportedly close to making a decision on whom to choose to lead the Federal Reserve. Fed Chairwoman Janet Yellen, whose four-year term expires in early February, is among the candidates the president is considering. Treasuries could weaken in price if the president selects someone more hawkish about rates.

For most of the past decade, historically low interest rates fostered ferocious demand for Brooklyn’s real estate, which sent prices substantially higher. Therefore, a move higher in rates in many ways is a positive development in that it should “normalize” market conditions, with sellers possibly inclined to lower prices to attract buyers who are more capital-constrained.

Even when the Fed chooses to tighten monetary policy further, interest rates should remain alluring because a host of lenders in Brooklyn, both traditional and alternative, are aggressively competing for business. Overall, the normalization of Fed monetary policy indicates an economy that is on solid footing, and therefore we expect capital markets activity in New York City’s biggest borough to remain vibrant, allowing investors easy accessibility to attractive and reliable financing.

 


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