Additional Fed Hike by Year End Suggested by High CPI Readings
Bonds continue their upward trajectory in response to the latest CPI and PPI inflation readings. As we’ve often pointed out, the path from 3% to 2% inflation presents many challenges. Both the Federal Reserve and the average American consumer face escalating home prices, rising food costs, and surging energy expenses.
While financial experts may attempt to interpret inflation reports in various ways, we believe it’s crucial to focus on food and energy costs. These commodities, although volatile, are indispensable elements of our modern world. Therefore, the persistent high costs of food and energy, coupled with ongoing wage inflation, are likely to keep the Federal Reserve from implementing any interest rate hikes in the upcoming week. Our expectation is that they will project an additional rate hike in November. Furthermore, it’s prudent not to anticipate any rate cuts from the Fed until at least the end of next year.
In the broader real estate market, office spaces continue to face problems. Nevertheless, there is a growing trend of companies reintroducing return-to-office requirements for employees. This shift could establish a floor for declining office values. In certain cities, office property values have plummeted by over 50%. What was once deemed a prime asset class is undergoing a transformation. Newer, amenity-rich office spaces may thrive, while older, cash-cow office buildings owned by generational landlords might ultimately be more valuable as land than as operational structures. However, there is emerging concern about the multifamily real estate sector, as a substantial amount of multifamily CMBS debt is set to mature in 2024 and 2025. In contrast, the single-family homes market remains largely unaffected by rising interest rates. This is primarily because many potential sellers are holding onto mortgages with rates below 5%. Such favorable rates are discouraging homeowners from listing their properties for sale.
Our attention is now focused on the 10-year Treasury yield, which recently closed just below 4.35%. Should it breach this level, yields will likely surge past 4.5%. There is currently little evidence to suggest that interest rates will move lower. It’s worth noting that interest rate cycles tend to be lengthy, a point emphasized by the renowned bond investor Bill Gross, often referred to as the “Bond King.” Gross once underscored the significance of the 30-year bull market in bonds, where declining rates are considered bullish in bond markets, as one of the defining features of his career.