Tag: banks

Market Commentary 7/7/2023

Posted on by Damon Germanides

Yields Rise As Strong Wages All But Ensure Fed Rate Hike

The ADP report this Thursday marked a significant week for the bond market, as both Treasury and Mortgage rates exhibited a notable increase. Fortunately, Friday’s employment report met expectations, easing some pressure on bonds. The probability of the Fed raising rates later this month is now nearly 100%, with elevated wage inflation and the strong job market. In addition, bond traders are realizing that interest rates will remain high for an extended period, due to persistent global inflation and forecasts of potential interest rate hikes in other countries (like the UK).

Some argue for the Fed to exercise patience and assess the long-term effects of their rate hikes on the US consumer and the economy. Despite this pushback, there are signs that the rate increases are making an impact. Banks are becoming more cautious with their underwriting box, consumers are exercising caution in their purchases, manufacturing data is declining, and credit card balances are rising as stimulus funds dwindle. One might wonder where we would be if the AI investment theme didn’t re-ignite animal spirits. Additionally, large apartment investment firms are facing challenges as floating rate debt reaches a tipping point, where monthly interest expenses exceed property cash flow. The pain of higher interest rates is gradually spreading beyond the office sector to other real estate asset classes.

An illustrative example demonstrates the risks of buying at very low cap rates:

  • 2021 Investment Environment Net Operating Income: $100,000 Cap Rate: 3.75% Value: $2,667,666
  • 2023 Investment Environment Net Operating Income: $100,000 Cap Rate: 5.75% Value: $1,739,130

This example equates to a loss of almost 35% on the property due to the movement in cap rates. While we don’t anticipate a systemic crisis in commercial real estate, buyers who relied on aggressive assumptions and maximum leverage may face difficulties ahead.

Rate Hikes & Real Estate: What’s Next?

Higher interest rates are influencing the existing housing market, resulting in continually elevated home prices, despite interest rates returning to 7%. This situation may limit what potential buyers can afford. Furthermore, the potential for an increase in housing supply seems plausible if equity markets reverse course in response to ongoing Fed rate hikes. Sellers may choose to sell their homes while existing home market inventory remains tight, rather than waiting for a recession or other negative events. Notably, the Southern California superluxury market is experiencing a swell in inventory as ultra-wealthy individuals are less inclined to expand their home portfolios. It will be intriguing to observe what factors will entice these buyers back into the market. Only time will reveal the answer.

Market Commentary 4/28/2023

Posted on by Damon Germanides

Economy Resilient As Fed Week Approaches 

The Fed’s preferred inflation gauge came in as expected. Inflation remains high despite showing signs of moderating, with the Fed planning to raise rates next week (on top of rumors of an additional hike in June). The rationale behind higher short-term interest rates is the economy is performing better than anticipated. Q1 earnings met the projected results, with consumer sentiment and PMI data being positive. Some parts of the country are even experiencing bidding wars on home sales. 

There are signs that indicate the next few months could be challenging. GDP growth is anemic. Some CEOs, including Amazon’s CEO, have spoken about slowing business spending in preparation for a downturn. The rally in the market has been led by a few large companies, as commercial real estate valuations remain uncertain and in decline, which could be problematic for banks. Overall, bank lending standards continue to tighten, creating opportunities for lenders with more expensive terms and rates. 

Supply & Demand, Homeowners & Mortgage Rates 

Housing supply remains a challenge, particularly in cities like Los Angeles. A decade of low rates allowed borrowers to secure manageable mortgage payments. Now that interest rates have doubled, homeowners may be deterred from wanting to sell because of the high mortgage rates relative to recent years, causing a strain on supply and putting a floor on housing values. The possibility of a recession could affect all asset classes at some point, but for now, home buyers must accept higher mortgage payments and prices. 

Next week will be critical, with the FOMC meeting and conference call on Wednesday, followed by the April Jobs Report on Friday. These events could significantly impact the equity and bond markets. 

Market Commentary 7/22/2022

Posted on by Damon Germanides

Treasury Rates Decline As Corporate Earnings Disappoint

Inflation continues to deplete consumer spending power. This trend aligns with some very interesting reports from AT&T on the increase in late payments and rising defaults on smartphones. Since many of us can’t live without our smartphones for work or social interaction, failure to pay smartphone bills is concerning. It also suggests the economy may be worse off than many economists believed. Credit balances rise along with other loan types like non-performing auto loans and BNPL (buy now and pay later). The massive stimulus that was pumped into the market appears to have left the economy to work towards normalization while also battling high inflation and slowing growth. Many layoffs in the banking business are being announced. I expect unemployment to rise in the coming months as companies expand layoffs and banks pull back on lending. The recession is here, in my opinion. The big unknown is the Fed’s strategy to combat persistent inflation in a slowing economy. 

The Fed’s Big Squeeze

The haste with which the Fed has risen and may continue to raise short-term interest rates is squeezing all but the biggest banks. This squeeze is distressing for housing as banks pull back on LTVs, Cash-Out Refinances, and Investment Property Loans. Prices will need to adjust to the combination of higher interest rates and tighter bank guidelines. Mortgage banks that have filled the void on the more niche product offerings are also being affected. The one silver lining in all of this? There is a dramatic increase in housing inventory from very low levels of supply. There are many prospective buyers who have been waiting to buy for quite some time. Their time may be here in the upcoming months.

The ECB raised rates and now short-term interest rates are no longer zero. Personally, I never understand negative interest rates. As an observer, why would you lend money to get less of a return in the future?  As we witness this all in real-time, the winding down of easy money policies and as central banks experiment with negative interest rates, remember the old saying “it doesn’t make sense.”  Should inflation persist and the recession be deeper and longer than forecasted, central bankers in the developed world should remember the damage easy money policies have historically resulted in. While we all loved zero rates (or near zero or negative in some countries), the use of these policies is so destructive that it would be wiser to shelve them for future generations. Basic finance requires a discount rate to calculate risk properly. Ultra-low interest rates increase wealth and risk-taking, while rates remain low. The flip side is what happens when rates rise and inflation becomes unanchored, as we are experiencing today. Wealth is destroyed, confidence is eroded, and the most fragile in our society suffer through the high prices of basic necessities. Free money and zero interest rates have consequences.