What to Make of the Federal Reserve Rate Cuts

The federal reserve cut rates by a quarter percent at their recent meeting.  This is the first cut since 2008.  A rate cut now is a bit peculiar as the economy is doing quite well with inflation low, unemployment at record lows and the stock market at record highs.  So, why did the federal reserve decide to cut now?  Does this put a ‘floor’ under real estate?  What does the recent rate cut mean for mortgage rates?

Why did the Federal Reserve Lower Rates?

The federal reserve sees that the economic train is starting to slow. 

“In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the committee decided to lower” rates, according to Jerome Powell, head of the federal reserve, in a statement following a two-day meeting in Washington.

It was also noted that “uncertainties” about the economic outlook remain.  The recent cut was meant as an “insurance policy” to ward off a sudden derailment of the economic train.  As mentioned in the quote by Powell, there are considerable uncertainties on the future of the economy as tax cuts wear off, manufacturing slows and trade disagreements drag on.

What Does This Mean for Mortgage Rates?

With the recent rate cuts, mortgage rates will continue to stay near historic lows.  The recent cut was fully factored into 10-year treasuries (most mortgage rates are pegged to the 10-year treasury) and therefore little movement occurred immediately after the meeting.  With the first rate cut of this cycle from the federal reserve, rates will continue to remain at historic lows and likely will fall further as we move into the next economic cycle.  This should help keep demand from falling off a cliff as relative buying power is increased due to the ultra-low rates.

Does the Recent Federal Reserve Move Put a ‘Floor’ Under Real Estate?

The federal reserve made a statement about rates with its recent move.  Although the pace of rate decreases is debatable, the federal reserve made it clear that rates will not be going up anytime soon.  The prior run of tightening is done, and the only way forward on rates from here is down as the easing cycle has begun. 

Why is the statement made so important for real estate?  Currently investors looking for “safe” long-term returns have first focused on treasuries and subsequently other asset classes like municipal bonds.  With the recent easing of monetary policy, treasuries and bonds will have continually low returns (yields).

For example, the 10-year treasury is returning around 2% now, and it is forecasted to go down further.  Investors are clamoring for safe returns on their money.  The second safest asset class is real estate.  As investors chase higher yields, high quality real estate is the next best thing to treasuries.  For example, you could buy a building with a company like Home Depot as a tenant and yield 5% to 6% return on your money.  The return is triple the rate of the 10-year U.S. treasury.  Although real estate is not “risk free” like the 10-year treasury it is considerably less risky than other asset classes.

With yields continuing at historic lows and demand for higher yielding assets growing this should put a floor under real estate. The ultra-low rate environment that we are in should create ample demand to protect real estate from a large movement to the downside.  For example, in this next cycle if there are large numbers of foreclosures, there should be more than ample investment dollars to buy these properties in order to get a higher rate of return than US treasuries or other government bonds.    This will greatly limit how far real estate will fall in the next cycle.

Summary

The recent move by the federal reserve will solidify that the ultra-low rate environment we are in will stick around for quite some time.  As a result, demand for increased yield on relatively safe investments like real estate will only grow.  This demand will create a floor under real estate to limit the downside risk.  Don’t get me wrong, this demand for yield will not eliminate risk in real estate but it will prevent a repeat of the 2008 real estate market collapse.