The Fed Increased Interest Rates; Don’t Panic.

Business people

The Federal Reserve decided to raise its benchmark rate to a range of 1.75 to 2 percent recently, the second rate hike this year and the 8th since 2015. The Federal Open Market Committee also signaled they expect to have four total increases this year, a departure from their March projection of three. There is some disagreement over the number of rate hikes for 2018, with 9 of the 16 FOMC participants expecting the rate to increase by 50 basis points or more. The remaining 7 estimated one or no more increases.

The acceleration of the FOMC’s policy from its original forward guidance was expected by many Fed watchers as the U.S. labor market continues to strengthen. While inflation is still running below the 2 percent target rate, the unemployment rate is well below what many economists consider the natural rate of unemployment and the competition for labor should put upward pressure on wages and inflation. The committee revised its projections for inflation, real GDP, and unemployment in 2018 to reflect these strong gains and removed language suggesting monetary policy would be accommodative for some time.

Generally, individual rate hikes should not have a major impact on Boston commercial real estate markets. For those of us whose Econ 101 is a little rusty, the Fed uses rate hikes to control the pace of economic activity by increasing the rate at which banks can borrow overnight from each other. Banks respond by raising their own rates which increases the cost of financing and can reduce demand in the real estate market and that can push up cap rates. However, cap rates are affected by more than just capital costs and despite three years of the fed slowly increasing rates, cap rates in Boston’s office market have continued to slowly decline. Economic growth, supply of commercial space, and labor market conditions will more likely affect local commercial real estate markets and cap rates than slow moving, predictable interest rate hikes.

Chart Final

What does this mean long term? The Fed policy of rate hikes while also shrinking their balance sheet will ultimately be a drag on economic growth. However, the narrative remains positive. The expectation of an additional rate hike while still unwinding their balance sheet and the committees projections show they are confident the U.S. economy can sustain itself without accommodative monetary policy while also giving policy makers space from the zero lower bound if they need it. While increased rates may weigh on economic growth, a strong U.S. economy is a tailwind for Boston’s commercial real estate markets.

Chart Final 2

This post was written by NAI Hunneman Research Analyst Joey Biasi

Source: Board of Governors, June 2018

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