The Federal Reserve raised interest rates last week for the third time this year, signaling increased confidence in the United States economy. The move saw the federal funds rate increase a quarter percentage point to a range of 2 to 2.25 percent. Looking ahead, a fourth rate hike is expected in December followed by at least three more increases next year and one in 2020.
The reasons for the hikes are difficult to ignore. Average hourly earnings increased 2.9 percent in August, which was the fastest rate of growth since June 2009, according to Marcus & Millichap. That has caused consumers to spend more, with core retail sales rising 5.9 percent over the past year ending in August. Meanwhile, small business optimism reached its highest level since 1983.
Additionally, the Fed raised its expectation for economic growth to 3.1 percent (up from 2.8 percent) this year. That growth is expected to slow next year to 2.5 percent due to concerns about the U.S.-China trade trouble.
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But what could these rate increases mean for the U.S. as we move ahead, especially as whispers get louder that a downturn could be near?
While shorter-term interest rates have increased in tandem with the Fed policy, Marcus & Millichap notes that longer-term yields have grown in a more measured way. Loose monetary policy and low interest rates in Europe and Japan have caused overseas investors to purchase U.S. Treasurys to capture a yield premium of more than 200 basis points, according to a recent report from the firm.
That activity has slowed the upward trend in long-term U.S. interest rates, and the capital flows have the potential to upset the yield curve where short-term rates rise above the long term. Marcus & Millichap notes that those types of inversions have been a precursor to every recession for the past five decades. The perfect storm has caused economists to question whether a downturn is on the horizon.
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While interest-rate gains have reduced the gap between borrowing costs and cap rates, buyers still remain active at present, the firm notes. While financing is plentiful now, Marcus & Millichap said that lenders are becoming more conservative. That has caused investors to look to more specialized financing options to meet return goals. Therefore, it might behoove today’s borrowers to lock in financing quickly.
Moving forward, the firm suggests that increases in borrowing costs could tighten yield spread. That could reduce a buyer’s willingness to offer asking price on assets, even if favorable operating metrics are prevalent.