Many rejoiced last week when the Fed cut the overnight lending rate by 50 basis points and the stock market responded as expected by breaking record highs.
For mortgages and corporate bonds, the Fed funds rate is less relevant than the 10-year US Treasury yields and they actually ticked higher the day after the Fed’s move. The increase is a reminder that the Fed doesn’t control all borrowing costs.
Longer term yields are largely driven by future expectations as to where rates will be and not where they are now. So, when Fed officials signaled that they were optimistic about the economy and suggested future rate cuts would only be 25 basis points, the 10-year yield increased. A so called “soft landing” may be good for the economy but it means mortgage rates may remain flat or decline at a much slower rate than the Fed cuts.
The 10-year yield is also determined by “term premium” or the amount of extra compensation investors demand to hold longer term Treasurys over short term debt. Investors generally expect a 1% difference between short and long term US Treasuries but sentiment about the future can be fickle, impacting the term premium.
While real estate investors must keep an eye on 10-year yields, they should keep the other focused on the spread lenders charge borrowers above the yield. One-eyed investors ought not invest alone.
It turns out, lenders need to eat too and the borrowing rate is always some amount above the 10-year yield. The good news for borrowers: the extra differential lenders charge tends to shrink when the Fed cuts rates.
For commercial real estate investors, the Fed cuts are a good thing for sure and directionally positive for borrowers but it doesn’t tell the whole story as to where borrowing costs will ultimately land.
Sources: https://www.wsj.com/finance/investing/the-rate-cut-happened-not-all-borrowing-costs-are-going-down-285168ac https://www.columbiathreadneedleus.com/insights/latest-insights/chart-the-fed-funds-rate-vs.-10-year-treasuries
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