[REN #775] What the Rate Cut Means for Real Estate Investors

Picture of glasses on notebook for Real Estate News for Investors Podcast Episode #775

The Federal Reserve (1) cut its benchmark interest rates by a quarter point on Wednesday, the first time since the 2008 financial crisis. This marks a dramatic shift in monetary policy. But President Trump argued that it wasn’t enough to support his administration’s trade wars and currency battles.

Just after the Federal Reserve changed course from tightening the money supply, to lowering rates in an effort to encourage more spending, the President offered more criticism to Fed Chair Jerome Powell.

Trump said Powell “let us down” by not being aggressive enough. He wanted a large cut in the benchmark rate to compete with China and Europe.  He believes they manipulate their currencies by lowering interest rates, and that we should too.

In an even bigger blow to the White House, Fed Chief Powell suggested this might a be a “one and done,” implying there may be no more rate cuts this year.

Wall Street was expecting a bigger rate cut as well. When that didn’t happen, disappointed stock traders dumped their holdings.

Why Cut Rates?

The Fed raised the federal fund rate 9 times in 3 years, and during the second half of last year, the economy started to feel it. Both stocks and home sales stagnated.

The Federal Reserve raised rates specifically to slow down inflated markets, and effectively achieved it’s goal. Home prices and stock prices had been soaring past sustainable levels for years.

However, President Trump, wants a booming economy. He is campaigning for re-election, after all, and a slowing economy would not help his case. Earlier this year, he started to put pressure on the Fed to reverse it’s tightening measures and start cutting rates to stimulate the economy.

Fed Chairman Jerome Powell (2) resisted, as inflation was in check, unemployment was low and jobs were abundant. But in June, the President said he’d find a way to fire him if he didn’t support his efforts. This week, the President got his rate cut, but it was only a quarter percent. He wanted at least twice that.

The Fed may be hesitating for several reasons. Rate cuts are intended to stimulate a slowing economy. It makes money cheaper to borrow, which  gives consumers more purchasing power. But too much stimulus can create bubbles and run-away inflation as more money chases assets, goods and services.

Plus, rate cuts are normally reserved for recessions – to either avoid them or to pull the economy out of them. They are not traditionally used during an economic expansion that is already at it’s peak. So what’s going on? Is the economy really expanding or is it contracting?

Peter Schiff said on his podcast that if you lower rates before prices drop, you’ve effectively stolen the opportunity for buyers to get discounts. In other words, if prices were already going down 5%, but rate cuts drive them back up, you are avoiding a recession. But you are also manipulating the economy such that prices continue to rise -potentially to unsustainable levels. 

Normally, the stock market would rally after a rate cut, because it nearly ensures that asset values will increase. However, this time the markets did the opposite. At the closing bell on Wednesday, the S&P 500 had dipped 1.1%, and the Dow and Nasdaq both fell 1.2%. 

This is likely due to Powell calling the rate cut a “mid-cycle adjustment.” Many traders interpret this as the last rate cut of the year and not the launching of a full fledge stimulus.

Delores Rubin, a senior equity trader at Deutsche Bank Wealth Management, said, “The press conference reveals details that do not sit well with the market. The response that this is a mid-cycle adjustment and not part of a longer term accommodative stance has raised concerns. The market has really talked itself into a need for lower rates. Obviously the FOMC still feels strongly the economy is resilient.”

Zhiwei Ren, Penn Mutual Asset Management portfolio manager, said, “The market pricing is for 3 more cuts for the next one year. He is pushing back that market pricing. He says this is a mid-cycle rate cut, which means it is 1-2 cuts and done…he is not giving the market what it wants — three cuts for next year. Basically he said, ‘We think that’s accommodative enough.’ he didn’t say they need to cut more. That’s a big surprise to me and the market.”

Louis Navalier said on his podcast, “We live in a deflationary environment… The Fed’s job is to promote full employment and keep inflation in check. I expect they are going to lower rates until inflation is 2%, right now it’s at 1.4%. This means, if anything, the markets are screaming a buy signal.”

My Thoughts On It All

Before yesterday’s rate cut, overnight lending rates were at 2.25% – 2.5%. This is very low already, and would normally be considered a stimulus measure, not a tightening.

In the 70’s the Fed cut rates down from about 12% to 3.8% to stimulate the economy. In the 80’s, they went down from about 18% to 8%. In the 90’s, rates were cut from 8% down to 3%, and in the 2000’s, down from 6.5% to 1%. Each time rates were cut, the economy boomed.

Today, we don’t have as much room to play because we’re starting at 2.25%. Such low rates don’t leave the central bank with much wiggle room if the country actually does go into recession or if the economy stagnates. This is likely why Powell is not eager to launch quantitative easing, or any kind of easing since the economy is actually doing pretty well.

It’s rare for the government or the Fed to push for stimulus when the unemployment rate is so low, job growth is high, home prices are past affordability levels and stock prices are soaring.

What it Means for Real Estate Investors

  • More people who have been sitting on the sidelines to buy a home but were priced out may be able to qualify. We may see an uptick in sales over the next year.
  • More demand from buyers on the market means that real estate values could continue to rise, along with stock prices.
  • Investors can increase their cash flow on rental properties by refinancing into a lower fixed rate payments.
  • Borrowing costs overall will become cheaper. If you have an adjustable rate mortgage, your payment may be lowered.  The same is true for home equity lines of credit, credit cards, student loans and car payments. 
  • It also means you won’t earn much interest from your savings account or from bonds so people might be more apt to invest in other things

So we will most likely see a strong economy through the rest of 2019, and probably up until the election. And, if the economy remains robust, there’s a strong chance Trump will get re-elected.

These are however, uncertain times. The best advice for real estate investors is to sell your high priced, low cash flow properties while interest rates are low, and exchange them for low cost properties with high cash flow. 

Links:

(1) CNBC Article

(2) CNBC Article 2

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