by Guest Contributor Kathy Fettke
The Federal Reserve kept its promise and raised interest rates for the 2nd time this year by a quarter point on Wednesday. Some critics say it’s too late. Others say it’s too soon.
When the Federal Reserve raises interest rates, it’s has more to do with the money supply and monitoring the economy than it does with 30 year fixed rate mortgages or consumer loans. Short term loans, like equity lines, adjustable rate mortgages and revolving credit card rates could increase. This nuance is often confused by media outlets.
The Federal Reserve typically raises the Fed Fund rate when the economy is robust as an attempt to slow things down and curb inflation. It is essentially a tightening of the money supply.
Chair of the Federal Reserve, Janet Yellen, announced at a prior FOMC meeting that a 2% rise in inflation would trigger a rate hike, and inflation is just under 2%.
The Fed also looks at employment numbers to gauge the health of the economy. In May, the unemployment rate was down to 4.3%, which would indicate a healthy job market. These two factors apparently gave the Fed enough confidence in the economy to make a move.
President Trump certainly appears to be optimistic about the economy. Today he announced, “We have regulations on top of regulations and in history nobody has gotten rid of so many regulations as the Trump administration.” He added, “And that’s one of the reasons that you see the jobs and the companies all kicking in so strongly. I think some very good numbers are going to be announced, by the way, in the very near future as to GDP.”
Yellen also announced the Fed will begin unwinding its $4.5 trillion balance sheet of Treasuries, mortgage backed securities and government agency debt.
This combination of a rate hike with a shrinking balance sheet will tighten the money supply, and some economists are concerned. They say there are
still big questions about real U.S. economic growth.
The GDP in Q1 was revised from 0.7% to 1.2% for Q1, which hardly reflects a robust economic output. Numbers for the second quarter report will be released on July 28th.
Additionally, the CPI (Consumer Price Index) posted its second decline in 3 months. That means inflation is actually in decline.
Some analysts believe the unemployment numbers aren’t as positive as reported, because they reflect part-time low paying jobs, and a fewer number of people actually looking for work, which skews the numbers. Additionally, wages have been flat.
If you focus on the stock market, you might think the economy is booming. Wall Street has been on a bull run since President Trump was elected with the Dow hitting over 21,000 for the first time ever. Wall Street investors don’t appears to be concerned about the historically high price to earnings ratios. The Trump euphoria seems to just keep marching on, regardless of economic data or political upheaval.
But whether you are bullish or bearish, it is a time to be cautious.
Peter Boockvar, chief market analyst at The Lindsey Group said on CNBC, “They desperately want this to be an easy, smooth, paint-drying type of process, but there’s no chance. The whole purpose of quantitative easing was to inflame the markets higher. Why shouldn’t the reverse happen when we do quantitative tightening?”
He added that “Since World War II we’ve had 13 rate-hike cycles: 10 put us into recession.”
Jeremy Lawson, chief economist at Standard Life Investments, said, “The open question coming out of the meeting is whether the Fed’s guidance is credible. The initial market reaction suggests that markets are doubtful.”
That’s why many economists fear a rate hike during a time of tepid economic growth could actually push us into recession. In the past when the Fed raised interest rates from ultra low levels during slow economic growth, The U.S. fell into recession within three to nine months.
When the Fed raised rates in March, Nobel Prize-winning economist Robert Schiller warned the public that Wall Street exuberance has gone overboard. He told Bloomberg that traders are captivated by President Trump’s bold plans to slash regulations, cut taxes, and “turbo-charge” the economy with an infrastructure building-boom – and thereby ignoring the data.
He warns that when situations like this have happened in the past, it hasn’t ended well for the investors. Economist Harry Dent says “There has never been a soft landing for a bubble. It usually just bursts.”
Yellen appeared to be quite optimistic, but the Fed hasn’t always been accurate in it’s forecasting.
In January of 2008, Ben Bernanke, then Chairman of the Fed said, “The Federal Reserve is not currently forecasting a recession.” Just 8 months later in September of 2008, Lehman Brothers collapsed and the financial markets worldwide came tumbling down.
If Trump and Yellen are wrong, how might an economic slowdown or market crash affect real estate?
It feels like our country has one foot on the gas pedal and one foot on the brakes. Half the country seem to think we are headed into an economic boom cycle, while the other half fears we’re headed into a financial crisis.
In this case, it would be wise to develop both offensive and defensive strategies.
If the Fed Fund rate hike does end up being the pin that pops the stock market bubble, some real estate markets would be affected. Metro areas with residents who are highly invested in the stock market, or who have jobs with companies that have high price to earnings ratios, might feel more pain in a downturn.
Companies and metro areas that tend to be less affected by economic ups and downs are called “linear” markets, and generally have more of a manufacturing base rather than a white collar economy. Areas with universities, senior housing and health care also fare well during recessions.
On the flip side, if the economy continues to steam ahead thanks to Trumps pro-business policies, then investors could continue to enjoy the rising tide.
As for long-term mortgage interest rates, we’ll probably continue to see 30 year fixed rate mortgages under 4% this summer. A weak economy mixed with uncertainty tends to drives more people to the safety of bonds, which effectively lower interest rates.
If you would like to learn more about defensive investing strategies through affordable cash flowing real estate investments in recession proof markets,