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Fed announces interest rate decision

The Federal Reserve reduced interest rates for the first time since the financial crisis and hinted it may cut again this year to insulate the record-long U.S. economic expansion from slowing global growth.

Central bankers voted, with two officials dissenting, to lower the target range for the benchmark rate by a quarter-percentage point to 2%-2.25%. The shift was predicted by most investors and economists, yet will disappoint President Donald Trump, who tweeted on Tuesday he wanted a “large cut.’’

“In light of the implications of global developments for the economic outlook as well as muted inflation pressures, the committee decided to lower’’ rates, the Federal Open Market Committee, led by Jerome Powell, said in a statement following a two-day meeting in Washington. It also noted that “uncertainties” about the economic outlook remain.

Officials also stopped shrinking the Fed’s balance sheet effective Aug. 1, ending a process that very modestly tightens monetary policy and was previously scheduled to come to a close at the end of September.

Policy makers appeared open to another cut as early as September when they next convene while sticking with wording in their statement that preserves their options.

“As the committee contemplates the future path of the target range for the federal funds rate, it will continue to monitor the implications of incoming information for the economic outlook and will act as appropriate to sustain the expansion,” they said.

Kansas City Fed President Esther George and Boston’s Eric Rosengren voted against the cut. The statement said they “preferred at this meeting to maintain the target range for the federal funds rate.” It was the first time since Powell took over as chairman in February 2018 that two policy makers dissented.

Investors had forecast the Fed to continue easing monetary policy this year, with futures pricing the key rate to fall about another half-point by January. U.S. stocks rose to a record last week in anticipation of easier money, while the yield on two-year Treasuries has undershot 2% since May.

While the domestic economy has performed relatively well, the Fed cut amid concern that softness abroad threatens the decade- long U.S. expansion. Trump’s trade war with China is hurting foreign demand. Data released earlier Wednesday showed the pace of quarter-over-quarter growth in the euro area slowed by half in the latest three months to 0.2%.

In the U.S., after growing 2.5% last year, fuelled by now-fading tax cuts and higher government spending, the economy expanded at a 2.1% annualized pace in the second quarter. The trade dispute was blamed for a manufacturing slowdown and the first drop in business investment since 2016.

In their assessment of the US economy, officials made only minor changes to their statement language.

Powell has repeatedly said the Fed’s “overarching goal’’ is to keep growth going. Acting now, when the central bank has less room to pare rates than in past downturns, is partly aimed at getting ahead of any potential slump.

Lacklustre inflation also offered the Fed space and reason to ease. Its preferred price gauge, excluding food and energy, rose 1.6% in June from a year earlier and hasn’t met the Fed’s 2% target this year.

Trump is unlikely to be satisfied as he puts the economy at the heart of his re-election bid. He has broken with convention and undermined the Fed’s political independence by lobbying it to loosen policy and publicly questioning his nomination of Powell as chairman.

At his press conference, Powell will almost certainly be asked if the Fed buckled to that pressure. He may also be quizzed on whether the Fed, if requested, would join the U.S. Treasury in any effort to weaken the dollar given Trump’s complaints about the currency’s value.

Limited Scope

While Trump and some investors wanted the Fed to be more aggressive, its scope for doing so is limited. Stocks are high, unemployment is around the lowest in a half-century and consumers continue to spend. At the same time, a measure of business in the Chicago region fell this month to the lowest since late 2015.

The rate reduction was the first since December 2008 when the Fed dropped its benchmark effectively to zero as it battled recession and financial crisis. It began raising borrowing costs in December 2015, doing so another eight times. Officials indicated as recently as December they intended to continue to hike this year.

They dumped that plan in January as financial markets fretted monetary policy had become too restrictive.

Fellow central banks are set to follow the Fed. Those in IndiaSouth Africa and Australia are among those to have cut this year. The European Central Bank has indicated it will do so in September.

A worry for policy makers is that a decade of easy money leaves them short of ammunition for fighting a serious downturn. That likely means governments will face demands to do more if economies keep struggling.

 

Copyright Bloomberg News

by Bloomberg 31 Jul 2019

Commercial Mortgage Commentary – Customer Forward Thinking.

Making News

Economy

2018 started with confidence from the Bank of Canada’s (“BOC”) economic outlook for the year. However, the GDP growth forecast gradually declined as oil prices dropped and as tensions grew in international trade markets. As a result, we saw a reversal in the increasing trend of Government of Canada (“GOC”) bond yields at the end of 2018. 2019 begins with some uncertainty around the growth in the Canadian economy, the direction of GOC yields, and whether further increases in the overnight rate will occur in 2019..


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GOC Yields

GOC bond yields ended generally flat in 2018 – the 3-year GOC
increased by 11 bps, 5-year increased by 1 bps, and the 10-year
GOC yield decreased by 9 bps.

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Overnight Rate

There were three rate hikes in 2018 for the Bank of Canada (“BOC”) overnight target rate, which brought the rate to 1.75%, the
highest since Q4/08, but the Bank of Canada held the overnight
rate constant for their last two meetings.


Commercial Mortgage

Capital supply and competition for commercial mortgages remained strong throughout 2018 as spreads continued to absorb the increases in the GOC yields, holding commercial mortgage coupons relatively steady. During Q4/18, GOC bond yields fell in response to the deteriorating outlook from the BOC, reversing the upward trend in 2018. Corporate bond markets reacted as investors demanded higher spreads – roughly 50 bps higher for BBB-rated corporate bonds in Q4/18 alone.

Commercial mortgage spreads became a hot topic towards the end of Q4, as brokers and investors alike were looking for signs of change in the market. Commercial mortgage spreads eventually reacted with an increase in December by 10-15 bps, ending the 

year at 150-170 bps for top quality assets. The average 5-year conventional commercial mortgage coupon ended 2018 roughly flat at 3.60%. January 2019 has quickly seen another 15 bps increase in spreads, now in the range of 165-185 bps for top quality assets.

BBB-rated corporate bond investments tend to compete for the same capital as commercial mortgages, since BBB-rated corporate bonds provide a similar return on risk. As firms look to make portfolio investment decisions, the spread premium for commercial mortgages over BBB-rated corporate bonds can be an indication of where capital supply may shift or how commercial mortgage spreads may respond to changes in BBB-rated corporate spreads.

Recent increases in BBB-rated corporate bond spreads improved the relative attractiveness of this investment against commercial mortgages. The spread premium for commercial mortgages dropped from 85 to 25 bps year over year – significantly lower relative to the 67 bps long term average. Consequently, commercial mortgage funds may 

require higher spreads to compete for capital against their BBB-rated corporate bond counterparts.

Based on the low spread premium for commercial mortgages compared to the long-term average, a further widening in commercial mortgage spreads is possible.


Senior Unsecured Debt

In Q4/18, senior unsecured debt issuance reached $1 billion,up from $375 million in Q3/18. Total issuance for the year was driven largely by the nearly $2 billion raised by Choice Properties REIT in Q1/18. 

Overall spreads on BBB-rated senior unsecured debt rose sharply from 145 bps at the end of Q3/18 to 194 bps by the end of Q4/18. With the increase, spreads surpassed those of conventional commercial mortgages. With the current premium for unsecured debt, REITs and REOCs may consider more conventional mortgage financing.


CMHC

CMHC-insured mortgages offer an attractive return for lenders looking to earn additional yield, while maintaining an indirect

guarantee from the Government of Canada. As most insured mortgages are originated with the purpose of securitization into the National Housing Act (“NHA”) Mortgage-Backed Security program run by CMHC, lenders tend to quote spreads based on Canada Mortgage Bond (“CMB”) spreads. Given this, it is no surprise with the increases in CMB spreads seen in Q4/18, that CMHC-insured spreads also increased.

Through Q4/18, the 5-year and 10-year CMB spreads increased from 29 bps to 42 bps and from 38 bps to 55 bps, respectively. Spreads on CMHC-insured mortgages followed suit with a 10 – 15 bps increase to 90 – 115 bps over GOC on 5-year terms and 100 – 125 bps on 10-year terms.


Quarterly Lenders Sentiment Survey and
Annual Commercial Mortgage Survey

The CMLS Mortgage Analytics Group conducts market surveys to enhance market knowledge and transparency on areas such as size, segment analysis, and trends in the Canadian commercial mortgage market. Since inception in 2010, the surveys have grown to cover over 90% of the commercial mortgage market.

 

February 2019