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All eyes on Fed as rates stay low

By Konrad Putzier

New York’s real estate industry has long been preparing for interest rates to start rising in mid-2015. But what if they don’t?

Over the past two months, a slowdown in inflation, declining wages and economic risk abroad have made it more likely that the Federal Reserve will delay its return to monetary normalcy.

Some economists are even urging a new round of asset purchases, or quantitative easing. For the real estate industry, this offers opportunities as well as risks.

On the surface, continually low interest rates should benefit real estate. Cheap loans encourage investment, while low yields on low-risk bonds (in part due to Fed-intervention) push yield-hungry investors into riskier assets, including real estate.

Both factors drive up real estate prices, which still haven’t recovered from the crisis in parts of the US.


“Where I think this is helpful for the industry is that a longer period of low rates coinciding with real improvement in the economy buys us some time for assets to catch up with economic fundamentals,” explained Sam Chandan, an economist at Chandan Economics and UPenn’s Wharton School.

But while low rates should be a boon to the industry as a whole, they also raise the specter of asset bubbles.
Cheap loans and low bond yields encourage risky investments, especially when asset prices are growing at their current rate. This may not be bad in markets still recovering from the crisis. But it could spell trouble for Manhattan’s already booming luxury condo market, explained Chandan.

“There are segments of the market that are at risk, for example luxury assets in New York City,” he said, adding that he is also concerned over the quality of multifamily loans across the US.

“The growth in the number of non-US buyers has, in some cases, been described as the result of an underlying strength of the real estate market,” he explained. “But if you’re at a price point where domestic investors are comfortable being sellers and foreign buyers take a larger share of the market, historically this tends to signal a pricing peak.”

To be sure, Fed-Chair Janet Yellen still maintains the central bank will start raising rates in the second quarter of 2015, as planned, and most observers still expect it do so. But a growing number of economists are arguing for a delay.

The Fed is in an uncomfortable position. Unemployment is below six percent and GDP is growing at a healthy rate, which would normally compel the central bank to slowly start selling assets and raising its benchmark short-term interest rate, the federal funds rate.

Both would combine to raise interest rates throughout the economy from their post-crisis lows.

But unlike past cycles, economic growth is not accompanied by rising inflation. Tumbling oil prices and the rising dollar (which makes imported goods cheaper) are pushing prices down further, raising the threat of deflation.

This poses a dilemma. To raise prices, the Fed has to keep interest rates low – the exact opposite of what employment growth commands.

In a blog post for the American Enterprise Institute published on Monday, the economist John H. Makin argued that the Fed is “too complacent” over the threat of deflation and should instead start a new round of quantitative easing.

“The Fed has decided simply to assert that US deflation won’t materialize, so it will continue on its current path toward mid-year tightening,” Makin wrote. “This is a dangerous course to follow, especially in view of rising global deflation pressure.”

As the debate over the right course of monetary policy continues, the real estate industry will be following it closely.

Meanwhile, factors outside of the Fed’s control are already holding mortgage rates down, according to a report by Guardhill Financial Corp.

“Jobs for December were stronger, but troublesome events in Europe and oil continued the flight to safety and helped to keep mortgage rates at their low levels,” the report noted.

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