Emerging from its final policy committee meeting of 2012, the Federal Reserve announced its latest interventions to support the economy. A new program of asset purchases – to the tune of $85 billion per month when combined with the Fed’s current mortgage bond program – was widely expected since maturity extension concludes later this month. Earlier this year, Fed officials had signaled that accommodative policy would remain in place absent a material improvement in the labor market. While the unemployment rate has fallen, it is nowhere near a healthy level. The rationale for intervention holds.
What does the Fed decision mean for commercial real estate? It is unclear how much the recent playbook has done to support real economic activity. Capital markets are another story. By pushing inflation-adjusted yields into negative territory, policymakers do more than ensure low borrowing costs for well-qualified borrowers. In the hunt for even modest yields, investors redirect capital to other opportunities, which bolsters valuations for stock markets, real estate, and a range of other assets.
As long as acquisitive real estate market participants remember that asset prices are being influenced by current monetary policy — and that current monetary policy will not last forever — we can manage the distortion. Underwriting trends in some segments of the market suggest we are struggling to exercise that much foresight. Rationalizations that depend on the spreads-to-Treasury argument are flawed, as well, since they ignore that Treasury markets are not functioning normally.
When will this period of experimental monetary policy run its course? The Fed has shifted its messaging on this question, a little earlier than was expected, by moving from a defined timeframe to threshold measures of employment and price stability. At least in relation to the federal funds target rate, current levels will likely hold as long as unemployment is above 6.5 percent and inflation below 2.5 percent. According to the Fed’s updated economic forecasts, we will not breach either of those conditions until 2015 at the earliest. In the baseline projection, low rates will be here for a while yet.