QE3 Continues (For Now)

LIVINGSTON, NJ-In mid-September, the Federal Open Market Committee revealed that it would not reduce the pace of its monthly $85-billion economic stimulus in the form of Treasury notes (more commonly known as Quantitative Easing 3 or QE3), which has led to suppressed interest rate levels for the past year.

With spreads over treasuries still tight (with lenders who have not met their 2013 lending targets) now is time to lock. Sure, spreads will tighten in Q1 2014 but how long will the Fed wait to begin to taper? Owners should look forward, evaluate prepay premiums and recast debt now, locking in these historically low rates before they are gone. 

The QE3 announcement, which was made at the National Bureau of Economic Research conference on in mid-September, put financial markets somewhat at ease in regard to short-term interest rates, which will remain at near zero for at least the short term. Specifically, the FOMC said that they “decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.”

This is a clear gift for borrowers concerned that there would be a tapering of QE3. The past year alone saw a run up in rates—close to 100 basis points. Following the announcement by the FOMC, however, the market saw a 25- to 30-basis point comeback.

The concern on the part of borrowers was quite genuine, as back in mid-June, Federal Reserve Chairman Ben Bernanke was singing a much different tune while testifying before the Joint Economic Committee of Congress. One of the main issues at hand was the fate of monetary stimulus that had bolstered the economy, among growing concerns that the Fed would stifle a meaningful recovery. That uncertainty led to a 50 basis point rise in rates. Specifically, Mr. Bernanke was taken to task by Congress over when the Fed would end its bond purchases.

Bernanke's statements in June indicated a sense of ambivalence in respect to the future of rates. In his opening statement, he mentioned that “the Committee is aware that a long period of low interest rates has costs and risks. For example, even as low interest rates have helped create jobs and supported the prices of homes and other assets, savers who rely on interest income from savings accounts or government bonds are receiving very low returns. Another cost, one that we take very seriously, is the possibility that very low interest rates, if maintained too long, could undermine financial stability. For example, investors or portfolio managers dissatisfied with low returns may reach for yield by taking on more credit risk, duration risk, or leverage.”

Meanwhile, in mid-December 2012, the Fed revealed that it may be nearer to ending its QE3. During a meeting of the Federal Open Market Committee, the presentation focused on the potential effects on the U.S. economy, based in part on simulations of a staff macroeconomic model, and for the Federal Reserve's balance sheet and income of continuing to buy MBS and longer-term Treasury securities over various time frames. According to the meeting minutes, “In their discussion of the staff presentation, some participants asked about the possible consequences of the alternative purchase programs for the expected path of Federal Reserve remittances to the Treasury Department.”

As a result of this posturing, the general consensus among investors was that the FOMC would taper its monthly bond buying to $75 billion from the current $85 billion level. However, with the decision to extend the current QE3 window, borrowers should take a hard look at what makes the most sense for their bottom line and recast, unwind, extend or rebind their loans into new 10- to 15-year term loans. Even with the extension, QE3 won't last forever.

Mark Scott is founder and president of Commercial Mortgage Capital. The views expressed in this column are the author's own.