The Interest Rate Paradox Waiting for the Fed at Jackson Hole

WASHINGTON, DC—Wall Street was so close to a happy ending on Tuesday. The day started out on a hopeful note, with pre-market trading suggesting a recovery was in the offing. And indeed, for most of the day the markets clawed back a good bit of what had been lost in the past few days. Then, in the last half hour as trading headed for a close, the Dow Jones Industrial Average dropped 1.3%.

This does not bode well for Wall Street as well as the global economy.

Tuesday also started out with China throwing, so it would seem, almost everything it had at this devolving situation. It announced yet another interest rate reduction – its fifth since November – as well as its announcement that it would lower, again, the level of deposits a bank is required to hold.

It was all for naught, though, for the US stock market and certainly for China's, where retail investors in particular are suffering huge losses.

The country's firepower to control its economy, it is feared, appears to have run out, or is close to it.

So attention now turns to another policy-maker that also could be short of ammunition to battle this crisis. That would be the US Federal Reserve Bank.

Up until Monday it appeared clear that it was set to finally begin raising interest rates. It may still do so, but the chances are presumably lower today than they were last week.

This week will be the annual retreat of the Federal Reserve Bank at Jackson Hole, Wyo., and it is widely assumed interest rates will be a fierce topic of debate.

One indicator that the Fed may hold off, at least in September, comes from Atlanta Fed President Dennis Lockhart, who was adamant earlier this month that rates would be raised in September. On Monday, in another speech, he acknowledged that the outlook was less certain.

Even before the events of these last few days, interest rates and their direction was a subject of intense interest in the real estate industry.

For starters, there is an entire generation of brokers that have not tried to do deals in a high-interest rate environment, said Sean O'Shea of The O'Shea Net Lease Advisory of BRC Advisors

These last few cycles have been extended and manipulated like never before, he told GlobeSt.com. Their lack of actual experience combined with a lack of a 'Sense of History', will ill equip them for life under the new regime.

Even run-of-the-mill transactions will need to be evaluated through a new filter. As Richard Walter of the Promontory Interfinancial Network, pointed out to GlobeSt.com, cap rates will be affected by higher rates, "especially in long-term leases with no upside."

But these comments, as already noted, were made before the current fracas.

And indeed, it is becoming moot whether the Fed raises rates or not – except in terms of market confidence.

In truth, interest rates sank even lower during Monday's sell off, as investors from across the globe piled into Treasurys. If China's woes continue interest rates could rise even if the Fed doesn't life a finger.

Why? All that cash the country has lost will need to be replaced. One theory is that the Chinese government will want to repatriate the huge level of investments it has made in US Treasurys. As it sells off its holdings, rates will rise.