The Federal Reserve has twice tried since 2008 to jumpstart the sagging economy by intervening in monetary policy, with the last attempt, dubbed quantitative easing 2 (QE2), ending in June. Since spring, the economy has continued to decelerate and stocks have fallen amid anemic job growth, politcal gridlock and overseas turmoil spurring fears that the U.S. economy is headed for another recession.
Now the Fed is at it again, and this time at least the latest intervention has a catchier name: Operation Twist. However, initial reactions from economists and investors suggest they expect the move to further lower long-term interest rates will have little impact on commercial real estate financing or fundamentals.
The Federal Open Market Committee (FOMC) last week launched its long-expect additional round of stimulus by deciding last week to purchase $400 billion in long-term Treasury bonds with maturities of six to 30 years, and to sell bonds with maturities of less than three years. Further, the central bank will reinvest principal and interest payments from its portfolio of mortgage-backed securities (MBS) purchased during earlier rounds of stimulus back into more MBS.
The goal is to “twist” the yield curve, lowering long-term interest rates and raising short-term rates in hopes of stimulating investment and borrowing, including mortgages and refinancings.
The move comes as the yield on the 10-year Treasury fell to 1.93% earlier this month, an all-time low since the Fed began to keep records in the early 1960s. The decline has been fueled both by fear that the inability of European and the U.S. policymakers to manage debt could push their economies into recession, and by anticipation that Operation Twist will push long-term rates even lower.
Investors and analysts are split between those who think the new intervention will produce the desired economic growth and those who think it will do almost nothing, and may even hurt job creation efforts.
The Federal Reserve and the new Kennedy Administration first launched Operation Twist, named after the dance craze started by Chubby Checker, in 1961 in an attempt to lower interest rates and stimulate the weak economy, which had been in recession for several months.
Operation Twist won’t likely have much impact on the job creation and debt reduction needed to get the economy and commercial real estate markets humming again, according to Hans Nordby, managing director of Property and Portfolio Research (PPR) CoStar Group’s analytics and forecasting division. While long-leased, well-located asset values and investments have benefited from government-engineered low interest rates, most distressed assets and development projects have not.
“I don’t believe this will be highly impactful. Interest rates are already so low at both the long and short end that we’ve probably reached a point now where the federal government has done almost everything it can,” Nordby said. “With rates already this low, there’s little marginal benefit left to be had. We now have to deleverage — pay down some debt and get right.”
The U.S. will need to avoid the mistakes of Japan, which has pursued several large and elaborate stimulus projects since the early 1990s which didn’t solve the nation’s economic problems but left it with a mountain of debt.
“We now have the choice to either throw a bunch of money at things that examples overseas suggest are not going to work — or we have to deleverage, which is what we need to do,” Nordby said.
While Americans have cut household debt and corporate America and even financial institutions have cut debt-to-GDP ratios, the federal government’s debt ratio has risen from 40% in February 2009 to 60%.
“Operation Twist will have a negligible impact on the economy,” said Kevin White, real estate strategist for CoStar’s PPR. “At the margin, it may lower long-term interest rates by a couple tenths of a percentage point. This helps to keep residential mortgage rates low, supporting the housing market and refinancings. But rates have already been pushed very low as investors have fled to the perceived safety of U.S. Treasuries.”
A paper published in April by the Federal Reserve Bank of San Francisco found that while most of the market-moving efforts in the 1961 Operation Twist had statistically significant effects, it resulted in a very moderate 15-basis point reduction in longer-term Treasury yields.
“The bigger issue is why the Fed is doing this. The answer is that the economic recovery is flagging, which will translate into a slower recovery of commercial real estate fundamentals. Operation Twist will help a little, but not much,” White said.
John Levy of real estate investment management firm John B. Levy & Co. also doesn’t expect the Fed action to have any direct impact on the commercial mortgage business in the near future.
“Borrowers like the fact that rates are lower, but it’s a two-headed snake,” Levy said in a company podcast this week, adding that lenders construe the action to lower rates as a reflection of the very weak economy, therefore reasoning that they should become more conservative and make lower leverage loans.
“I’d love to say it’s going to increase things and make us more aggressive and active, but I don’t think so. We’re in a much more conservative phase then we were [last spring].”
“Lower rates would encourage businesses to borrow and take on more risk, although the results are likely to be modest as long as business and consumer confidence remains depressed,” said Robert Bach, chief economist and senior vice president for Grubb & Ellis Co., in a market insight note earlier this month. “Businesses are concerned about final demand and the opaque regulatory climate, and lower rates may not be enough to get them back in the game.”
In normal times, low Treasury rates are good for commercial real estate, encouraging lenders to ease terms and making property cash flows and REIT dividends look more compelling for investors, Bach said. In the “new normal,” ultra-low interest rates are a sign of fear as investors pile into low-risk Treasury debt.
“This heightened aversion to risk makes safer commercial real estate assets look appealing, especially apartments and higher-quality properties secured by long-term leases with no near-term rollover risk,” Bach said. “But the uncertainty is not good for the overall commercial real estate market, which needs business confidence to generate leasing activity and fill vacant space.”
By Randyl Drummer, Costar Group