Interest Rates on the March
Inflation is the current buzzword, as it has now hit its highest rate in 40 years. There are many explanations and theories as to the source of inflation, from supply chain constraints and pent-up demand, however no one can argue that it is real. The US has done a good job of maintaining inflation in or around the long-term target rate of 2%, but it is also argued that the measurement of inflation over the years has been inaccurate and doesn’t take into account a lot of household costs that have been rising substantially, such as Education.
The Fed has the authority over the nation’s monetary policy. Congress has given the Fed a “dual mandate” of maximum employment and stable prices (i.e. stable inflation). With the job market being so tight, effectively at full employment, the Fed must then be most focused on stabilizing inflation. The Fed has one main tool for that, the Fed Funds Rate. A second and newer tool is Quantitative Easing or Quantitative Tightening. This second tool began life during the Global Financial Crisis with the adoption of Quantitative Easing, whereby the Fed bought Bonds in the market to help keep market interest rates down. Conversely, when they adopted Quantitative Tightening, they sold these Bonds back into the market, which has the opposite effect of lowering the Bond Prices and increasing the market interest rate.
The Fed has already telegraphed that they anticipate up to four interest rate hikes in 2022. They tend to make rate adjustments of 25 basis points (0.25%) per adjustment, but they have at times moved by 50 basis points (0.5%) or more, therefore you could interpret the four rate adjustments to mean a minimum of at least 100 basis points (1.0%), but it could be more. The Feds Funds Rate is the interest rate set by the Fed, and it is the interest rate that banks charge each other when lending to each other overnight. The Fed Funds Rate is not used directly by banks when setting interest rates on commercial loans or home mortgages, however movements in the Fed Funds Rate is usually a precursor to their movement.
What is likely to have a more profound impact on commercial loan and home mortgage interest rates is the adoption of Quantitative Tightening. The Fed has already announced that their Quantitative Easing program is being wound down, and they have indicated once interest rates have begun to move up that they will then begin the Tightening phase of the program.
Commercial Mortgage and Construction Loan rates have already started to move over the past few months, anywhere from 25 basis points (0.25%) to 50 basis points (0.5%). Keep in mind that historically we are still in an extremely low interest rate environment. A 1% increase in interest rates may seem shocking, but if held against historical rates they are not.
Today is one of the best times to lock in a low interest rate loan on your real estate. A low fixed interest rate loan against a cash-flowing asset is one of the greatest hedges to inflation. The interest cost is fixed, and if inflation keeps climbing your rents should grow too.
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