Recent economic reports have sent shockwaves through the financial markets, dampening the possibility of immediate Federal Reserve rate cuts and propelling the yield of the 10-year Treasury to a significant jump, reaching 4.7% since Thursday, April 25. While this may bode well for lenders and fixed-income investors, it spells trouble for commercial real estate (CRE) owners, investors, and developers.
The surge in the 10-year Treasury yield isn't necessarily indicative of poor economic fundamentals. As Roger Aliaga-Diaz, Vanguard global head of portfolio construction, pointed out, despite a weaker-than-expected headline number for first-quarter U.S. GDP, underlying indicators such as consumer spending, business capital expenditures, and housing remain robust. Vanguard continues to project full-year 2024 growth to be slightly above trend.
However, concerns loom over core inflation, as reflected in the Personal Consumption Expenditures index for March, which suggests that the Federal Reserve may be unable to cut interest rates this year. Vanguard has long maintained that the neutral rate of interest—the rate that neither stimulates nor restricts an economy—is higher than previously believed, indicating an end to the ultra-low interest rates of the pre-COVID era.
According to Vanguard's estimates, the neutral rate of interest should have been around 1.5%, significantly higher than the 0.6% level the Fed had previously considered. Reuters reports that some investors are bracing for the 10-year U.S. Treasury yield to surpass the 16-year high of 5% reached last October. The current 4.7% rate marks a five-month high and suggests a persistent upward trend since December 28, 2023.
The concept of stagflation was once deemed unlikely, but with inflation on the rise, economic growth slowing, and historically low unemployment rates, the possibility is increasingly real. Factors such as an aging workforce and retirement trends may be contributing to this unique economic scenario.
As financial markets continue to react to economic data and policymakers' decisions, uncertainty looms over the future trajectory of interest rates and inflation. Investors, businesses, and policymakers alike are closely monitoring developments, preparing for potential shifts in economic conditions and their implications for various sectors of the economy.