Fed drops a BOMB … but will it work?

You probably heard the Fed just dropped their interest rate target 50 basis points … which is economic geek speak for half a percent.

If you’re a devoted market observer, you’ve probably seen a dozen reports with as many interpretations about why they did it and what it means to everyone … except YOU.

That’s because mainstream financial media doesn’t talk to real estate investors. In fact, they barely acknowledge we exist …

… and they surely have NO idea how we think or what we really do.

They just look at investing through their “buy low, sell high” paradigm …

… and are therefore understandably obsessed with trying to divine which direction the next bloviation from the Eccles building will send the paper trading lemmings scurrying.

To Wall Street, “investing” is sprinting in and out of positions faster than the crowd. Miss a step and you get trampled.

And MOST of what they think and say means NOTHING to Main Street real estate investors.

Meanwhile, issues critical to real estate investors (and syndicators) go completely ignored … leaving you to read between the lines for clues in the news.

Not to worry! Your friendly neighborhood compulsive-obsessive newshounds here at The Real Estate Guys™ radio show are here to fill the gap.

So … what’s a real estate investor to think … and do … in the wake of this latest extraordinary tactic by a clearly concerned Federal Reserve?

Let’s break the topic into bite size pieces …

First, the CONTEXT …

This is the Fed’s first “emergency” action …

(at least in terms of a big, unscheduled rate cut … pay no attention to the billions in “not QE” printed to plug the ongoing problems in the repo market)

… since October 2008.

Hmmm … that date seems oddly familiar … didn’t something big happen back then?

And if the economy is really as strong as everyone claims, WHY is this “shock and awe” unscheduled cut needed?

We’re being told this is in response to the Coronavirus threat to the economy. Some say the Fed’s move validates the fears of a global pandemic.

Weird. Weren’t all the recent press conferences designed to calm such fears?

But there’s a MUCH bigger question to consider …

If the threat of a pandemic has closed factories and broken supply chains, how does printing more money fix that?

Hint: It doesn’t. But it does create some other side effects investors … real estate and otherwise … probably want to pay attention to (more on that in a moment).

We think there are a couple of issues at play …

First, as we’ve been saying for the last few years, there’s an important difference between economic activity (the speed of the vehicle) and the financial system it runs on (the vehicle itself).

If your car is zipping down the road to riches at 75 miles per hour, you’re feeling like you’re making great progress.

But if you don’t notice the oil pressure dropping and engine temperature rising, you won’t know the vehicle is breaking down … and your trip is in jeopardy.

Make sense?

Gold, oil, the dollar, and interest rates are all important gauges on the financial system dashboard …

… right alongside the speedometer and tachometers of employment and GDP, which measure the speed of the economy.

We think there’s a possibility the Fed is injecting liquidity trying to lubricate an engine that’s on the brink of breaking down.

Remember, the repo market crisis all happened BEFORE the coronavirus showed up.

The second major issue helping put the Fed’s latest move in context is a variation on the same theme … interest rates.

But not the “let’s lower interest rates to stimulate this already red-hot economy” use of interest rates.

More like the “let’s put a bid on bonds to prop up fragile credit markets” kind of interest rates … the “black hole event horizon” kind (which is a much bigger discussion we’ve had before).

For today’s discussion, here’s what you need to know …

The Fed doesn’t “set” interest rates. They simply set a target at which to aim their “open market operations”.

This is a confusing way of saying the Fed will buy or sell bonds in the open market in order to manipulate interest rates up or down.

When the Fed sells, it adds to supply, driving bond prices down and interest rates up. That’s clearly NOT the plan right now.

So the flip side is the Fed plans to BUY bonds, bidding UP the prices, and driving interest rates DOWN.

Here’s the important point …

Bond traders KNOW this. And they also know the Fed will pay ANY price to make it happen.

Rising interest rates would be like SAND (or worse) in the financial system’s engine … triggering a wave of defaults, margin calls, and a liquidity crisis of biblical proportions. It would make 2008 look like a bad hair day.

So what do bond traders do? (And yes, you should care …)

Bond traders FRONT-RUN the Fed and PILE into Treasuries, bidding them up, driving interest rates DOWN … to ALL-TIME lows.

Yes, we realize many headlines claim “scared” investors are fleeing the “dangers” of the stock market to the “safety” of bonds.

Maybe … but we think not.

Our guess is it’s not fear, but greed driving the flurry of Treasury bond buying.

Meanwhile, let’s now quickly consider the potential ramifications for Main Street real estate investors 

The most obvious is what we discussed last time … low interest rates create a big opportunity to restructure debt and acquire new cheap debt.

We also think TRUE safety-seekers will start migrating into real assets … like precious metalsoil, and real estate.

Of course, we’ve been talking about this for years. But these macro trends roll out slowly, so we’re pretty sure there’s a lot of room to get on the long-term trend train.

And while we could (and probably should) discuss what the rise of precious metals and oil say about the dollar, we’ll probably save all that for the Summit … when he have all big brains with us.

The more germane discussion for real estate investors is the effect of low interest rates on income producing real estate.

Three words: Shrinking. Cap. Rates.

As Treasury yields fall, they pull down the yields on ALL investments, including rental properties.

Of course, as any seasoned real estate investor knows, falling cap rates mean RISING prices … and EQUITY for those who acquire real estate at the front end of the cycle.

As insane as it seems, this move by the Fed suggests the bull market in cash-flowing real estate might actually be getting a booster shot.

But BE CAREFUL … because it’s easy to get sloppy with underwriting and market selection when things get hotter and even more competitive.

Always remember, unlike stocks and bonds, people still need real jobs to make income properties perform. It’s hard for unemployed tenants to pay rent.

While admitting we’re far from experts on the matter, our guess is the coronavirus crisis will come and go like the many others before it.

So the real lasting impact may not be (hopefully) loss of large numbers of human lives … or even major disruptions to America’s economy or individual lifestyle and freedoms.

But it may wake America up to the vulnerability created by an over-dependence on Chinese manufacturing …

… and a renewed enthusiasm to bring more manufacturing back to the United States.

These are the kind of durable jobs with the potential to drive a sustainable surge in demand for real estate of all kinds.

Smart investors will be watching to see if and where these jobs end up … and will jump in to ride the wave as those markets revitalize.

Yes, these are troubling times. But they’re also full of lessons and opportunities.

The odds are good that the world will not just survive, but thrive, despite the consistent parade of threats and temporary turmoil.

Real estate investing is a long-term game played best by watching the long-term trends … and letting real estate do for you what it does best …

… providing investors with a way to profit from the long-term decline of the dollar while staying mostly insulated from the wild volatility of the Wall Street casinos.

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