The Fed's September Meeting

Will the rate change happen?

Wednesday and Thursday of this week is when the Federal Reserve holds an important meeting. The short-term rates (Federal Funds) has been between 0% and .25% for the past seven years, which tells you how weak the Fed has thought that the economy has been. With a lot of improved economic data, many Fed watchers have suggested that the Fed is likely to bump the Federal Funds rate by .25%. The economic turbulence emanating from China, along with consistently horrible Eurozone data, has some believing that the global economy is still too weak to justify a normalization in interest rates. Dollar strength relative to most other major currencies also have some questioning this possibility. Others believe it is time to start normalizing rates and that the Fed will at least make a minor adjustment this September. 

In some sense, I think its a bit sad that the U.S stock market seems to react negatively when it appears as though the Fed raising rates is more likely. The Fed should be raising rates in response to improving economic conditions, which should be good for the companies in the major indices. Instead, like heroin, the equity market can't seem to ween itself off of prevailing low interest rates. This may be all the more reason to raise rates. Eventually reality must set in.

Some have worried that when observing the national housing market, some areas have not been on strong footing. Others are headed to the moon, like San Francisco. Our market, Las Vegas, seems to be priced pretty close to our estimates of fundamental values and Phoenix looks similar. Denver has also been strong and seems to have price strength but maybe for the wrong reasons, with extreme limitations in supply. New York and Los Angeles, which are obviously major draws for foreign interests, continue to have sky high prices. Even places like Bozeman Montana seem to have a strange, fast recovery and many homes are priced much higher than equivalently sized homes in major cities with strong job markets. That points towards individuals making lifestyle choices above purely job related choices.

I tend to agree with Lincoln Ellis, writing in Bloomberg, who states, "In short, the data we have for housing and infrastructure investment suggest that the first 25, 50 or even 100 basis points of policy normalization will have very little to no effect on these activities and thus little or no effect on the real economy. If anything, a rate rise might help dampen a little of the froth that is evident in some markets. With home prices hovering at or above their 2008 highs, a little slowdown in price increases could be a good thing." 

My view is that keeping rates so low for so long has resulted in some malinvestment, which occurs when market signals are distorted and investors pile into projects that ordinarily wouldn't make sense in interest rate environments that are even a little bit higher than the extreme low bound rates we have been experiencing. 

One thing is certain, and that is uncertainty. If we combine some really bad global news along with a rate hike, the equity market is likely to fall out of bed. However, reality must set in eventually. 

As for Las Vegas housing, we are reasonably confident in current values, along with some of the underlying, supportive trends. Vacancy rates are improving and price increases are moderating. The job market, while still not on all cylinders, is improved substantially from the trough and is likely to meet its prior peak for employment in the next 12-18 months if growth rates continue. We are seeing a lot of strength in the rental market in our own managed single family pool as well as observations from the broader market, supporting the properties that investors bought over the past several years. I think the current local housing market can sustain much more than it had in the recent past, particularly because the level of equity is much, much higher than it was a few years ago.

So while we brace for some reverberations in the global markets, to some extent we welcome change because we may have been on this low rate path for a bit too long.