Treasury Market Volatility
Treasury volatility in the U.S. has caught on fire in 2019. The U.S. 10-year Treasury dropped as low as 1.477% on August 15th and slipped past the lowest level that we have seen since October 2016. Earlier in the morning on August 15th, the 30-year Treasury bond fell below 2.00% (1.943%) for the first time ever. To add to the drama of August, on the 14th, the yield on the 10-year Treasury inverted with the 2-year Treasury which has preceded every single recession in U.S. history. Most mainstream economists agree that Treasury volatility is not going to subside in the near future, so where does that leave us moving forward?
As noted in Table 1, 2019 has seen major events relating to the U.S. treasury “yield curve”. The Treasury yield curve (3-month T-bill vs 10-year Treasury) inverted on March 22nd, 2019, and since that day, we have seen continued volatility in the Treasury market. Before we dive into the implications of continued Treasury volatility on the commercial real estate market, let’s review as to why, and how, the Treasury market is priced.
The Treasury marketplace is best described as a bid-auction process with the main goal of providing institutions and governments around the world the opportunity to obtain “risk-free” interest. This interaction between institutions and governments is dictated by geopolitical events (i.e. China, Brexit, Tariffs, Trade, Iran), global central banks (i.e. $15 trillion in negative-yielding bonds including Germany, France, Switzerland, Netherlands, and Japan), the U.S. Federal Reserve, inflation expectations, global fiscal policy, and @RealDonaldTrump’s Twitter account. Currently, we are in a point in the market cycle in which most of the factors mentioned above are experiencing heightened uncertainty in addition to a plethora of weakening global economic data. To the contrary, the U.S. continues to see record employment, low inflation, better than expected consumer spending and consumer confidence, better than expected corporate earnings, and a high probability of future rate cuts by our Federal Reserve.
Implications and Opportunities for CRE
At this point, it seems as though all of the wires are crossed. Volatility continues to be a result of investor fears in the global marketplace. So what does this mean for commercial real estate? Well, if you are holding onto floating-rate debt, you may see some relief in your debt service payments as well as an increase in your net cash flow. Additionally, if you are an individual who is seeking fixed-rate debt; it is a very favorable time to take advantage of the low-interest rates and low floor rates that are being offered in the marketplace today.
In conclusion, we are in uncharted territory when it comes to our Treasury market. What we do know, for now, is that the Fed will continue to be accommodative and believes that an increase in the economic stimulus (lowering of Fed Funds Rates) can extend the current duration of our market expansion. This means that the cost of capital and the cost of borrowing will be in historically favorable conditions for those individuals looking to acquire or refinance existing debt. As of now, the spread between market cap rates and long-term Treasuries are in a healthy range. Historically, this suggests that the commercial real estate market is still in a stable and healthy position for the near-term. Reach out to one of the Q10 | KDH mortgage banking professionals to talk more about how you can make the most of today’s interest rate environment.
Notable Current Events
- The U.S. 30-year Treasury yield falls below 2% for the first time (Aug 15th)
- The U.S. 10-year minus the 2-year yield has inverted for the first time since August 2007
- Japan surpasses China as the largest foreign debt holder reaching $1.123 trillion with China standing around $1.113 trillion
- 10-year Treasury has dropped approximately 115 basis points from its January 18th high of 2.79%