A “skip” or a “pause”?

That was the biggest question on investors’ minds after yesterday’s FOMC rate decision.

It marked the first time the Fed has held rates steady during this entire tightening cycle.

I thought it was a telegraphed pause. Just a few weeks ago, Fed officials were outright calling for at least a “skip.”

And we anticipated this skip.

A downtrend in leading economic indicators – coupled with the deceleration of inflation – led me to write on June 2, “The market is beginning to understand that the Fed may be done here.”

We’ve come a long way. Inflation has been slowing, and the stock market is at a 14-month high.

So was it a “skip,” or was it a “pause”? The market began debating ever since the beginning of June.

That’s when Philadelphia Fed president Patrick Harker said: “I am in a camp increasingly coming into this [upcoming FOMC] meeting thinking that we really should skip, not pause.”

But I don’t think they themselves know yet.

I think this skip will turn into a pause. And that will eventually turn into outright rate cuts.

And it’s coming sooner rather than later.

Rents Will Fall

The only thing keeping official inflation readings above the Fed’s 2% inflation target is the cost of rent.

And rent is likely to start coming down as well.

The last consumer price index (CPI) print came in at a 4% year-over-year (YoY) growth rate. So even without rent coming down, we’re almost there already.

The ramifications of this development are extraordinary.

On one hand, it will bring the official CPI growth rate down further. But on the other, lower rent rolls mean that real estate prices will continue to be under pressure.

In the view of many economists, that is the biggest risk on bank balance sheets.

That’s why the only comment from Powell that I was paying attention to was when he was asked what the risks are with commercial real estate.

His response was: “[We are watching it] very carefully… We do expect losses… It feels like something will be around for some time, rather than a sudden hit that wallops the financial system.”

To understand why he’s watching this “very carefully” but should probably be already lowering rates, let’s take a look at the supply-demand of apartment units in U.S. metro areas:


Any value below zero means that there’s more supply out there than demand for apartments.

Right now, it’s at its lowest level since the Great Recession of 2008 unfolded.

The three spikes on the chart all came as a result of the zero interest-rate policy (ZIRP), with the last one coming after the Fed lowered the interest rate to zero.

The one before that came when Powell threw in the towel on normalizing rates and reversed course.

Rates and real estate are intertwined. The lower rates go, the more demand for real estate due to low financing costs.

Right now, demand is cratering.

And already, we’re seeing the vacancy rate trough.


The average vacancy rate since 2000 has been 8.35%. We are at 6.4% and trending higher.

If vacancy rates simply hit their average, the price of multi-family real estate across the nation will fall.

That’s especially true since there was such a rampant buying spree in the months after the initial COVID shock. And as always, the banks were willing to lend.

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“Throw the Keys Back to the Bank”

Real estate values are determined to a large extent by rent rolls and operating costs. And with demand cratering and rates still high, rent rolls will fall and operating costs continue to rise.

Many real estate operators’ predefined exit strategy for owning a building or rentable unit is to eventually refinance at a lower rate. Then they pay off the mortgage and “cash out.”

With mortgage rates where they are now, that option is simply off the table. When these loans come due after years of buying real estate with cheap money, the fear is that operators will simply “throw the keys back to the bank.” That’s a common outcome when the real estate market goes south.

This is why the YoY growth rate in national rents (according to Zillow) continues to toboggan down. There’s just too much supply from when times were good in real estate to absorb current levels of demand.


As this dynamic continues to unfold, the CPI rate will continue to fall, leaving no reason for the Fed to raise further.

And it will give them all the reason they need to start cutting soon. Because as goes real estate goes the economy.


Eric Shamilov
Analyst, Trading With Larry Benedict