In just two short weeks, "Powell's turn"! What does the Federal Reserve know that the market doesn't know?

The market initially thought that Federal Reserve Chairman Powell, who was "stubborn" just two weeks ago, would finally be "stubborn" again. However, he unexpectedly "surrendered" and signaled a rate cut.

The overnight Fed decision was "dovish," with the dot plot showing that more than half of the Fed officials expect at least three rate cuts next year. Powell, who had been trying to contain market "rate cut expectations," no longer suppressed them during the post-meeting press conference. He stated that the prospect of a rate cut was discussed during the meeting and that a rate cut was "clearly a topic of discussion."

Upon hearing Powell's remarks, Nick Timiraos of the "New Fed Communications Agency" expressed on X that the "Powell pivot" has begun, with a huge change in attitude in just the past two weeks:

December 1st: "It's a bit too early to speculate when policy will start to ease..."

December 13th: "Rate cuts are in our sights, and we are discussing the issue of rate cuts."

In these two weeks, Powell's attitude has undergone a "huge change." What did he discover that the market overlooked?

ING Group analysis suggests that Powell may have seen a crisis that the market has not noticed, a crisis that may exist in areas such as commercial real estate, the rental market, or private credit, which are overly sensitive to high interest rates and prone to risk exposure. Although the market does not know the exact reasons behind this, the consequences of past rate hikes may be quite severe:

When the Fed Chairman comes out and says that he understands the dangers of maintaining high interest rates for a long time, it seems like a warning to the market.

Wall Street News previously analyzed that just before the December interest rate meeting, U.S. Treasury Secretary Yellen stated that the current decline in inflation means that, with the Fed keeping nominal interest rates unchanged, real interest rates adjusted for inflation are actually rising, which seems to be a reasonable reason for the Fed to cut rates in the near future.

Combining this with previous statements by New York Fed President Williams, a decline in inflation is a condition for rate cuts. If inflation eases and the Fed does not cut rates, real interest rates will rise, making the Fed's policy stance more restrictive. From the speeches of Yellen and Williams, it can be seen that real interest rates are an important factor influencing the Fed's interest rate decisions.

Areas where a crisis may exist

Negative news about the U.S. commercial real estate industry has been emerging this year: multiple large properties defaulting, office occupancy rates declining, and rising interest rates making refinancing difficult.

High interest rates have led to a decrease in consumers' willingness to buy homes. At the same time, banks and financial institutions have limited lending capacity, which also suppresses housing demand. Data from the Mortgage Bankers Association (MBA) shows that rising interest rates have led to mortgage applications falling to the lowest level in nearly 30 years.At the same time, the demand for remote work in the United States continues to rise, and the vacancy rate of office space in the United States has reached a historical high. McKinsey warns that in the worst case scenario, office prices could drop an average of 42%.

Meanwhile, inflation and unemployment are suppressing the demand for rental housing.

According to the Apartment List National Rent Report, the Apartment List National Rent Index decreased by 0.9% MoM in November (compared to a decrease of 0.7% the previous month) to $1,340, marking the fourth consecutive monthly decline. Seasonal factors are likely to further push down rents in the next one or two months.

Apartment List data shows that the vacancy rate index remains at 6.4%. In November, rents in 89 out of the top 100 largest cities in the US decreased MoM, with 68 cities experiencing negative YoY rent growth. Due to the high number of apartments still under construction, Apartment List expects the vacancy rate to remain high next year.

At the same time, the expansion of the private credit market may increase systemic risks, thereby affecting the overall stability of the economy.

Colm Kelleher, Chairman of UBS, expressed concern about the growth of the private market over the past decade and believes that the next financial crisis is likely to occur in the shadow banking sector.

Did real interest rates play a role?

In an article, Wall Street pointed out that the role of real interest rates played a certain role behind the dovish turn of the Federal Reserve in this meeting.

Although in the September dot plot, Federal Reserve officials raised their forecast for the benchmark interest rate in 2024 by 50 basis points, in the Summary of Economic Projections (SEP), the forecast for core PCE in 2024 remained unchanged at 2.6%, and even lowered the median forecast for core PCE in 2023 to 3.7% (compared to 3.9% in June forecast).

The December SEP further lowered the forecast for core PCE in 2023 and 2024 to 3.2% and 2.4% respectively. Looking at the changes from September to December, although the Federal Reserve did not adjust the benchmark interest rate, it "quietly" raised the expected future real interest rate by 50 basis points.

Since September, the real interest rate has remained between 1.9% and 2.5%. For the Federal Reserve, this level may already be enough to cool down the economy.