Week of December 12, 2022
Dec Mullarkey, CFA , Managing Director, Investment Strategy and Asset Allocation
As expected, the U.S. Federal Reserve raised rates 50 basis points this week. But the more intriguing content was the Fed’s “dot plot” and its updated economic projections. In summary, the Fed expects to pause next year at a federal funds rate of 5.1%. The central bank still expects a soft landing, with 2023 growth around 0.5% and unemployment moving up to 4.6%.
Amongst the barrage of Fed numbers, the estimate markets quibble with the most is how long the Fed can keep rates high. The markets expect two rate cuts next year, while the Fed signals it will be in no rush to pull back.
In his catchup with the press, Fed Chair Jerome Powell reiterated that while inflation is moving in the right direction, the service sector – ex. housing – is not coming off the boil. And the big catalyst is wages, which remain robust. Powell continued to remind markets that “it feels like we have a structural labor shortage” driven by early retirements, fewer immigrants and COVID casualties. There is no quick fix to this labor shortfall, which will force the Fed to keep cooling demand.
This is at the crux of the difference in the rate view. Markets expect that Fed tightening will hammer activity and force it to relent next year. Meanwhile, the Fed’s view is that rightsizing demand with labor supply will be a slog, but with patience and restrictive rates it can deliver a soft landing.
Source: Bloomberg, Financial Times, 2022.
Andrew Kleeman , Senior Managing Director, Head of Corporate Private Placements
As we enter the middle of December, there are always a handful of investment grade private credit deals that issuers want priced before year end. We typically see a “December premium” as some investors have completed their investment program for the year or are focused on year-end portfolio maintenance items. Those investors willing to work to the year-end finish line are rewarded with good allocations, improved terms and strong relative value as stocking stuffers for the year. In addition, many investors are cleaning up portfolios, leading to an active secondary market. Whether that is selling smaller positions that they view as uneconomical to follow or selling lower coupon bonds to improve book yield, we have seen a number of attractive secondary opportunities for performing credits that we like. It always feels good to finish the year with some great relative value for our clients.
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Abbe Franchot Borok , Managing Director, Head of U.S. Debt, BGO
The debt capital markets in the real estate space have certainly not been immune to 2022’s unprecedented volatility. However, through our real estate boutique BentallGreenOak, we have continued to originate loans that provide strong returns while maintaining a very defensible position in the capital stack. For instance, CM1 and CM2 loans continue to generate spreads at a compelling premium to other debt products at lower attachment points than one year ago. And the CM3 and value-add lending spaces are exhibiting the potential for equity-like returns.
Amid the turmoil of 2022, the second half of the year has become a lenders’ market generating many investment ideas, and we believe 2023 and 2024 will prove to be a particularly promising environment for commercial loans across the risk–return spectrum. While there will likely be continuing challenges, especially with downward pressures on investment volumes, upcoming debt refinancings and pullbacks in other lending segments (e.g., banks and securitized lenders) should enhance the opportunity set for investment managers.
For more details on the environment for real estate lending, check out SLC Management’s three in five podcast here.
Market insights are based on individual portfolio manager opinions and market observations. These are observations only and are not intended to provide specific financial, tax, investment, insurance, legal or accounting advice and should not be relied upon and does not?constitute a specific offer to buy and/or sell securities, insurance or investment services. Investors should consult with their professional advisors before acting upon any information posted here.
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