February 15, 2019
As news releases go, it wasn’t the most earth-shattering of announcements. A table of interest rates had indicated a rate of 4.6% for the fourth quarter of 2018, but that figure was corrected to 4.8%.
Yet coming from the Federal Reserve, which both analyzes and issues troves of data on a daily basis, it was a rare acknowledgement of a slip-up and a reminder that even omniscient policy-setting bodies occasionally make mistakes.
The setting for this 20-basis-point inaccuracy was several pages of tables of both historical and hypothetical variables, ranging from euro zone GDP growth to U.S. mortgage rates. The 4.6% mortgage rate originally published for Q4 may well have been a proofreader’s error, since 4.6% was the mortgage rate for Q3.
The uncorrected Q4 mortgage rate data suggested that rate increases were flat from Q3. In fact the rate has increased every quarter since Q4 2017—the only four-quarter stretch of consecutive growth going back to Q1 2000.
In turn, these tables followed the Fed’s discussion of its 2019 scenarios for the “stress tests” of large financial institutions, which are mandated under Dodd-Frank in the wake of the 2008 financial crisis.
Of interest to commercial real estate is the Fed’s “baseline” scenario through 2022, as well as the fact that its “severely adverse” scenario is even more severely adverse than last year’s. The hypothetically stormier weather in the 2019 scenario is in keeping with the Fed’s Policy Statement on the Scenario Design Framework for Stress Testing, “which calls for a more pronounced economic downturn when current conditions are especially strong.”
The baseline scenario for the U.S. is pretty much what the country has experienced in recent years: a moderate economic expansion through the scenario period. “Real GDP growth averages 2.25% in 2019, drops slightly to 1.5% in 2020 and then rises to 2% in 2021,” under the baseline scenario.
This scenario calls for unemployment to continue dropping to about 3.5% this year and then increase to about 4% during the first half of 2021. CPI inflation averages about 2.25% each year.
At the other end of the spectrum, the “severely adverse” scenario is characterized by “a severe global recession accompanied by a period of heightened stress in commercial real estate markets and corporate debt markets,” according to the Fed.
Unemployment peaks at 10% in Q3 of 2020 under this scenario, while real GDP falls about 8% from its pre-recession peak, reaching a trough in next year’s third quarter.
“As a result of the severe decline in real activity, the interest rate for three-month Treasury bills falls 2¼ percentage points and remains near zero” through the end of the “severely adverse” scenario. “The 10-year Treasury yield falls by a somewhat smaller amount, resulting in a mildly steeper yield curve.”
Somewhere between the best-case “baseline” scenario and the worst-case “severely adverse” scenario is the “adverse” scenario. “The macroeconomic and financial developments in this year’s adverse scenario are similar to the developments in the severely adverse scenario, but are more moderate in magnitude,” according to the Fed.
“As a result, the two scenarios together allow for an investigation of the relationship between firm-specific outcomes and the intensity of economic and financial dislocations.”
For comments, questions or concerns, please contact Paul Bubny