On September 17, the U.S. Federal Reserve cut the federal funds rate (overnight interest rate) for the first time this year. Policymakers were concerned about weakness in the labor market, which historically is an early sign of an economic slowdown.

Wall Street agrees that another interest rate cut might be appropriate at the central bank’s next two-day meeting on October 28-29.

The Push/Pull of Inflation vs. Jobs

The Fed has two main goals. First, keeping price stability which means keeping the Consumer Price Index (CPI) measure of inflation at a rate of around 2% per year. Second, setting policy to support a healthy employment market, although it doesn’t have a specific target for the unemployment rate.

According to the most recent data from August, the CPI is increasing at a rate of 2.9% this year. While 2.9% is clearly above the Fed's target, it’s down significantly from 2022 when it hit a 40-year high of 8%. That surge caused the central bank to increase the federal funds rate from zero to 5.25% in 2022 and 2023.

The Fed would normally hold interest rates steady with inflation still hovering close to 3%, but the jobs market has thrown a wrench in that plan. The U.S. economy created just 73,000 new jobs in July, below the 110,000 that economists expected. Plus, in that same non-farm payrolls employment report, the Bureau of Labor Statistics (BLS) revised the May and June numbers down by a combined 258,000 jobs, suggesting the economy is far weaker than initially thought.

The weakness continued in August, with just 22,000 jobs created during the month. While the unemployment rate hit a four-year high of 4.3%, economists expected to see about 50,000 new jobs. While we won’t know the official number until after the government shutdown ends and the BLS releases additional information, new private-sector employment data released by payroll processing giant ADP showed a net loss of around 30,000 jobs in September, a decline of 80,000 jobs from the earlier prediction. Ouch.

What Happens in October?

The Fed released a new edition of its quarterly Summary of Economic Projections (SEP) at its September meeting. It tells the public where members of the Federal Open Market Committee (FOMC) expect interest rates, economic growth, inflation, and unemployment to be over the next couple of years. But, for now, September’s employment data – a key metric for the health of the U.S. labor market – will not be released. At the same time, the increase in the unemployment rate is concerning.

When the Fed cut borrowing costs last month, Chairman Powell warned that the overall economic picture was so cloudy that central bankers were having a tough time forecasting what would come next. “Ordinarily, when the labor market is weak, inflation is low, and when the labor market is really strong, that’s when you’ve got to be careful about inflation,” Powell said at a mid-September news conference. The labor market was showing signs of weakness even as inflation crept up. As a result of those dueling forces, “there’s no risk-free path” ahead for the Fed, Powell said. “It’s quite a difficult situation for policymakers.”

According to the SEP, policymakers already favor an interest rate cut in October, followed by another in December.  Wall Street agrees: the CME Group’s FedWatch projection tool places the odds of an October interest rate cut at 96.2% and suggests there is an 86.3% chance of another 25-basis point cut in December.

We believe that further weakness in the jobs market will bolster the consensus for lower rates.

What Further Rate Cuts Could Mean for Public Equities

Typically, lower interest rates are great for stocks. They reduce borrowing costs, which provides a tailwind for corporate earnings, and they allow businesses to take on more debt to fuel growth. Falling rates also reduce the yield on risk-free assets like cash and Treasuries, which pushes more investors into growth assets like stocks and real estate.

However, the long-term direction of stock prices is determined more by corporate earnings than interest rates. When corporate earnings rise, stock prices typically trend higher, and the reverse is also true. If the Fed slashes interest rates because of a weak economic outlook, stock prices likely head lower in the short term despite the benefits of looser monetary policy.

The rising unemployment rate could be an early sign of trouble. It suggests businesses are cautious about hiring more workers, either because they are growing more slowly than expected, or because they feel concerned about the future. We’re hearing that in some of the conversations we’re having with our peers in various industries. Concerns about future growth do not bode well for earnings or, by extension, stock prices.

What Further Rate Cuts Could Mean for Commercial Real Estate

Rate cuts by the Fed generally have a greater impact on lending by commercial banks, the typical lenders for office, retail and industrial properties. Multifamily, on the other hand, is generally tied to lending from the government-backed lenders, Fannie Mae and Freddie Mac. Multifamily rates move in sync with the yield on treasury bills. Rate cuts by the Fed do not have a direct, linear impact on treasury yields, but they are an influencing factor.

A further reduction in rates should spur real estate transaction activity, which has remained sluggish since the peak in 2022. A reduction in rates generally increases overall investment returns, as positive debt leverage bolsters rates of return.

In the multifamily investing space, we see two primary tailwinds. First, a modest reduction in rates as noted above. Second, and perhaps more importantly, a dramatic reduction in new supply which should result in increased occupancy and rental rates during the next several years.

It’s choppy out there. We think the seas are not going to calm down for a while. Make sure you have your lifejacket nearby and don’t forget the Dramamine.

Lorne Polger is Senior Managing Director of Pathfinder Partners.  Prior to co-founding Pathfinder in 2006, Lorne was a partner with a leading San Diego law firm, where he headed the Real Estate, Land Use and Environmental Law group. He can be reached at lpolger@pathfinderfunds.com.