First Rate Cut Drives Rates Up

In what can best be described as a strange day, the Federal Reserve cut their target rate by 50 basis points.

Background

In early 2024, the market expected several cuts.

Throughout the year, hope for cuts largely faded.

However, during the third quarter, interest rates began falling again.

Over the last several days, the theory of a 50-basis point cut gained steam.

Today, it played out.

However, the reaction was pretty strange:

Source: MBSLive

It’s a bit strange. Blame it on commentary? That’s probably the best choice available.

The 2-year rate has been bouncing back and forth today, so there’s no way to tell if it will end higher or lower.

At the longer ends of the yield curve, rates moved higher on the day. However, all Treasury rates had at least a temporary dip on the announcement.

What On Earth Are REITs Doing?

First off, let’s cut REITs into segments.

Mortgage REITs are generally higher, based on the change in the index ETFs.

Looking at equity REITs, we see several different stories.

The largest equity REITs dominate the Vanguard Real Estate ETF (VNQ). VNQ is only up about 0.15%. It was up more, but it’s been falling as this article is prepared.

On the other hand, poorly managed and over-leveraged equity REITs dominate the Invesco KBW Premium Yield Equity REIT ETF (KBWY).

KBWY is up about 1.31%.

There is a plethora of narratives that could be used to explain that divergence.

My preferred narrative is that the over-leveraged REITs have more debt, so they are more exposed to refinancing. Therefore, a reduction in rates is more favorable for them.

That’s a good explanation, as long as we’re looking at 3-month rates.

The problem is that refinancing typically involves issuing debt that lasts many years.

Since Treasury rates longer than 2 years are all higher, that’s not favorable.

When a company issues debt, we can often think of it as issuing at a spread to Treasury rates. Since these REITs typically have too much debt, they will issue at higher spreads to Treasuries. 

However, it is still a rate that is influenced heavily by Treasury rates. With 5-year Treasury rates going up, the rate an investor demands to lend to the company should also go up.

Edit: By the time this one segment was finished, VNQ is down 0.1% on the day.

Best and Worst Performers

I keep a “portfolio” on Seeking Alpha that contains almost every REIT based in the United States and the BDCs we cover.

The only thing I do with the “portfolio” is sort it by which stocks are up (or down) the most.

Why?

Because the correlation can be interesting.

The best-performing REITs were office REITs.

SL Green Realty Corp (SLG)

Kilroy Realty Corporation (KRC)

Hudson Pacific Properties (HPP)

From this one statement, it would be easy to conclude that office REITs are hot.

Well, HPP suspended their common stock dividend less than two weeks ago. They aren’t hot. They are down dramatically compared to their 52-week high.

Suspending the common stock dividend is generally a bad sign.

The second REIT in that list, KRC is within 10% of the 52-week high. So go figure.

However, the market is not simply favoring REITs with too much debt.

Wheeler (WHLR) is a tiny REIT headed to $0. Down 25% today.

InnSuites Hospitality Trust (IHT) is a tiny hotel REIT. Massive volatility. Down nearly 10%.

Medical Properties (MPW) is known much better, it’s also a trash REIT with too much debt and bad management. MPW is down over 5%.

Note: MPW roared higher recently on news about Steward. The slump could be entirely driven by changes in the expected outcome of their settlement with Steward.

The Ironic Ones

The part I found interesting at first was the dip for the tower REITs. 

The market generally treated tower REITs and industrial REITs as more sensitive to interest rates. Since those types of REITs are typically intended for long-term growth, that makes sense.

So why would these REITs be down on a 50-basis point cut?

Because they aren’t moving on the Federal Funds rate. They are being influenced by the longer end of the curve.

10-year yields are up 5 basis points and 30-year yields are up 7 basis points is not remotely surprising.

KBWY Gets Slapped

KBWY’s gain of 1.31% on the day was reduced to 0.28% by the close. It isn’t down despite rates jumping higher, but the gain was mostly erased.

Conclusion

It’s been a pretty wild day.

That was expected since the market was going into this meeting with relatively equal odds assigned to a 25 or 50-basis point cut.

Either way, there was going to be a “surprise”.

However, the bigger surprise may be that the 2-year rates went higher after a bigger cut.

If it was just the 30-year rates, that would be pretty easy to explain as inflation expectations or something along those lines.

Do Words Still Have Meanings?

Near the end of the live stream of the press conference, Chairman Jerome Powell misused a term.

Would it be too much to ask him, as Chairman of the Federal Reserve, to not use the term “Labor Shortage” to describe something that is not a shortage?

Somehow non-economists (a group which includes Jerome Powell based on education, despite his position) decided it to fine to repurpose the word “shortage” to refer to any situation where they didn’t like the price.

In 2023, YouTube Premium prices were raised from $11.99 to $13.99 for customers in the US. Was that a shortage? 

They hammered subscribers who use an iOS device with $18.99 per month.  That was a 58% increase. So that must be a shortage, right?

How did we end up with a shortage of a service that could be sold an infinite number of times?

Not enough homes? Call it a shortage.

People won’t take a job getting yelled at for minimum wage? Call it a shortage.

I can’t buy a Tesla for $5. Can that be a shortage?

It does nothing to improve education when viewers are constantly bombarded by terms being misused.

The New York Jets could be “champions” if the term is applied to perpetual lottery teams.

What is a shortage?

A shortage is an event where you cannot legally buy something at any price.
There is debate over whether that should include “within reason”.

Many people took this “within reason” to mean “at the price they paid before”.

However, if there are no transactions because sellers are demanding a higher price, that is called a “price disagreement”.

Shortages are extremely rare, despite the constant abuse of the term.

When shortages occur, it is usually because of a government-imposed restriction on either the price or legal supply.