Facts Matter

Most economists (if not all) believe that the Fed will lower the discount rate by another 25 bps later this week when they meet. We think it is time for the Fed to pause and stay put.

Fed Chairman Ben Bernanke should halt the roaring commodities rally by keeping rates steady. He needs to wait to see the impact of his past short-term interest rate cuts before he takes more action. Unfortunately, the Chairman and his colleagues are unlikely to take rate cuts off the table entirely (lesson from the past, the Fed did that in October by saying weak growth and inflation were of equal concern. Within weeks, deteriorating market conditions forced the Fed to signal a resumption of rate cuts). However, while downside risks to the economy persist today (far less than 6 months ago), we remain very unsettled about inflation and its impact on the global economy. We worry that inflation is feeding the fall in the dollar and the rise in commodity prices, and that further rate cuts could aggravate inflation and reduce the world confidence and dependency on the U.S. dollar.

The Fed chief’s inflation-fighting credentials have been in doubt since he said in a 2002 speech that “central banks could prevent deflation by dropping money out of a helicopter.” This is more evident today by the Fed’s aggressive response to the current credit crunch and its six rate cuts in the last 7 months. Unlike his predecessor, the current Fed chief is far more concerned with recession than the possibility of growing inflation.

One could come to conclusion that the Fed is partly to blame for the spike in commodity prices since rate cut policies have helped to weaken the dollar (I never thought that I would be criticizing the Fed’s action). The rate of inflation growth (32 bps just in the last 6 months) has surpassed many economists’ forecasts and will significantly deteriorate the economy by slowing consumer spending. It also could send a powerful statement to global monetary policy makers that this Fed is letting inflation out of its sights. The Fed chief needs to restore the world confidence in the U.S. dollar and start stabilizing its value immediately before other governments start taking steps to unload their reserve dollars and replace it with more commodities, which could fuel the inflation and price increases.

The recent reports of food shortages and riots in developing nations and food rationing in developed nations (Costco and Sam’s club are rationing rice) should send a strong signal to the Fed Chairman and all governing bodies. The Fed has taken appropriate steps to rescue the financial systems, now it needs to do more to bolster the sagging US dollar.

The jobless claims dropped unexpectedly last week (economists predicated claims would rise by 3,000). The Labor Department’s report that claims for unemployment benefits declined by 33,000 last week to 342,000 and the notion that unemployment might be contained appeared to cap some concern about the economy. This is good news for the office market and we still see no significant increase in vacancy rates and steady increases in the rental rates. The only weakness in the Commercial Real Estate sector is lack of available debt financing that we think should resume by end of this quarter (banks will not make any money if they don’t lend).

We continue to favor investment in selected or Rising Markets such as Texas. The Houston and Dallas office markets continued with positive real estate indicators through the first quarter 2008 compared to other parts of the country. The rapid pace of decreasing vacancy and increasing rents is an excellent indicator of the resilience of this State’s fundamentals. Stronger job growth and very stable unemployment are major reasons why lenders should start lending in this market before they miss the opportunity.