Legal Alert

Higher Rates, Tighter Money, Greater Distress: The Impact of the Fed's Latest Moves

February 2, 2023

The Federal Reserve raised interest rates on Wednesday by 25 basis points, marking the eighth hike in a year, bringing the target range to 4.5 to 4.75 percent. Rates were near zero a year ago.

Chair Jerome Powell also announced that the Fed was “continuing the process of significantly reducing the size of our balance sheet.” Though he did not go into detail, the central bank has been draining liquidity from the U.S. financial system by shrinking its bond portfolio by up to $95 billion a month through “quantitative tightening.”

The combined impact of the two measureshigher rates and tighter money -- appears to be effectively slowing inflation. Overall inflation eased to 6.5 percent annually in December, down from a four-decade peak of 9.1 percent in June.

“We can now say I think for the first time,” Chair Powell said, “that the disinflationary process has started.”

The hikes, however, have increased the costs of consumer and business loans, may continue to dampen real estate markets, and may fuel the risk of a recession.

The commercial real estate market is feeling the effects. Trepp’s CMBS Delinquency Rate had inched up for three consecutive months, rising to above 3 percent in December for the first time since July 2022. In January, the overall CMBS delinquency rate dipped slightly to 2.94 percent. According to Trepp data, the rate of retail delinquencies led all property types at 6.58 percent; lodging followed at 4.44 percent. Office delinquencies ticked up slightly to 1.83 percent from December’s 1.58 percent. Multifamily delinquencies stood at 1.56 percent.

Analysts expect delinquency rates to continue to climb, as a wave of maturities come due this year, rates rise, and traditional capital sources remain constrained.

An expected recession, however short, could seriously impact corporate and commercial property revenues resulting in further challenges in the public and private debt markets and further declines in commercial real estate.

The Fed’s measures have done little to effect the labor markets. Chair Powell said unemployment remained at “a 50-year low.” Job openings were up to 11 million in January from 10.4 million the month before.

Chair Powell indicated additional hikes to the benchmark rate may be coming in March and April.

“We have covered a lot of ground, and the full effects of our rapid tightening so far are yet to be felt,” he said. “Even so, we have more work to do.”

In a statement issued on the Fed’s website, the Fed also said it would continue to reduce its holdings of Treasury securities, agency debt, and agency mortgage-backed securities, as accordance with its previously announced plans. According to Reuters, the M2 money supply, the Fed’s main measure of the nation’s money stock, slid for a fifth straight month in December, falling by $147.4 billion from the month before to a seasonally adjusted $21.2 trillion.

Ballard Spahr's multidisciplinary Distressed Assets and Opportunities team is ready to meet clients where they are and assist clients through the turbulence of a macroeconomy where the cost of capital is likely to continue to increase over the foreseeable future, and its availability may become further constrained, creating both challenges and opportunities. Please contact us if you have questions or would like to learn more about our team.

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