Earlier this week, Janet Yellen, the Chairman of the Federal Reserve, gave an important speech at the International Monetary Fund in Washington D.C., which offered listeners some insight into her thinking and what the central bank might do with interest rates going forward. Since 2008 the Fed has kept its benchmark federal funds rate at or near zero in an effort to stimulate economic growth. This has been successful as low interest rates have fueled increased investment activity in a number of different industries, including senior housing. Because of the effect that interest rates have on the cost of capital and valuations, senior housing providers and investors have been attuned to movements by the Fed to try to gauge what it might do with interest rates in the future so that they can adjust their behavior accordingly. While Ms. Yellen did not give audience members a date certain regarding when the Fed would raise rates, or by how much, her comments were still instructive and industry participants should take note of them.
Possible Results of Low Interest Rates
Two primary concerns that economists have with keeping interest rates low for a prolonged period of time are that this could lead to runaway inflation, which could seriously damage the economy, or it could lead to asset bubbles, which could also damage the economy if they were to suddenly burst instead of receding slowly. The risk of inflation appears to be low because there is no evidence indicating that it will rise above the Fed’s 2% target anytime in the near future. However, with respect to asset bubbles, the stock market continues to flirt with record gains and this has worried many economists because these gains seem to be excessive when compared with economic growth and other metrics such as price to earnings ratios, profits, and cash flows. Some economists fear that by keeping interest rates at historic lows for the past few years, the Fed is contributing to a stock market bubble that could throw the economy back into a recession if it were to burst, similar to the way the bursting of the dot-com bubble coincided with a mild recession in 2001. These economists argue that the Fed should raise interest rates sooner rather than later in order to reduce the risk of this happening. Ms. Yellen’s comments on this subject were highly instructive as she made it clear that she doesn’t believe that monetary policy can be used to curve financial excesses and successfully pop asset bubbles before they burst and inflict widespread economic damage. Instead, she believes that the Fed should tailor its monetary policy to fulfill its dual mandates of full employment and price stability, and leave the task of curbing financial excesses to rules and regulations. Of course, in addition to implementing monetary policy, the Federal Reserve is also tasked with regulating parts of the financial system and in this role Ms. Yellen believes that the stress tests it carries out and its ability to order banks to hold more capital are better tools to crush asset bubbles than changing interest rates. Her statement that“Monetary policy faces significant limitations as a tool to promote financial stability. Its effects on financial vulnerabilities…are not well understood and are less direct than a regulatory or supervisory approach; in addition, efforts to promote financial stability through adjustments in interest rates would increase the volatility of inflation and employment,” clearly demonstrates her views on the subject and also put economists on notice that the Fed will most likely not raise interest rates just to dampen a stock market that some economists think is inflated. Instead, the Fed will continue to use monetary policy to try to boost employment while keeping inflation low.
Ms. Yellen’s comments that continued growth in the stock market will not affect decisions that the Fed makes on future interest rate hikes is also important because market actors, including senior living providers, can now factor this information into their projections when trying to determine when the Fed will raise interest rates. By most estimates, the Fed is on pace to raise the federal funds rate in mid-2015. Before this happens, senior housing participants who are interested in obtaining capital to refinance loans, for growth, acquisitions, or other purposes, should contact the Chicago-based firm Cambridge Realty Capital to learn more about the many differentfinancing programs that it offers.