2024 Prediction: The Federal Reserve will stop its balance sheet runoff.

Let’s end the year by calling a shot about the next.

Prediction: The Federal Reserve will stop its balance sheet runoff

The implications of this will be meaningful for residential and commercial real estate. But first, here’s why:

The Fed has been shrinking its bond portfolio after peaking at over $8.4 trillion. Since runoff began in May 2022, holdings have shrunk over $1T to $7.1 trillion. This is the largest quantitative tightening undertaken by the Fed (admittedly, only the second true QT cycle ever).

Tightening does two things, one implicitly and one explicitly. Implicitly, it reduces securities demand. No longer an active buyer, the demand pool returns to the traditional purchasers. By nature, less demand makes issuances less valuable, and pushes yields upwards. Explicitly, it rapidly expands supply, too. When treasury securities held by the Fed mature, the treasury must repay the Fed. How does it do this? By issuing new securities. Only now, the Fed is no longer a buyer. Supply has expanded and the demand has decreased. Both reduce security values and push yields higher.

Compounding this pressure is the US budget deficit, which also must be financed by the treasury. The expanding deficit has led, of course, to more treasury issuances. The market is now flooded with treasuries from both the balance sheet runoff and the budget deficit. With the Fed out of the picture, how is demand meeting this supply?

The answer lies, paradoxically, with the Federal Reserve, again. Its reverse repurchase agreement program (RRP) has been funding purchases. The RRP program allows institutions to park excess liquidity at the Fed in exchange for securities that earn them yield. Simply, when there is a lot of cash in the system, the RRP program balance will increase. When it decreases, this cash is being used elsewhere, namely, to purchase new securities.

This pot of liquidity has shrunk from $2.3T in April to $724B today and is a key means of meeting the expanded supply of treasury issuances.

As tightening continues, though, it will eventually hit $0 again. This excess liquidity will be drained from the market, removing yet another demand driver. To keep supply and demand stable (the treasury needs buyers for all its issuances, after all), the Fed will step in. Since it cannot do anything about the deficit, the only other lever to pull is to curb its balance sheet runoff. When security holdings mature, the Fed can opt to reinvest the proceeds rather than take the cash proceeds from the treasury. This would end the need to find new buyers of treasury issuances funding the Fed’s runoff. The Fed’s reinvestment would effectively neutralize this additional supply and keep its balance sheet at a static level.

The Takeaways

The implications of this on interest rates are difficult to diagnose apart from a clear inference: a bond route (and higher yields) becomes less likely. Many other factors affect bond demand from buyers all over the world. But all else equal, this would be good news for residential and commercial real estate investors looking to secure cheaper financing next year.

Combined with a pending Fed rate cut cycle, demand for bond safety should be high. Short term rates will be impacted the quickest as the yield curve un-inverts. And, of course, it gets the Fed one step closer to an easing cycle.

ALX in 2024

Shifting gears, this year has had its fair share of challenges, and while difficult and trying, challenges present opportunities to grow.

For us, that growth includes investment type expansion and offering new ways to support real estate sponsors and investors.

In 2024 and in addition to multifamily, we will partner with trusted land developers and home builders to develop and build single-family homes.

We will also offer the following services:

  • Investment Analysis
  • Project Underwriting
  • Market Analysis
  • Modeling
  • Insights Report
  • Investment Presentation
  • Pitch Decks
  • Capital Raising Strategy
  • Communication and Reporting Templates
  • Limited Partner (LP) Advisement
  • Opportunity Evaluation (Micro)
  • Risk Assessment (Macro)
  • Sponsor Interview
  • Insights Report
  • Asset Management
  • Financial Report Audit
  • Business Plan Evaluation
  • Sell vs Refi Analysis
  • Performance Reporting
  • Debt Consulting
  • Capital Markets Overview
  • Loan Application Presentation
  • Term Sheet Review

Our team is excited for the future, but before we get too far ahead of ourselves, we want to stop and express gratitude to all of you who continue to trust and believe in us. We are thankful and much appreciative for what you do and who you are.

God bless you, and we hope you and your families have a wonderful Christmas!

Patrick Dunne
Leads property underwriting, economic analysis, debt structuring, and investment management.
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