What Could Make the Fed Continue Tightening?

More housing price increases might squelch the conventional wisdom that July’s hike will be the last, some strategists say.


Wednesday will be the last rate increase from Federal Reserve policymakers. At least, that is the widespread expectation for the July Fed meeting, as inflation has slumped two-thirds, to 3.0% annually in June, from 9.1% 12 months before. Since March 2022, the central bank has steadily raised its benchmark federal funds rate, now in a band between 5.0% and 5.25%.

But what might convince the Fed that more boosts, at least one at the September meeting, are warranted?

Housing costs. Home prices have begun to rise again, as demand for homes still outpaces the supply, according to Torsten Sløk, chief economist for Apollo Global Management, in a note.

“If housing begins to recover more meaningfully, that raises the risk that inflation is going to be more sticky,” he observed. “The real risk here is—meaning from a markets perspective—that the Fed has to step harder on the brakes.”

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Home prices have bounced back after last year’s slide, S&P Corelogic Case-Shiller data indicated. They peaked in June 2022, then gradually began ascending again, rising 1.3% annually in April, the most recent reading.  

Shelter costs, a broader measure than home prices, constitute about 40% of the core Consumer Price Index. Rent increases—and the equivalent housing costs for owned homes—have stayed muted this year. But this is a lagging statistic, with the most recent reading in May. The fear is that higher home purchase prices eventually will lift those rent and rent-equivalent numbers.

While expecting housing inflation to soften up ahead, “a rebound in housing would pose an upside risk to inflation down the road,” warned Dallas Fed President Lorie Logan at a conference earlier this month.

Fed Chair Jerome Powell “will not rule out further action, pointing to the June projections that indicated most members expected more than one hike before year-end would be appropriate,” wrote Michael Gapan, U.S. economist at Bank of America Securities.

The futures market forecasts that the federal funds rate will rise at the July meeting by a quarter percentage point and stay there through year-end. At its June conclave, however, policymakers signaled in their “dot plots” survey that the median benchmark will be 5.6% come December. Getting there would take two more 2023 rate hikes.

On Wednesday, “investors will be watching closely to see if there’s any messaging as to whether a subsequent hike will be announced at the September meeting,” said Stephen Rich, chairman and CEO of Mutual of America Capital Management.

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Private Credit: Fees Down, Rates Ascend

Investors in the in-vogue asset class hope that rising yields will boost their take.




Institutions have been piling into private debt limited partnerships in hopes of fat yields derived from rising rates, a study from consulting firm Callan LLC found. In the meantime, these investors do get one benefit: Fees are on the way down.

Among asset allocators, private credit is the in thing. Its assets under management jumped to $1.2 trillion globally last year, from just $332 billion in 2010, Preqin research found. That total should hit $16.1 trillion in 2027, PitchBook estimated. Among U.S. and Canadian public pension plans, per Preqin, private credit claims 3.8% of portfolios. 

Helping that trend are Federal Reserve-stoked interest rates—private credit is largely a floating rate asset class, thus benefiting from the Fed’s upward rate movement.

Callan surveyed 330 private credit partnerships that were launched between 2016 and last year’s third quarter, aiming to allow investors a peek into how this burgeoning asset class is doing as a whole.

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About two-thirds of the assets in this asset class are devoted to direct lending, in which a private credit fund makes a loan to a business, typically for three years. The rest of private debt is devoted to lending strategies ranging from real assets to distressed companies.

With the expansion of private debt funds, the management fees raked in by the general partners (nowadays often a massive financial giant with a large private equity presence, on the order of Apollo Global Management) have dipped. Originally, the funds followed the PE model and charged 2% annually of assets under management. In recent years, that has descended to a median 1.15%, Callan reported.

The general partners’ take of the distribution—when loans are paid off or, before that, as interest payments are distributed to investors—has classically been 20%, following the PE paradigm. But over time, with more entrants into the private credit field, that has come down to about 15% (known as carried interest), by Callan’s reckoning.

The hurdle rate—the minimum return GPs must clear before helping themselves to the carried interest bonanza—has been between 6% and 7% in recent years, down from the 8% that had long prevailed before the 2008 financial crisis, the report stated. Many LPs argue, Callan noted, that the hurdle rate should be restored to 8%, in light of today’s higher interest rates.

Related Stories:

What Could Derail Private Credit’s Momentum?

Popular Private Credit Strategy Will Keep Low Default Rate, Study Says

Private Credit: Too Risky? Not for Asset Allocators

 

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