If your head is spinning from all the good news/bad news scenarios whipsawing the financial markets

this year, you’re not alone. Already 2022 has been one of the most volatile years in recent memory -- and we’re just starting October, which is historically the most volatile month of the year. According to LPL Research, more than seven out of eight (87%) trading days so far in 2022 have experienced daily swings of at least 1%. Pop a few Advil. The last time the market experienced intraday volatility this often was in 2008 — amid the Great Recession and a global financial crisis.

The whirling financial dervishes are wreaking havoc on the bond market as well. Treasury volatility (as measured by the MOVE index) is at its highest level since the depths of the pandemic in 2020. The Fed’s aggressive commitment to tightening monetary policy has pushed bond yields higher, exacerbating the biggest selloff in at half a century. Meanwhile, the risk of recession keeps growing, thus creating the yin yang effect. Rates retreat downward as investors sell stocks and plow funds into Treasurys as a haven. The unheard-of intraday swings of up to 35 basis points in the normally slumbering 10-year T-bill are truly unsettling. I have one screen monitoring the bank at all times so I’m always looking to rate-lock clients at the bottom of the day.

Folks, I’m feeling like a day trader lately and that’s not healthy.

As Bloomberg observed: “The tug-of-war in the Treasury market is unlikely to subside until the outlook for the economy and the Fed’s interest-rate path are clarified.” Good luck on that.

What’s clear is that when you have the worst stock market since the global financial crisis and the worst bond market since the Great Depression, every piece of economic data seems to take on larger-than-life importance. I hope all this spinning isn’t making you nauseous yet.

As The Journal added, “economic data swings about from month to month, while the market treats them as gospel truth. Any data point has the potential to create huge swings and changes in directions. Overreactions thus become far more likely.” In layperson’s terms, it’s a chase down the rabbit hole as everyone is perseverating about further Fed tightening. Short term worries are being magnified to any potential problem. Case in point, last week the British government bond market cracked and had to be saved. That in turn exposed potential risks lurking in pensions and government bond markets, which have traditionally been very calm waters during past financial flare-ups.

It’s pretty clear that volatility and uncertainty will be the rule, not the exception near term. Many rate watchers expect the Fed to lift interest rates to the highest level since 2007 as part of its war on inflation. Bankrate’s Third-Quarter Economic Indicator poll says the key federal funds rate will peak at a range of 4.5% to 4.75% in 2023. Those are levels we haven’t seen since late 2007. Those moves could also help keep another key borrowing benchmark — the 10-year Treasury yield — at an elevated level a year from now. The average forecast among economists in Bankrate’s poll put the interest rate at 3.79% by September 2023, a level we haven’t seen since 2010.

Newsflash: The 10-year T-Bill has tipped over 4% in the last month and currently trades at 3.95%. Economists may still be right with their forecasts -- but for the wrong reasons. What goes up must come down. The effects of Fed tightening are starting to look more like buckshot than pin pricks into the economic balloon. With a soft landing not so likely, long term rates can collapse just as quickly as they rise. ​

CRE in a rising rate environment ​

After a decade-plus of low-cost financing, the CRE industry is adjusting to a big jump in the cost of debt. In some cases, loan rates that were quoted around 3% six months ago are now squarely in the 5% range. For some lenders with higher cost of funds, I’ve had deals at moderate 60% leverage quoted north of 7%. CRE financing is still readily available, but it’s now more critical to find favorable terms to make the deals work, as I had mentioned in my recent blog about debt being the tail wagging the CRE dog.

For the first time in the past two years, cap rates increased for two straight consecutive quarters, according to Randy Blankstein, who runs Net Lease Advisory. If you’re keeping score at home, Blankstein said single tenant cap rates increased to 5.86% (+6 bps) for retail, to 6.80% (+3 bps) for office and to 6.61% (+1 bps) for industrial in the third quarter of 2022. The correlation to rising interest rates is no fluke. There really are no additional variables to consider other than borrowing costs and cap rate in NNN. If borrowing costs go up by 50 basis points, then cap rates will generally increase commensurately over a period of time. Cap rates and asset prices generally follow interest rates: the cause and effect of the investor’s required rate of return.

We are foraging our way out of what is commonly known as the Buyer-Seller Gap. Sales inventory diminished ​ as “formerly optimistic sellers,” trying to take advantage of historically low cap rates, attempted to cash out, but missed green on the roulette wheel. The cause and effect of rate movement saw the supply of net lease properties decrease by more than 12% in Q3 compared to Q2. The sales market has started to regain traction as property pricing slowly comes into line with the new reality of Fed tightening. In a positive rate environment, something must give and it is usually cap rates expanding for a lower price point.

Many CRE investors are on a treasure hunt for yield. They’re bypassing investment grade tenancy with flat rents and superior location simply because the income has no hedge against inflation. Factor in negative leverage (loan rates higher than cap rate) and you are a left with a paltry return that may equal today’s 2.85% money market payout. While waiting on official market statistics, my Spidey senses along with the pile of offering memorandums on my desk recently quoted signal most sellers have repriced to the new reality. The occasional negative leveraged deal gets whacked very quickly back into its hole.

The days of juicing your return with a rock bottom interest rate are in the rear-view mirror. However, debt when structured efficiently, creates a long-term winning play. The economic tea leaves tell us a recession, with a subsequent reduction in interest rates, is almost inevitable. How quick and severe the recession is, well, that’s the wager every investor must make based on their own modeling. My inputs always include 30-year amortization to maximize present cash on cash returns, and open prepayment so there is no punitive measure when the rate axe falls…and the ax will fall during the loan term.

As author and motivational speaker Rick Warren said: “The most damaging aspect of contemporary living is short-term thinking.” Until we change that mindset, expect more whirling dervish-ness in the market until things stabilize.