The Fed’s independence

The Federal Reserve’s job is to promote stable prices and maximum employment independent of interference from Congress or the White House. Like central banks in most capitalist democracies, the Fed has the freedom to deploy tools—mainly interest rate benchmarks—to achieve its goals.

Monetary policy relies on the Fed's ability to maintain its independence amid rising political pressure. The Department of Justice launched a criminal investigation into current Fed Chair Jerome Powell regarding his testimony on renovation of the Fed's headquarters. In an uncharacteristically candid video, Powell described the investigation as a "pretext" by the Trump administration to pressure the Fed into lowering interest rates.

Historically, most outgoing Fed chairs leave their governor roles at the end of their leadership term. While Powell’s term as chair ends in May, he could choose to stay on the FOMC as a governor through 2028.

“Markets will be watching closely for any signs of changes in Fed independence or policy direction, as these could affect both short- and long-term interest rates,” according to Chambless. 

The Trump administration announced its intent to nominate Kevin Warsh—who supports lowering interest rates—as the new Fed Chair when Powell’s term ends. However, there could be delays in the confirmation process, as Senator Thom Tillis stated that outstanding questions arising from recent Fed subpoenas must resolved before the nomination of a new Chair is considered.

It's important to remember the Fed Chair is only one of the FOMC’s 12 voting members. Although they have a strong influence, the Chair ultimately has no more power than any other member and must persuade a majority of the committee to join them on any initiative.

Continued treasury volatility

“The bond market craves certainty and stability. Earlier in the year, it instead had to deal with uncertainty and chaos due to the on-again, off-again status of tariffs,” said Mike Kraft, Commercial Real Estate Treasurer for Commercial Banking at J.P. Morgan.

As the administration reached trade agreements, tariffs became less of a concern. “However, there has been a renewed willingness to impose fresh tariffs in spite of those trade agreements, which has reintroduced uncertainty into bond markets,” Kraft said.

“Warsh’s track record as an inflation hawk during his previous stint at the Fed from 2006 to 2011 raises additional uncertainty with regard to his possible stance in the longer term,” Kraft said. “He is also known to view the use of the Fed’s $6 trillion balance sheet as a management tool with disfavor. Any effort on his part to reduce the balance sheet could bump up longer term rates.”

The impact of actual or perceived inflation is felt most acutely in the realm of medium- and long-term Treasury yields, and uncertainty regarding such perceptions can result in volatility. Market volatility and economic uncertainty can influence interest rates in both directions.

“Increased uncertainty often leads investors to seek safer assets, including U.S. Treasuries, which can push rates lower. Central banks may cut policy rates to support growth if the economic outlook deteriorates in response to uncertainty,” Chambless said. “Alternatively, persistent market swings can prompt lenders and investors to demand higher returns for added risk, potentially driving rates higher. The net effect depends on how markets and policymakers respond to evolving conditions.”

How the Fed affects short- and long-term interest rates

As always, it’s important to differentiate between short- and long-term interest rates and how the Fed’s actions impact each.

• Short-term interest rates are directly impacted by the Federal Reserve. As the Fed’s primary tool for influencing interest rates and the economy, the federal funds target range directly drives other short-term market rates such as prime and SOFR.
• Medium- and long-term interest rates—such as yields on Treasury notes and bonds, interest rate swaps and corporate bonds—can be influenced by the Fed but ultimately depend on the market’s long-term expectations of inflation and the direction of the economy. From day to day, supply and demand can also drive these rates. Because the collective view of the market is outside of anyone’s control and can be driven by many factors, long-term rates are more difficult to forecast and—particularly in the current market environment—can exhibit considerable volatility.

What future interest rates could mean for commercial real estate

“While the fed funds rate and Treasury yields remain above pre-pandemic levels, they have eased from their recent cycle highs as inflation pressures have moderated,” Chambless said. “Looking ahead, the 2-year Treasury yield is projected to reach 3.85% and the 10-year yield 4.35% by year-end, end, assuming our outlook for resilient growth and persistent inflation is correct.”

“Economists differ widely in their outlook for the year,” Kraft said. “Even setting aside uncertainty arising from the American political scene, unexpected outside factors—the recent selloff in Japanese bonds, or regional tensions, or oil prices—may grab headlines from time to time and influence the course of events.”

“The Fed is presently on a wait-and-see course, evaluating data as it becomes available to determine what actions, if any, to take at the time of each FOMC meeting,” Kraft said. ”But the future economic and political environment could shift the Fed’s timeline unexpectedly”

The cost of tariffs could be passed to producers and consumers in the form of higher prices, causing measures of inflation to rise. “Higher inflation would likely result in stable to higher interest rates as the FOMC might deem it appropriate to stay on pause for longer,” Chambless said.

Higher-for-longer interest rates could keep the environment for commercial real estate somewhat challenging, but to varying degrees. “Each local market and asset class will face its own unique dynamics depending on population trends, employment trends, and supply and demand,” Chambless said.

• Demand for affordable multifamily properties remains elevated, while there’s some downward cyclical pressure on luxury properties.
• Industrial real estate is beginning to normalize, but still experiencing tailwinds related to domestic manufacturing capacity and infrastructure investments to meet customers’ on-demand expectations.
• Retail performance has been mixed depending on location and concept. Neighborhood shopping centers continue to perform well.
• Office is starting to show signs of normalization. As more employees return to the office full time a flight to quality is possible.

The possibility of a recession

A recession could have wide-ranging impacts on multifamily and other commercial real estate assets. An economic downturn could also impact interest rates. 

“Typically, the FOMC would adjust interest rates lower in a recessionary environment,” Chambless said. “How quickly rates drop and to what degree depends on how high inflation is running and the severity of an economic slowdown.” 

“In the event of stagflation—a recession accompanied by higher prices—the situation becomes more complex, and creates more challenges for decision-making by the Fed,” Kraft said. “The Fed would ultimately need to decide at the time which risk—higher inflation or lower employment—demands their immediate attention.”

While interest rates have a unique influence on commercial real estate, it’s important to look at multiple economic factors, including:

• Labor markets: Labor markets remain steady. Total nonfarm payroll employment increased by 50,000 in December. The unemployment rate changed little at 4.4%, according to the U.S. Bureau of Labor Statistics.
• Inflation: Inflation progress has stalled in recent months. As of September, the Personal Consumption Expenditures (PCE) price index increased 0.5% in November from the previous month. Excluding food and energy—the Fed’s preferred inflation index—the PCE price index increased 0.2% in November from the previous month and 2.8% from November 2024.
• Commercial mortgage rates: Treasury yields can impact hybrid- and fixed-rate loan pricing for commercial real estate investments. Rising yields may reflect higher levels of expected inflation in the long term, while falling yields could indicate lower inflation and a possible slowdown or recession.

It’s also important to consider factors specific to commercial real estate, such as location, asset class and cap rates, as well as demographic shifts and supply and demand.