The Rate Cut Story Is Falling Apart. Here’s Why That’s Not the Risk

The Consensus Narrative, and Why It’s Cracking

The case for a 2026 rate-cut cycle rested on three pillars: a softening labor market, cooling inflation, and a Fed willing to ease into a slowdown. Each is now under pressure.

• On inflation. The Iran conflict, now into its third quarter, has reintroduced energy as a meaningful inflation driver. April 2026 CPI came in at 3.8% year-over-year — the highest reading since May 2023 — with core CPI at 2.8% and core PCE running around 3.2%. Energy alone accounted for over 40% of April’s headline gain, but the more concerning data point is the pass-through into core. Jet fuel feeds into airfares. Diesel feeds into trucked goods. Shelter, which had been easing, ticked back up 0.6% in April. The Federal Reserve Bank of Minneapolis recently published research suggesting policymakers may not be able to “look through” this commodity shock the way they typically would, because we entered the war already running nearly 100+ basis points above the Fed’s 2% target.
  
• On employment. The labor market is not collapsing. April nonfarm payrolls came in at +115,000 against a consensus of +55,000, and March was revised up to +185,000. Unemployment held at 4.3%. The hiring rate, layoff rate, and vacancy rate have all been stable for over a year. This is not the picture of a market requiring emergency monetary accommodation.
  
• On the Fed itself. Kevin Warsh’s confirmation hearing was perhaps the most important macro signal of the year. Pressed on whether he had committed to rate cuts as a condition of his nomination, Warsh stated explicitly that the President “never asked me to commit to interest rate cuts. He did not demand it.” That single sentence, delivered against a backdrop of public political pressure, reframed market expectations within hours. CME FedWatch now prices in no more than one cut for all of 2026. A Reuters survey of 103 economists found 56 expected rates to stay steady through September. JP Morgan’s house view contemplates a tail-risk scenario in which the Fed actually hikes in early 2027.

The rate-cut narrative is not dead. But it is now a tail outcome, not a base case. And the deeper point is that the entire framing was built on a question that may not be the right one to ask.

A Different Frame

The CRE industry has spent the last eighteen months litigating a question that’s fundamentally unanswerable in real time: where are rates going? An enormous amount of capital and underwriting has been built on directional bets about a variable that has confounded every major forecaster repeatedly since 2022. We’ve been guilty of caring too much about the answer ourselves, at various points.

The more useful question, in our experience, is a different one. Not where are rates going, but what strategy performs across the range of plausible outcomes?

That reframing forces a different kind of underwriting. Strategies that require rates to fall meaningfully — high-leverage acquisitions priced at sub-6% cap rates, opportunistic plays underwritten to compressed exit assumptions, refinancing-dependent business plans — are essentially levered bets on the path of monetary policy. They can produce extraordinary returns when right. They are also disproportionately exposed when wrong.

Strategies built around durable NOI growth, conservative leverage, and net-lease structures with built-in rent escalators look different. They benefit from rate cuts when they happen, but they don’t require them. The cash flow story is the cash flow story. That doesn’t make these strategies better — it makes them less dependent on getting the macro call right. Our own underwriting reflects this: we model flat rates and cap rates at disposition, and we look for returns through under-market rents and other operational levers we can pull regardless of what the macro environment does. For most of the last two years, the consensus view has rewarded conviction about a specific macro outcome. We think the next two years will reward humility about the range.

How We Stack Up Across Four Scenarios

Here’s how we think about the four scenarios most likely to play out — and how our strategy performs in each. We’ve put rough probability weightings on each, but the numbers matter less than the discipline of forcing yourself to assign them. Honestly, the most useful conversations we’ve had internally over the past six months haven’t been about which scenario will play out. They’ve been about how our portfolio performs in each one, and what we’d adjust if our base case shifted.

1. Scenario 1: Rates stay range-bound at 5.5–6.5% — our base case. This is what current Fed Funds futures and most economist surveys imply, and it’s the environment our strategy is purpose-built for. Transaction volume normalizes as bid-ask spreads compress around a stable benchmark. NOI growth becomes the dominant return driver. Operational levers — lease-up, mark-to-market on under-market rents, capital improvements — produce the kind of returns that don’t require a Fed assist. Sponsors who depended on cap rate compression to make their numbers work struggle; sponsors with real operating playbooks do well. We expect to perform strongly here.
2. Scenario 2: Modest rate cuts in late 2026 or 2027 — a meaningful tailwind. A path back toward 4.5–5.0% on the Fed Funds rate. Acquisition financing improves; existing assets benefit from modest cap rate compression on top of the NOI growth we’ve already underwritten. This is a strong scenario for us. The only honest caveat is that more aggressive sponsors who underwrote cap rate compression will outperform on paper — they took the leverage and basis risk we didn’t, and in this scenario, that risk pays off. Our returns are still excellent. They just aren’t maximized in the way that aggressive underwriting can maximize them in a cut cycle.
3. Scenario 3: Stagflationary persistence — a tail risk that’s grown more plausible, and one our structures are designed for. Sticky 3%+ inflation, stalling growth, Fed paralysis. A scenario the Iran conflict has made meaningfully more likely than it was six months ago. This is where the structural features of our deals do real work: net-lease structures with CPI-linked or fixed escalators pass cost increases through to tenants rather than absorbing them at the landlord level, and replacement cost protects our basis on existing assets. The honest caveat — and it’s an important one — is that the pass-through mechanism is only as durable as the tenants’ ability to absorb it. Labor, inputs, utilities, and rent all moving in the same direction puts real pressure on a tenant’s income statement. In a true stagflationary environment, the underwriting question isn’t whether the lease passes costs through. It’s whether the tenant survives the pass-through. That’s why credit underwriting at acquisition matters as much as the lease form itself. It’s also the discipline we’ve leaned into hardest since 2022 — we expect to perform well here, but we earn that outcome at the front end.
4. Scenario 4: Deflationary recession — the least likely scenario, and the one we’d struggle in. Demand collapses, tenants struggle to absorb passed-through costs, and the inflation-protective features of NNN leases become less useful because there’s no inflation to protect against. Vacancy risk rises, lease-up timelines extend, and rent escalators reset downward at renewal. This is the genuine vulnerability in our strategy. Tenant credit quality matters more than asset quality, and diversified rent rolls are the only real protection. Disciplined acquisition underwriting is the best mitigant we have, but a true deflationary recession would be a difficult environment for us.

What We’re Honest With Ourselves About

Across those four scenarios, we’re confident in three and clear-eyed about the fourth. Scenarios 1, 2, and 3 are all environments where our strategy delivers the kind of returns our investors expect — strong in the base case, accelerated by cuts in the modest-easing case, and protected by structure and credit discipline in the stagflationary case. Scenario 4 — a genuine deflationary recession — is the one we’d struggle in, and we don’t think pretending otherwise serves anyone. We haven’t seen that environment in commercial real estate since the early 1990s. We watch for it. We size our positions and underwrite tenant credit with it in mind. But if it arrives, our strategy is not the one that will outperform.

The other thing worth saying plainly: in a fast and aggressive rate-cut cycle, the more aggressive sponsors will outperform us on paper. That’s a function of the leverage and cap rate assumptions we deliberately don’t take, not a flaw in execution. We’d rather produce excellent returns in most scenarios than maximum returns in one, and we think most investors who’ve watched the last three years would agree.

What This Leaves Us With

The investor takeaway isn’t that any single macro outcome is more or less likely. It’s that the debate itself has been miscast. Asking “when will rates fall?” presupposes an answer the data doesn’t currently support, and it frames CRE allocation as a directional macro bet.

The more useful question is whether a given strategy is structured to perform across the range of outcomes that are actually plausible — and whether the sponsor running it has been honest about the scenarios in which it would not.

We don’t know where rates are going. Neither does anyone else, including the Fed. What we do know is what’s in our rent roll, what our basis is, what each asset would do in each of the four scenarios above, and which tenants will be paying us through our hold period. Those are the variables we can actually underwrite, and those are the variables we believe will drive returns over the next cycle.

The rate cut story may continue to fall apart. It may not. We’re not betting on it either way.

Excelsior Capital is a private real estate investment firm focused on value-add acquisitions of industrial, medical office, and retail assets in growth markets across the Southeast and Midwest United States. Nothing in this commentary constitutes investment advice or a recommendation to buy or sell any security. Past performance is not indicative of future results.