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Without policy changes, the economy’s trajectory is unaltered

The U.S. economy expanded at an annualized rate of 2.6 percent based on the advanced estimate. This rate fell within, but at the low end, of our estimated range. During the annual revision, growth in the prior three quarters was revised downward, which brings that average growth rate in the first half of the year to 1.9 percent and the year-over-year growth in the second quarter to 2.1 percent. Both growth rates registered just a shade below the 2.2 percent average during the current economic expansion. The economy has now officially entered its ninth year of expansion, the third-longest in history. Growth during the second quarter was supported by stronger consumer spending (after a weak start to the year), business investment, and international trade.

economic growth

In the absence of any substantial fiscal or monetary policy changes, nothing fundamental about the way the economy operates has been changed. As a result, we expect the economy to continue along its current trajectory for the rest of this year, with growth of around 2 percent. The potential for somewhat stronger growth in 2018 remains, but only if policy changes occur. Quarterly growth spurts remain possible, but are harder to achieve as the expansion ages. For example, the economy has not grown by 3 percent or greater at an annualized rate since the first quarter of 2015. Expectations for sustained stronger growth, particularly at this late stage of an economic expansion, amount to little more than wishful thinking. The economy has not grown by 3 percent or greater during a calendar since 2005, although it came close in 2015.

What does it mean for CRE?

As we've said in the past, this "Goldilocks" economy serves commercial real estate well because it prevents expansion-ending imbalances from building. It also extends the economic cycle, supports real estate fundamentals, and maintains investor interest in the asset class. While each of the major property types are facing some form of headwind, none of those is a function of economic growth:

  • The office market continues to see rising rents, even as vacancy drifts slightly higher, because the market remains relatively tight and new construction supports wage growth. The biggest challenge remains a lack of labor to fill jobs, which has limited net absorption.
  • Industrial rents remain high and vacancies at or near all-time low levels because of strong demand, to a large extent fueled by ecommerce growth. The biggest challenge remains supply growth which has increased as the market tightened.
  • Strong demographics have boosted apartment rents and kept vacancy rates at low levels. But new completions have increased over the last few years, limiting the upside.
  • Retail, always a nuanced property type, faces shifting economic sands. Ecommerce has siphoned demand away from some retail centers, while the sector continues to deal with the construction hangover from the last cycle. Even grocery stores, a non-discretionary subtype, have not been immune to recent overbuilding.

Inflation data imperils third rate hike, but balance sheet normalization is coming "relatively soon"

As we expected, the Personal Consumption Expenditure (PCE) price index remained below the Fed's 2 percent target rate. Headline PCE grew by 1.6 percent on a year-over-year basis while core PCE grew by 1.5 percent on a year-over-year basis. As we predicted, the Fed held rates steady last week in the face of this data. Because of relatively weak inflation we continue to believe that there is roughly a 50 percent change of a third rate hike for 2017. But the Fed announced that balance sheet normalization – the process of selling off assets it acquired while implementing quantitative easing – should begin "relatively soon." We expect this will mean an announcement by September with implementation soon after, unless there are issues surrounding the budget and debt ceiling.

Healthcare reform zombie: finally dead?

Once again, healthcare reform died. Or did it? Last week seemed to be the last gasp for widespread healthcare reform. Whatever form healthcare reform takes in the future, it will likely be far more focused and targeted. Because of this, the potential impact on the economy cannot be determined until we see what specific shape reform takes. For now, Congress is moving on from broad healthcare changes and will have to address the budget and debt ceiling, as well as tax reform, over the next month or two. But they do so knowing that they haven't been able to pocket any tax cuts or spending reductions as a result of healthcare reform.

What we're watching this week

Nonfarm payrolls and unemployment for July should show another strong month in the labor market, with payroll growth of around 200,000 net new jobs created and the unemployment rate declining very slightly. Wage growth for July is expected to have increased slightly relative to wage growth in June. The ISM Manufacturing and Nonmanufacturing Indexes for July will also be released this week. Both are anticipated to show just modest decreases, still indicative of widespread economic expansion.

Thought of the week

Of the $4.53 trillion sitting on the Fed's balance sheet, $3.7 trillion (roughly 82 percent) was acquired during three rounds of purchases known as quantitative easing.

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