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Goldilocks Golden for CRE

​Economic Growth Remains Firm, On Pace

The U.S. economy expanded at an annualized rate of 3 percent during the third quarter. This exceeded our projection and the consensus, both of which expected growth in the mid-2 percent range. A number of factors drove growth during the quarter, but the negative impact from hurricanes Harvey and Irma was not as bad as feared. Consumer spending continued to contribute to growth, but at a declining rate as consumers continue to spend out of savings. This type of spending cannot continue indefinitely without meaningful wage growth because savings are depleted over time. During the quarter, business investment continued to rebound from its 2016 lull. The slowdown in 2016 stemmed primarily from the appreciation of the dollar (which made American goods more expensive abroad) and weak oil prices (which hampered investment). Inventory accumulation contributed almost 75 basis points to growth and indicates that companies anticipate stronger future demand. But this could signal lower investment in the future as inventories are sold. A smaller trade deficit and an increase in government spending also contributed to growth. However, they were partially offset by negative contributions from residential investment and state and local government spending.

On the whole, GDP during the quarter presented much to cheer. But it is important to keep things in perspective. While growth continues to recover, the economy has not broken out of its current growth trajectory. Consecutive quarters of at least 3 percent growth are welcome, but the economy has previously experienced similar "false dawns" during the current expansion. In mid-2014, the economy was growing at roughly 5 percent during consecutive quarters, but couldn't sustain that pace. Year-over-year economic growth of 2.3 percent is an improvement relative to recent quarters, but remains on par with the long-term average during the current expansion of 2.2 percent per year and well below the high watermark for the current expansion of 3.8 percent, set during the first quarter of 2015.

Economic performance in the third quarter supports our belief that the economy remains firm, maintaining its current growth trajectory. 

Relatively strong growth despite hurricane impacts shows resiliency. The biggest impediment to faster economic growth remains inadequate labor supply. Growth in recent quarters also reaffirms our position that interest rate increases, at least in the short term, do not kill economic expansions and market rallies. Despite four rate hikes since December 2015 and the beginning of the Fed's balance sheet normalization, economic growth has not slowed. And data indicates that lending standards continue to ease, even as rates across the yield curve increase.

What does it mean for CRE?

For commercial real estate (CRE), the news remains good if not great. The past eight years have demonstrated the CRE does not require rapid economic growth to perform well. 

"Goldilocks" moderate economic growth drives improvement in real estate fundamentals without creating imbalances that often lead to the end of economic and real estate expansions.

This phenomenon is happening right now and if the economy continues to follow along its current trajectory, benign growth can continue for at least the next 12-18 months. Of course, any major deviations in fiscal or monetary policy could threaten this prediction, but right now we see little in economic fundamentals to cause concern about real estate as an asset class.

No rate hike this week, but Fed Chair announcement likely

We expect no change in interest rates at the Fed's meeting this week. At most we could receive some commentary on how balance sheet normalization is unfolding. 

We continue to anticipate the next rate hike coming in December now that the Fed's decisions appear to be less data-dependent. 

At the least the data used for monetary policy decisions appears to be a moving target since core inflation remains weak, well below the Fed's 2 percent target rate. We should learn within the next week who the next Fed Chair will be. The market and the media continue to signal that Jerome Powell will get the nod, but nothing is certain.

Details on tax plan due as well

The House's tax plan should be released this week. Last week, the House narrowly passed the Senate's budget resolution last week, which enables Congress to use reconciliation and avoid negotiation over a common version of the budget and a Democratic filibuster. We continue to estimate the probability of passing legislation by early next year as roughly 50 percent. The devil will be in the details, but rough sketches indicate that budget could provide a $1.5 trillion deficit increase over the next decade, roughly equivalent to 0.6 percent of GDP. Such a package could provide a boost to the economy next year of up to 50 basis points, depending upon how tax cuts are structured.

What else happened last week?

Durable goods orders for September showed a second consecutive month of modest gains, an optimistic sign for the fourth quarter. New home sales surprisingly surged in September despite the hurricanes. Consumer sentiment for October was revised slightly downward, but nonetheless maintained its highest reading since January 2004, propped up by a strong labor market.

What we are watching this week

This week will be a busy one. The employment situation for October should show a net increase of over 300,000 jobs as the labor market snaps back from the hurricane-related contraction in September. Wage growth should moderate slightly after being artificially inflated by hurricane distortions (namely the effective elimination of many low-wage jobs) in September. The unemployment rate should remain largely unchanged. The ISM Manufacturing and Nonmanufacturing Indexes for October should both pull back a bit, but remain at levels indicating a broad economic expansion in both the manufacturing and service sectors of the economy.

Thought of the week

Mobility among Americans continues to decline. The median duration owners stayed in their homes in 2017 was 10 years, according to data from the National Association of Realtors (NAR). That equaled both 2014 and 2016 for the longest duration since the NAR started tracking the data in 1985.

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