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Go for launch?

Economy is go for launch

The economy grew by 2.6 percent in the fourth quarter, coming in at the low end of our expected range. Growth was driven by both consumer spending and corporate investment. But this growth disappointed slightly because it followed two consecutive quarters of at least 3 percent economic growth. The economy has not shown 3+ percent growth for at least three consecutive quarters since the first quarter of 2015. Growth of 2.3 percent in 2017 and 2.5 percent on fourth-quarter-over-fourth-quarter basis exactly matched our expectations.  Growth during 2017 roughly matched the average annualized growth rate during the current expansion of 2.2 percent. 2015 – which saw a 2.9 percent increase in GDP -- remains the high watermark in the current expansion.

Performance in 2017 confirmed our staunchly held belief that "animal spirits" alone would not be sufficient to generate accelerated economic growth. 

Business confidence and consumer confidence remained at elevated levels throughout 2017, with a number of measures reaching heights not reached since the dot-com bubble. Yet despite these strong positive feelings, we knew that growth would not accelerate without policy changes.




Such changes are coming in the form of the tax cut passed in December. Consumers and business should both receive a boost in their spending power thanks to lower statutory tax rates.

And corporations have an important additional incentive to spend this year thanks to the expensing provision which lets them write-off the entire cost of their investments in the first year. 

We expect a slight increase in consumption, which grew at a healthy 3.8 percent annualized rate in the fourth quarter and a more robust increase in corporate investment due to favorable tax treatment. This should help spur productivity growth and reorient economic growth slightly away from consumption toward investment. We anticipate that economic growth will increase to 2.8 percent in 2018, with growth surging in the first half of the year. Yet despite the benefits of the tax cuts, growth should not exceed 2015's 2.9 percent, a testament to the structural challenges posed to the economy by slowing labor force growth and weak productivity growth.

Personnel, pressures changing at the Fed          

Chair Yellen will oversee her last Open Market Committee meeting this week. We expect the Fed to leave rates unchanged. Next month Jerome Powell, who was confirmed last week by the Senate, will take the reins. Additionally a number of voting members of the Open Market Committee are changing, likely turning the committee more hawkish: we currently anticipate three rate hikes of 25 basis points from the Fed this year with the first coming at the meeting in March. At the same time, pressure on yields, particularly long-dated Treasury yields, appears to be building. The tax cuts, though likely stimulative in the short run, will add to the amount of Treasuries that will need to be sold at the same time that a key purchaser of Treasuries, the Fed, will continue unwinding its balance sheet. And wage growth and inflationary pressures, both dormant through most of the current economic expansion, also look poised to put upward pressure on yields. Last week we emphasized that when yields increase, they tend to do so quickly. That appears to be case once again with the 10-year Treasury recently surpassing 2.7 percent for the first time since 2014 and the 2-year Treasury hitting highs last seen in 2008.

Apocalypse delayed?

Although the government shutdown ended after only three days, the underlying issues that led to the shutdown were not solved. The continuing resolution passed by Congress in January avoided a political backlash and negative economic impact, but provides funding until only February 8th. The main issues that caused the shutdown, immigration and border security, look far from resolved with a short deadline looming.

Re-thinking trade issues

The administration placed punitive tariffs on American imports of solar panels and washing machines, claiming to protect domestic manufacturers and employees. The administration believes that cheap Asian imports pose a serious threat. Chinese officials have not yet responded with retaliatory measures. The administration also signaled, faintly, that it could reconsider rejoining the Trans-Pacific Partnership free trade agreement if it felt the rules were fair. And the renegotiations of NAFTA are proceeding this week, though progress remains elusive.

What else happened last week

Existing and new home sales in December both declined last week, as expected. New home sales declined a bit more than expected while existing sales were constrained by record-low inventory levels. Both series are trending upward over time, but new home sales continue to lag historical levels due to insufficient construction levels.

What it means for CRE

The economy will almost surely accelerate this year, undoubtedly benefitting commercial real estate. A resurgent economy should help spur demand and provide investors with opportunities that they might not otherwise have this far into an economic expansion. But, stimulus this late in the cycle risks being short-lived because of its potential impacts on wage growth, inflation, and ultimately interest rates which could ironically hasten the end of the expansion. We see another positive year for commercial real estate in 2018, but the medium-term risks to the economy have likely increased. 

What we are watching this week

Economic data will come fast and furious this week. Data on spending in December should show healthy growth while inflation, measured by the personal consumption expenditures index PCE, should follow the recently released consumer price index (CPI) data and show that inflation rebounded in the latter half of the year, particularly in the fourth quarter. Consumer confidence and sentiment for January should both remain at elevated levels thanks to a tight labor market and tax cuts. The ISM manufacturing index for January should have changed little versus December, but still indicate a strong environment for manufacturers. Finally, the employment situation for January should show that jobs continued to grow in the 150,000-200,000 range, with the unemployment rate holding steady and wage growth ticking up on a year-over-year basis. 

Thought of the week

The dollar recently reached a three-year low against a basket of currencies after the Treasury secretary said that he welcomed a weak dollar because it would improve the outlook for international trade.





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