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Potential rate hikes rattle markets

​Fed minutes roil nervous markets

Last week was supposed to be relatively quiet on the economic front. But the minutes from the Fed's Open Market Committee (FOMC) meeting in January spooked already nervous markets. Markets disliked the evolution of the language in the minutes, particularly the statement that read: "A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate." In other words, the committee thinks that a greater number of rate hikes could be necessary to offset the potential negative impact from faster economic growth. Though "negative impact from faster growth" sounds like an oxymoron, we have previously raised concerns about fiscal-stimulus-induced acceleration potentially causing greater wage growth and ultimately inflation. The 10-year Treasury yield surged to a fresh four-year high, just under 3 percent, after last week's statement was released.

The yield has since fallen in advance of new Federal Reserve Chairman Jerome Powell's testimony to Congress this week. The market will be closely listening for clues in order to help solve the mystery of future rate hikes.

We continue to forecast three rate hikes of 25 basis points
each for 2018, but many noteworthy economists have increased
their forecast to four rate hikes for this year.

The futures market is assigning a roughly 87 percent probability that the Fed hikes rates 25 basis points in March. The Fed will want to avoid upsetting markets so that is almost certain to occur. What comes after March remains less certain.

Labor market remains strong

Initial unemployment claims edged downward last week as the labor market continued to show no signs of weakening. The four-week moving average for unemployment claims, which smooths out some weekly random volatility, remains just above historically low levels. Meanwhile, the number of open-but-unfilled jobs remains elevated at roughly 5.8 million and wage growth continues to accelerate. Job openings fall across the industry and skills spectrum, indicating a pervasive problem. While hiring could receive a temporary boost from the tax cuts, the cuts could also increase unfilled openings as well. The tax legislation did nothing to address the shortage of qualified labor so filling open positions will remain difficult. And competition for the best workers should intensify because productive companies will be able to use some of their tax savings to compete for the best talent.

We anticipate that a strengthening labor market will
continue to put upward pressure on wages, which combined
with a weaker dollar should exert upward pressure on inflation.



Existing home sales still plagued by chronic low inventories

Existing home sales declined on an annualized basis in January, the second consecutive monthly decrease. A lack of inventory coupled with high prices remain the primary culprits. The decline in sales primarily occurred in single-family homes. The lack of inventory is concentrated at the low end of the housing market, shutting out many potential first-time buyers.  Although inventory increased slightly versus December's level, it remains well below levels that most economists consider indicative of a healthy market. Meanwhile, the median home price increased on a year-over-year basis for the 71st consecutive month, just shy of six years. And more trouble could lie ahead – last week 30-year fixed mortgage rates rose to their highest level since April 2014. That could present a headwind for not only transaction volume, but also the overall economy due to its impact on residential commissions and investment in the first quarter.

Dreamers receive a temporary reprieve

The Supreme Court recently decided that it would stay out of the dispute over the Deferred Action for Childhood Arrivals (DACA) program for now, granting the "Dreamers" a temporary reprieve. Participants in the programs will be able to renew their status, which would not have been possible after March 5 after the administration terminated DACA last year. But this action simply delays a true decision. The case will continue to move through the lower courts toward a true resolution which could take a number of months. And the decision by the Supreme Court will likely reduce the impetus for Congress to act on a permanent solution for DACA.

Trade concerns raise their ugly head, again       

The administration is considering imposing tariffs on steel and aluminum imports. Citing national security concerns, Commerce Secretary Wilbur Ross recommended last week that the administration impose such tariffs. Meanwhile, NAFTA negotiations continue, though progress remains slow. We highlighted trade barriers as a key policy risk after the presidential election in 2018 and our view on that remains unchanged.

While trade certainly creates winners and losers,
everyone would be made worse off by erecting trade
barriers, particularly if they prompt a response from trade partners.

What it means for CRE

Commercial real estate (CRE) is playing the long game with interest rates. While we remain concerned about the impact that sustained increases over time could ultimately have, in the short turn the fallout on fundamentals should be minimal because of the underlying strength in the economy. Capital markets could feel some disruptions, particularly if the bond markets remain tumultuous, but risks remain concentrated in the long run. The labor market will cheer both the low unemployment claims and the reprieve for the Dreamers, but scarce qualified labor should remain a defining feature. This will be felt most directly by the office market as a constraint on net absorption, but apartment and retail would also welcome more job creation.


What we are watching this week

Many noteworthy data points will be released this week. Personal income and spending both are expected to increase slightly while the personal consumption expenditures (PCE) headline and core inflation indexes should show little year-over-year change in January. New home sales for January could come in weaker than anticipated, though the data can be volatile and the long-term trend remains upward.  Consumer confidence and sentiment are expected to have changed little in February, remaining at elevated levels supported by the tight labor market and overall business conditions. We expect the second estimate of fourth quarter real GDP growth to show a slight downward revision due to the downward revision in November and December retail sales. The ISM Manufacturing index for February could show a slight increase in February, reflective of the strong business sentiment in the economy.


Thought of the week

Despite widely held beliefs to the contrary, the Millennial population grew faster in the suburbs than in urban cores during the 2010-2015 period.

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