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Circling the wagons on trade

Circling the wagons on trade

Trade protectionism, the key risk that we highlighted amidst the euphoria in the wake of the presidential election in 2016, reared its ugly head last week. We highlighted this risk because it is one area where the administration can take unilateral action without direct Congressional oversight. For most of the last 16 months, that risk got put on the backburner, especially after the passage of tax cuts and increased government spending which is poised to boost the economy this year. But after the administration announced that it would place tariffs on imported steel and aluminum, the risk of trade protectionism came back to the fore. The tariffs proposed by the administration will significantly raise domestic prices for steel and aluminum and push inflation, which is already accelerating, even higher.

While the increased tariffs should not impact the overall economy
 too much, they could prompt retaliatory responses from
trading partners of the U.S. And there's no question trade
 wars cause problems and slow economic growth. 

For now, we remain optimistic about the outlook for the economy this year, but the risk of an escalating trade war will hang over the economy like the sword of Damocles.

New Fed Chair Powell takes center stage

With his first public remarks during Congressional testimony last week, Jerome Powell found himself front and center since taking the reins of the Fed. In this first appearance before the House Financial Services Committee, the chair was quite candid, discussing job gains, lower unemployment, economic growth, and the prospect of quicker inflation. He sees inflation moving up to the Fed's 2-percent target rate, but he noted that the Fed was concerned about fiscal stimulus potentially overheating the economy. His relatively hawkish tone, which suggested that there could be as many as four rate hikes this year, caught many by surprise, and the stock market reacted negatively.  Two days later, testifying before the Senate Banking Committee, he appeared to walk back some of his comments, perhaps because he was concerned about the impact of his earlier statements.  Going forward, he will need to exercise caution to avoid being inconsistent with his public remarks which could potentially undermine faith in the institution.

Divergence between hard and soft data

In what feels like a rehash of last year, we are observing a divergence in early 2018 between hard and soft data.

Consumer confidence for February reached its highest level since
November 2000 while final consumer sentiment for February declined
slightly but remained near record-high levels.

The ISM Manufacturing Index for February increased to its highest level since 2004 and its third-highest reading since 1985. At such lofty levels, the sentiment data signal that the economy should be growing closer to 5 or 6 percent on an annualized basis.

The hard data, on the other hand, continue to show a strong economy, but fall short of the dizzying heights set by the soft data. Final real GDP growth for the fourth quarter of 2017 was revised slightly downward to 2.5 percent on an annualized basis, with minor revisions pulling growth down slightly. Consumer spending for January declined versus December's level, falling below expectations. Inflation in January, as measured by the Personal Consumption Expenditures (PCE) Index came in below expectations with both headline and core inflation remaining unchanged versus the previous month on a year-over-year basis. Despite this, the overall trend in PCE inflation, particularly core inflation, remains upward. Durable goods orders for January fell more than anticipated, even after December's figure was revised downward. And new home sales for January came in below expectations, although the data is often later revised and the trend over time remains upward.

Initial unemployment claims remained incredibly low, the one
true bright spot in last week's hard data. Claims registered
a scant 210,000, the lowest level since 1969, a remarkable
achievement given how much larger the labor force is today
than it was in the late 1960s. 

What it means for CRE

The prospect of a trade war imperils this economy, which is otherwise on solid footing and should support space market fundamentals and capital markets for commercial real estate (CRE). If we find ourselves in a mutually destructive trade war that reduces economic growth (and potentially triggers a recession), then CRE will suffer along with the overall economy. While we still don't know exactly how trade protectionism will unfold, and protectionist measures by recent U.S. administrations did not prompt in-kind retaliation, the risks are clearly on the downside. At a minimum, the tariffs will push up domestic prices at a time when underlying inflation is already accelerating and the prospect of a fourth rate hike is now on the table.  In particular, rising steel prices would make construction more expensive and ultimately reduce development. Our outlook for the economy and CRE remains positive, but risks to the outlook are clearly building.




What we are watching this week

The employment situation report for February should show continued strength in the labor market. Nonfarm payrolls should grow by roughly 200,000 net new jobs, following January's gain of 200,000. The unemployment rate should remain largely unchanged, though downward pressure will continue throughout this year. Hourly earnings should also change little relative to January's 2.9 percent year-over-year growth rate. The ISM Non-Manufacturing Index for February should move down slightly in but remain at an elevated level, indicating significant economic expansion.


Thought of the week

For those looking for the canary in the coal mine for the next recession, credit card balances reached their highest point ever in 2017, surpassing $1 trillion. Recently, delinquencies and losses have been slowly rising.  To compete with bigger banks, small banks loosened credit standards. Over the last year small banks' losses have spiked, an indication that cardholders are taking on more debt than they can repay.





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