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A Hawkish Turn

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Outlook turns more hawkish

The Fed hiked rates 25 basis points as expected at its meeting last week, marking the first meeting and first hike under new Chair Jerome Powell. That marked the sixth increase of 25 basis points since the Fed began its tightening cycle in December 2015. The target rate now stands at 150 basis points to 175 basis points. But more importantly, the Fed’s outlook for future rate hikes turned more hawkish. The announcement noted that the economic outlook had strengthened in recent months.  Correspondingly, the Fed increased its average year-end projections for the Fed funds rate for all periods, lowered its projections for unemployment, and raised its forecasts for economic growth and core inflation. For now, the Fed’s median projection is showing two more rate hikes this year. But the voting was close – 7 of the 15 members see at least four rate hikes this year, bringing the vote one short of a median projection of three more rate hikes in 2018. We are not yet moving from our forecast of three rate hikes for 2018, but the risk has clearly moved to the upside with the Fed’s more hawkish stance. We will revisit our projection as the data unfolds.

Trade Wars: The Phantom Menace

To paraphrase, what is a trade war good for? Absolutely nothing. We continue to believe that the world will avert an all-out trade war, but steps taken last week were not reassuring. The limited tariffs on steel and aluminum took effect and the administration announced another 25 percent tariff on up to $60 billion of imports from China along with investment restrictions (related to the investigation of intellectual property theft).  In response to the steel and aluminum tariffs, China indicated that it would impose $3 billion in tariffs on U.S. goods. China could still respond to the administration's second round of tariffs. But China also extended a potential olive branch by offering to buy more semiconductors from the U.S. And Chinese officials are working to finalize new regulations by May that will allow foreign financial groups to take majority stakes in its securities firms. Will these measures help improve trading relations? The situation remains unclear – tensions are ratcheting up and the administration is replacing cabinet-level officials with individuals who are more in favor of trade protectionism.

Government shut-down avoided once again

After threatening to veto the $1.3 billion omnibus spending bill passed by Congress, the president reluctantly signed it. No one, including the president, wanted to risk the political fallout from another government shutdown.  The spending package should provide some minor boost to GDP growth in the short run. The legislation funds the federal government through the end of September.

What it means for CRE

Despite the rate increase last week, interest rates remain low enough to stimulate economic growth, especially since financial conditions remain loose. Economic growth should continue to support commercial real estate (CRE) fundamentals so we see little risk from this most recent increase. But the prospect of four (rather than three) rate hikes in 2018 would bring the target Fed funds rate up to a range of 225 basis points to 250 basis points at the end of the year. Based on our estimate, that would bring the rate close to the neutral rate, which is neither stimulative nor contractionary. Three to four rate hikes in 2019 would likely push the Fed funds rate past the neutral rate which could drag on the economy and CRE. The Fed is not currently forecasting this to occur until 2020. But the timing is critical here and real estate participants should pay close attention to the trajectory of rate hikes over the next 12-18 months.

What we are watching this week

The third reading on fourth quarter 2017 GDP will be released and we expect a minor upward revision to growth. Data on personal income and spending should show steady income growth and modest spending growth. Core inflation, as measured by personal consumption expenditures (PCE), should show slight deceleration on a monthly basis, but a slight increase on a year-over-year basis, reflective of slow but steady increases in inflationary pressures. Both consumer confidence and consumer sentiment are expected to decline slightly, but should still remain at elevated levels – an indicator of strong optimism.

Thought of the week

Easter spending should total roughly $18.2 billion this year which would be the second-highest total on record. Roughly 81 percent of Americans will celebrate and spend an average of $150 per person.

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