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A Trio of Potential Risks

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A strong finish for 2017, but slow start for 2018

Last week the Bureau of Economic Analysis revised economic growth in the fourth quarter of 2017 to 2.9 percent from 2.5 percent due to stronger consumer spending and inventory investment (goods that are produced but not sold). Growth for the year remained unchanged at 2.3 percent. Unfortunately, it does not look like the economy will sustain this growth rate in the first quarter of 2018.   Although official measures have not yet been calculated, we anticipate that growth will slow in the first quarter, as weakness in consumer spending will drag economic growth. This mirrors the trend during most of the current expansion – the economy began the year slowly and then generally accelerated in later quarters in six of the past eight years. We expect the pattern will continue this year.

The stimulus provided by fiscal policy measures should cause growth
 to accelerate toward the middle of the year. 

We still forecast that growth for 2018 will accelerate toward 3 percent, which means that growth in the coming quarters should exceed that rate.

Trade Wars: The Empire Strikes Back

China implemented the defensive trade measures that it outlined last month. China announced that it is imposing new tariffs on 128 U.S. products, including fruit and meat, which total roughly $3 billion based on imports in 2017. These tariffs were implemented in response to the steel and tariffs that the Trump administration previously announced. The Trump administration plans on imposing an additional $60 billion worth of tariffs on Chinese goods and China has not yet announced a response to those potential measures.

The Chinese tariffs should not impact the economy
much, but they may place more upward pressure on inflation. 

The equity markets have become a bit more volatile in response to rising trade tensions, but that poses little risk to the real economy. Yet the risk of escalating trade measures continues to increase, placing the economy in greater risk. Worryingly, uncertainty over trade measures alone could disrupt growth if it causes people and organizations to postpone or cancel economic decisions.

Fed's preferred measure of inflation slowly rising

Headline and core inflation, measured by the personal consumption expenditures (PCE) index, both increased as expected during February. These increases pushed the year-over-year growth rates up to 1.8 percent for headline inflation and 1.5 percent for core inflation. This slow upward trend largely mirrors what we have observed in other measures of inflation, notably the consumer price index (CPI). Inflation is gradually increasing toward the Fed's 2-percent target rate, which has emboldened many to increase their forecasts for rate hikes this year. We have not yet moved off of our forecast of three rate hikes of 25 basis points each, but the risk to our forecast is clearly on the upside and we will revisit it in the coming months.

Consumer confidence and sentiment pull back slightly

Consumer confidence and sentiment both declined slightly in March. The combination of rising gas prices, stock market volatility, and increasing interest rates have slightly dampened consumers' spirits. But those spirits remain largely elevated due to a tight labor market, rising wages, and favorable business conditions. We anticipate consumers will remain positive, but uncertainty and volatility could increase in the future.

What it means for CRE

Commercial real estate remains in a favorable position. Temporary weakness in the first quarter should not have much impact on commercial real estate (CRE) fundamentals and capital markets. The anticipated acceleration in the coming quarters should more strongly impact CRE. Likewise, the implemented trade measures should not pose much risk to CRE. But any escalation that threatens the macroeconomy would also threaten CRE. Though the risk of trade fallout remains low, the prospect is increasing over time. Rising inflation poses the most direct threat to CRE. Upward inflation will gradually push up interest rates across the yield curve which could ultimately slow the economy and CRE markets. While that risk lies in the medium-term, it is the most likely risk on the horizon. 

What we are watching this week

The employment situation for March should show a smaller gain than the previous two months. But we still expect roughly 150,000 net new jobs, a strong showing for this far into an economic expansion. The unemployment rate should remain largely unchanged while wage growth should slightly accelerate. Both the ISM Manufacturing and Non-manufacturing Indexes are expected to have declined slightly in March. But both remain at elevated levels indicative of economic expansion.

Thought of the week

Winter weather often wreaks havoc on first-quarter economic data. This year's late-winter and early spring snowstorms could produce the same result once again.

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