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Retail revs up

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Retail sales rebound

Retail sales rebounded robustly in March after a few months of weakness. Headline retail sales jumped by a stronger-than-expected growth rate while core retail sales also bounced back after some recent softness. Tax cuts, along with income gains, and to a lesser extent tax refunds, likely supported consumer spending.

We believe that relatively strong spending will continue
in the second and third quarters of this year due to the same factors. 

While the weakness in first-quarter spending held back GDP growth, stronger spending should boost GDP growth in later periods.

Oil quietly comes back  

Somewhat quietly the price of crude oil has crept up to levels not seen in several years. The price for West Texas Intermediate crude oil is nearing almost $70 per barrel, a daily price unreached since November 2014. The fracking revolution and the supply growth that it enabled drove down oil prices from above $100 per barrel in 2014 to a cyclical low of roughly $26 per barrel in February 2016. The recent heights in prices have occurred despite threats of a trade war, tweets from the administration, and active drilling in the U.S. Export restrictions by oil-producing countries have certainly helped prop up prices, but economic growth is also driving prices upward. Correspondingly, gasoline prices have also risen in recent periods. These increases should ultimately filter through to measures of inflation and could offset or reverse some of the drag on inflation from energy prices that occurred in March.

Yield curve flattens despite rising yields

The yield curve continued to flatten last week despite rising yields across the maturity spectrum. The spread between 10-year yields and 2-year yields on U.S. Treasuries reached a cyclical low of about 41 basis points, a level unseen since September 2007. Although the 10-year yield is nearing an important threshold at 3 percent (a level it has touched only twice since the Great Recession), the short end of the curve has risen faster than the long end due to the Fed pushing up short-term rates. This flattening typically occurs during tightening cycles. But this cycle differs from previous cycles in an important way – late-cycle fiscal stimulus. Stimulus of this sort, pushing up economic growth and inflation, should push



So why hasn't stimulus pushed up long-term yields and what does it mean? It likely means that bond investors remain confident in the short term, but do not believe that faster growth will persist into the longer term. Investors likely perceive the stimulus will impact the economy on a temporary basis but that will ultimately fade. How much caution should we take from this? In the short term, not much.

Economic growth should remain firm this year and into 2019. 

The yield curve needs to actually invert before it signals economic recession, which typically arrives about one year later. And the type of yield curve inversion that signals recessions occurs when bond investors lose confidence in the future and rotate out of risk-tolerant asset classes like equities and real estate and into risk-averse asset classes like Treasury bonds. That dynamic has not yet occurred and should not occur this year. One note of caution: the 10-2 yield spread has moved in long, pronounced cycles, even with short-term fluctuations, since Paul Volcker and Fed raised rates dramatically in the early 1980s to drive down rampant inflation. We are currently in a downward cycle which means the spread should not significantly widen out until after it swings negative.

What it means for CRE

The rebound and outlook for improved retail sales bodes well for retail centers this year. Contrary to popular opinion and incendiary headlines, retail centers are not dead. Structural changes in the economy are widening the rift between winners and losers, but the overall demise of retail appears exaggerated. Well-tenanted, well-positioned centers should fare well this year, even if rising energy prices take some firepower from consumers. The flattening of the yield curve itself does not pose much of a problem yet. Of course, when it inverts market participants should take that as a clear negative signal. But the yield on the 10-year Treasury should be monitored, especially if it races past 3 percent. As we noted last week, the cap rate compression cycle has largely ended. Cap rates have changed little in recent periods as upward pressure from rising yields and downward pressure from market fundamentals and the risk premium are largely in balance. As economic growth slows in the coming years, translating into weaker fundamentals and less appetite for risk, rising rates will eventually win out and cap rates will rise.


What we are watching this week

First quarter GDP should show relatively weak growth, keeping with the trend in recent periods. We believe temporary factors caused this blip and that growth will surge in the coming quarters. New and existing home sales for March should continue to rise as the housing market continues to shake off some slight weakness in recent months. Consumer sentiment and consumer confidence should both show some softening in March as higher gas prices and interest rates dampen spirits slightly.


Thought of the week

Significant tightness in the labor market in Vermont (a scant 2.8 percent unemployment rate) is causing the state's tourism and economic development teams to roll out a program this summer that attempts to persuade tourists to relocate to Vermont and fill job vacancies.





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