A year in a week
Economic data points are coming in fast and furious this week, many of which could be pivotal to the direction of CRE
- Ryan Severino
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- Fed set to hike 75 bps
- 2Q GDP should look weak
- Inflation remains hot
- Consumers grumpy, but spending
- CRE takes a beat amidst uncertainty
Data and events scheduled for this week will make it seem as if a year’s worth of economic occurrences got packed into one week. It could prove pivotal to the direction of the economy and the commercial real estate (CRE) market. This follows data from last week that showed the Fed’s efforts to raise rates and tamp down the interest-rate sensitive parts of the economy are already bearing some fruit.
Most prominent on the calendar, the FOMC is meeting this week and will likely raise the target fed funds rate by 75 basis points (bps). Momentum for a 100-bps rate hike faded with some recent data points. Such a move would bring the range for the target rate up to 225 bps to 250 bps. That would move the target range to the peak from the last tightening cycle.
“The Fed is attempting to slow demand growth and evidence from housing shows some signs of success.”
Last week the homebuilders’ sentiment index fell to its lowest level since the early stages of the pandemic, starts and permits data weakened and existing home sales fell. While pricing has not yet declined, the Fed likely views these developments as a sign that its moves are working. As we have repeatedly emphasized, the terminal rate remains more important than the speed with which they raise. After this week’s meeting, additional hikes will likely push into contractionary territory, risking economic growth, as the cost of capital increases, some institutions pull back on lending, yields get impacted and the dollar gets more expensive.
Target Rate Probabilities for July 27 Meeting
First glance at 2Q GDP
Speaking of economic growth, we get our first look at second quarter economic growth this week. We continue to expect slight growth, but certainly the potential for a contraction exists. If so, that would represent the first consecutive quarterly declines in GDP since the first half of 2020 when the pandemic began. We knew that growth almost certainly had to decline from the breakneck pace of 2021. External events, like the evolving pandemic and war in Ukraine, have accelerated the slowdown. The slowdown in housing likely restrained growth during the second quarter, as did a slowdown in consumer spending and business investment. Inventories also likely contributed to slower growth. On the positive side of the ledger, international trade likely contributed to economic growth, reversing its impact during the last two years.
We will also get a look at a lot of spending data this week. New home sales in June should show a decline, much like what occurred in existing home sales. Durable goods orders for June could also come under some pressure from higher interest rates, even though we expect some of the subcategories to remain positive.
”Personal income and personal spending (both nominal and real) for June should all show increases as consumers continue to power ahead despite their dour feelings.”
Speaking of which, both consumer confidence and consumer sentiment for July should remain at low levels, reflective of consumers’ low spirits amidst ongoing high inflation.
More hot inflation
The personal consumption expenditures (PCE) deflator for June should show continued high inflation readings in both the headline and core measures. We expect the year-over-year change in the headline reading to tick higher, driven by energy. But the core measure could hold steady, reflecting the slight moderation observed in recent months. And the employment cost index, a broad measure of compensation, should also show another meaningful increase in the second quarter amidst an ongoing tight labor market.
| What it means for CRE |
“Thus far we do not see clear signs of a downturn in the CRE market, but momentum has slowed and risks to the downside are building.”
While most of this week’s events reflect the past, they have a lot to say about the future. And that future looks more tenuous and uncertain than just a quarter or two ago. Noneconomic factors like the pandemic and war have turned the outlook on its head. Uncertainty impacts momentum in the economy and the CRE markets. People often avoid or delay decisions out of fear of making a mistake. A slowing economy only serves to compound the problem.
We see this reflected in recent CRE data and events. Some tenants, across property types, are giving space back or paring back their requests for space. Net absorption has generally slowed, even in property types like industrial and apartments. Sublease space is already ticking up in some markets and property types. And some property types, namely office, already faced much uncertainty due to the fits-and-starts return to office (RTO) experienced over the last year. This pattern of behavior risks becoming a self-fulfilling prophecy – if too many people expect uncertain or poor times ahead and change their behaviors, it can lead to certain outcomes. Thus far we do not see clear signs of a downturn in the CRE market, but momentum has slowed and risks to the downside are building. Caution amidst uncertainty seems likely to prevail until we get greater transparency on the direction of the economy.