Colder weather = 
more COVID headwinds?

As the weather changes, the economic downturn will likely manifest itself in deteriorating space market fundamentals

September 22, 2020
>> Quick takes:
  • Fed pledges long-term support for the economy
  • Congress remains stuck in neutral on stimulus
  • Colder weather could mean more COVID headwinds
  • Housing market remains a bright spot
  • CRE markets facing deteriorating fundamentals 

Without (a fiscal stimulus), the economy likely faces a headwind after what should prove a snapback third quarter, a headwind that monetary policy alone will likely not overcome.

Events from last week have us wondering if the economy is falling into a trap that we have seen before. Last week the Federal Reserve (Fed) committed to support the economy not just in the short run but also in the long run. Clearly the Fed has taken an aggressive approach to supporting the economy and the capital markets in 2020. But beyond this the Fed looks poised to keep supporting the economy, attempting to avoid the mistake of withdrawing support too quickly. If you recall, the Fed recently announced it was altering its framework to allow rates to remain near zero for a prolonged period until certain conditions occur: full employment, 2% inflation, and inflation sits above 2% for some period. This reflects the Fed’s new altered policy stance. We could use a bit more clarity on things like time frame and the level of inflation the Fed would ultimately tolerate, but for now the famous dot plot shows the Fed leaving rates near zero until at least 2023. For some perspective, the Fed cut rates to near zero in December 2008 and did not raise them again until December 2015.

Meanwhile, as we mentioned last week, fiscal policy remains stuck in neutral after benefits for most households expired at the end of July. The Senate and the House remain far apart on a spending package, leaving many that once depended on government support twisting in the wind, increasingly reliant upon the portion of their benefits that they managed to save. The sides have made little progress in recent weeks. We already worried that Congress was running out of time with the election looming just six weeks away and campaigning for many in the Senate in the House set to kick into a higher gear, likely requiring them to return to their home states. The death of Justice Ruth Bader Ginsburg potentially throws a wrench into the works if the Senate begins to take up (or at least debate) a vote on a nomination for her replacement. That could siphon time that might otherwise get spent on the next spending package. In short, the prospects for another stimulus in advance of the election continue to diminish, though some time remains.

That ultimately brings us to a familiar concern: that we will continue to rely too heavily on monetary policy and not enough on fiscal policy. While the economy has started its recovery phase, fiscal stimulus clearly played an important role in the process. Without it, the economy likely faces a headwind after what should prove a snapback third quarter, a headwind that monetary policy alone will likely not overcome. We could see the economy face similar challenges to the ones faced during the last business cycle when interest rates remained near zero, but fiscal policy remained relatively limited. The data already shows signs of this becoming a problem. Improvement in the economy continues, but at a declining pace. Retail sales for August grew, but came in below expectations and declined relative to the rebound over the prior few months. Industrial production also continued to recover in August, but similarly at a declining rate. Unemployment claims remain elevated on an initial and continued basis, with a clear loss of momentum. And consumer sentiment remains depressed, even with some slight improvement. In short, the economic recovery clearly lost momentum in the latter half of the third quarter.

But this familiar concern comes with a twist. The imminent change in the weather compounds our concern. We are heading into the colder months as we move into the later stages of the year.  Colder temperatures will force people indoors, stymying the ability of restaurants and bars to service customers outdoors. Moreover, people spend more time indoors in places with poor ventilation and viruses have a propensity to travel more efficiently in cold, dry air. This shows in higher cases of seasonal colds and influenza during the fall and winter every year. Will COVID show a similar pattern? While hard to say for certain, we note that daily case levels remain elevated. Although they have declined since peaking in July and August, they remain well above the levels from June. More than half the states are already seeing a rise in the number of new cases. Together, the key risks to our base case trajectory remain squarely in play: austerity from the expiration of fiscal stimulus, potential lockdowns if cases increase at concerning rates, and the potential for consumers to alter their behaviors of fear of falling ill increases. 

Housing remains a bright spot

The housing market remains a bright spot. Demand for housing remains strong, spurring a rebound near pre-pandemic levels for housing starts and permits. The risk in the market remains limited supply, particularly with surging demand and continued upward pressure on prices. Even if the recent spike in the homeownership rate is overstated (as we believe) we do not doubt the underlying dynamic. This stands in stark contrast to the Great Recession, which centered on the housing market. Not only did prices and volume tumble but starts and permits activity remain well below activity from the 1990s and 2000s despite continued population and household growth. 

Housing starts' long recovery


|  What it means for CRE  |

For commercial real estate (CRE), the downturn has not yet manifested itself in space market fundamentals, but that is very likely coming. Our proprietary scenario models predict significant deterioration in rents and vacancy rates across markets and property types heading into the balance of the year, though clearly not on a uniform basis. Yet performance differs significantly across scenarios. If we get another stimulus package and the pandemic does not meaningfully intensify, then we could tack toward our base case outlook. But if we do not get another spending package and a resurgent pandemic becomes an impediment to economic activity, then we could tack toward our downside case. The economy has clearly improved since its nadir in April, but asymmetrical risks remain clearly and significantly skewed toward the downside.

|  Thought of the week  |

Since peaking on September 2, the S&P 500 had declined by roughly 9%, effectively giving back the gains from August.