Research

Economic Insights:
Cut the chatter

There’s silence from the Fed as it preps for a potential rate cut next week, and consumers are spending while businesses pull back — which makes for a very cloudy future

July 24, 2019

Retail sales posted their largest annualized quarterly increase since the fourth quarter of 2017.

After a week of significant chatter from Fed officials, the communications blackout period will shift attention to data releases this week, ahead of the Fed’s key meeting next week. The GDP report for the second quarter should indicate that growth decelerated considerably relative to first-quarter strength (that we feel was somewhat exaggerated). On the demand side, we expect that growth in the second quarter should likely show that the consumer remained resilient. Retail sales data for June showed a solid increase, exceeding expectations, for both headline and core sales. Taken with the previous months of the quarter, retail sales posted their largest annualized quarterly increase since the fourth quarter of 2017. Meanwhile, business investment likely faltered during the quarter.

However, we believe that any decline in investment will exaggerate the underlying trend. Several idiosyncratic factors adversely impacted business investment in the second quarter. Among these, a significant decline in aircraft deliveries from Boeing after another crash of one of its products and a reduction in oil drilling activity occurred after a decrease of more than 20% in crude oil prices both weighed on investment. We think these factors overstate the downturn in investment activity. On the supply side we expect greater weakness from the manufacturing sector than the services sector because of manufacturing’s more direct exposure to exports and international trade. Yet even on the supply side, evidence abounds for overstating second-quarter weakness — manufacturing surveys from last week noted increases in activity in July.

Downturns in profits could presage further cutbacks in investment and potentially a retrenchment in hiring, both of which would hold negative consequences for the economy. 

“Transitory” downturn in inflation?

Earlier in the year, before concern among Fed officials intensified, the Fed took the position that weakness in inflation seemed transitory and would reaccelerate later in the year. The GDP report should reflect this, to an extent. A rebound in core PCE (personal consumption expenditures) inflation, the Fed’s preferred measure, likely occurred during the second quarter. The year-over-year change probably decreased, but underlying expectations for future inflation are also firming up, which would indicate no further deceleration in the trend. 

Profit warning?

Roughly one-third of S&P 500 companies will report second quarter earnings this week. Analysts expect a slight decline in earnings for both the second and third quarters, which would meet the unofficial definition of a profit “recession” — two consecutive quarters of profit declines. While such a downturn in profits does not guarantee a corresponding downturn in the macroeconomy, corporate profits will draw attention for any hint that the slowing in the economy is impacting earnings. That would provide more fodder for the more bearish among economic actors. Downturns in profits could presage further cutbacks in investment and potentially a retrenchment in hiring, both of which would hold negative consequences for the economy. While investment is slowing somewhat, the labor market shows no indication of significant deterioration, even if hiring is slowing as the supply of qualified labor is becoming exhausted.

Don’t overlook fiscal policy

While monetary policy remains the focus of attention these days with the upcoming Fed meeting, we caution against ignoring fiscal policy. The government is once again bumping up against the debt limit. The administration is attempting to get Congress to reach a deal before members begin their summer recess on Friday because of concerns that the Treasury could exhaust its “extraordinary measures” to service the debt before Congress returns in September. Considerations of the debt limit are entangled in the annual budget battle, including potential caps on spending that could effectively produce fiscal tightening. Of course, budget battles always raise the specter of a government shutdown, even if the likelihood of that occurring currently seems low. An agreement could come as soon as this week.

What it means for CRE

For commercial real estate (CRE), we still focus on the data even though the Fed is siphoning all the oxygen out of the room. If second-quarter growth comes in near expectations, especially if inflation shows no sign of collapsing, it will reaffirm our view that the economy still supports solid CRE performance. We have yet to see any major indication of erosion in CRE fundamentals and unless the economy falters more than we anticipate, we do not anticipate that will occur soon. CRE capital markets, waiting for the Fed, should still take note. If the economy continues to perform relatively well, it will sap some of the strength away from the doves who want to see a rate cut next week of 50 basis points (bps) or multiple cuts this year. At some point, the Fed’s concerns about “crosscurrents” will either be realized or misplaced. Second-quarter results take us one step closer to knowing. Nonetheless, easing on the part of the Fed, to whatever degree it occurs, will likely keep cap rates at or near historically-low levels and potentially put some wind in the sails of the transaction market. While that will keep the market challenging for buyers looking to deploy their “dry powder,” it could present attractive opportunities for owners looking to sell, refinance, or recapitalize valuable assets.

Thought of the week

2002 ranks as the best year for the domestic movie box office, measured by both tickets sold and inflation-adjusted revenues. This occurred despite the number or movies released that year totaling just 55% of the number of movies released in 2018. 

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