Research

Economic Insights:
Expanding and Retrenching

Confidence is up amongst consumers but corporations aren’t so sure. Even so, the office sector, along with industrial and retail are all performing well.

November 05, 2019

Consumers remained the main engine of economic growth during the quarter, supported by an incredibly tight labor market with demand exceeding supply of qualified workers.

It is what we thought it was

Data released last week confirmed our view that the economy is slowing, but not collapsing. Economic growth for the third quarter exceeded expectations but slowed relative to second quarter’s growth rate. As we expected, the key divergence from the second quarter persisted into the third quarter: personal consumption continued to drive the economy while private investment again contracted. Consumers remained the main engine of economic growth during the quarter, supported by an incredibly tight labor market with demand exceeding supply of qualified workers. But for corporations, trade policy uncertainty combined with a somewhat darkening global picture restrained investment, particularly nonresidential investment which contracted at its slowest rate in almost four years and declined for consecutive quarters for the first time since 2009. One bright note in investment: residential investment (essentially housing) grew for the first time in almost two years. Net exports and government expenditures grew slightly during the quarter, making marginal contributions to growth.

The Fed signaled that it will pause rate cuts and will need to see more serious signs of deterioration before cutting again.

Data shows trends from third quarter will likely spill over into the fourth quarter

The net employment change for October exceeded expectations, including upward revisions to August and September job gains, but still showed a downward trend in job growth. Through October, the average monthly job gains registered 167,000 net new jobs. If that pace holds for the year, it would represent the slowest pace of job growth since 2010 when the labor market began recovering from the recession. Job gains are slowing because of a dearth of qualified labor, not because of a contraction in demand. The most recent reading on open but unfilled jobs (from August) remains not far off its record high at 7.1 million. That figure exceeds the number of gross hires per month and the number of people technically unemployed. The unemployment rate ticked up slightly to 3.6% but increased because the labor force participation rate reached 63.3%, its highest level since 2013. And wage growth held firm at 3% on a year-over-year basis. While growth decelerated relative to readings from earlier this year, it still exceeds all inflationary indexes, a hopeful sign as we head into the all-important holiday shopping season in November and December. We anticipate that holiday sales should grow by 4.5% to 5% and expect the consumer to continue to drive the demand side of the economy in the fourth quarter.

For the corporate sector, data unfortunately also likely signals continuation. The ISM manufacturing index increased slightly but remained below 50 for the third straight month during October. Readings below 50 indicate that the manufacturing sector is contracting, although not at levels indicative of a recession. Recall that in 2016 the manufacturing sector contracted without spilling over into the broader economy, preventing a recession.

The key risk motivating the Fed

Yet, the risk that trouble in the corporate sector (namely manufacturing) spills over into the consumer sector (via slowing in job growth or job cuts) is motivating the Fed to cut interest rates despite economic growth near long-run potential. Last week the Fed, as anticipated, cut rates by 25 basis points for the third time this year. That brings the target fed funds rate down into a range of 150-175 bps. Importantly, when we consider core inflation, as measured by the core consumer price index (CPI), the real fed funds rate sits in the -90 to -65 bps range. Typically, we only observe real rates at that low of a level during actual recessions. Is the risk of a spillover so great that the Fed feels compelled to lower rates to such a low level despite economic growth? The Fed surely must think so. But we reiterate our view that the interest rate cuts at this juncture likely will have muted impacts relative to cuts in previous cycles because interest rates already sit at low levels and rate cuts do nothing to directly address the two main issues retraining private investment: trade policy uncertainty and slowing global growth. The Fed signaled that it will pause rate cuts and will need to see more serious signs of deterioration before cutting again. Therefore, the Fed will likely hold rates at its next meeting in December and reassess the situation in the first quarter of 2020.

What we are watching this week

Two key items to note this week. First, the ISM non-manufacturing index for October should rebound a bit after plunging in September, remaining above 50 and signaling continued expansion but at a somewhat slower pace. Consumer sentiment should change little. Both consumer confidence and sentiment indexes declined in recent periods and remain important indicators for signs of weakening.

What it means for CRE

For commercial real estate (CRE), data from last week supports our view that CRE continues to fare well despite general slowing in the economy. Supported by continued job growth, the office sector continues to perform well. Boston, San Francisco, and New York ranked 1, 2, and 4 respectively for year-over-year rent growth during the third quarter. The industrial sector continues to benefit from robust consumer spending. Preleasing continues its strong run, helping to keep the national vacancy rate on a downward trajectory despite a robust development pipeline. Retail, often unfairly maligned, should continue to benefit from a strong consumer and tight labor market. While some pockets of weakness exist, consumers continue to be drawn to higher-end and experiential centers. The recent opening of the American Dream megamall in Northern New Jersey reflects this trend. Multihousing also remains healthy despite increasing construction volumes and rising homeownership. Continued job growth and favorable demographics, with a relatively large number of younger households, should support demand heading into 2020.

Thought of the week

The death of homeownership, especially among millennials, has been greatly exaggerated. The homeownership rate in the U.S. reached 64.8% during the third quarter. That matches the highest reading since the first quarter of 2014 when the rate was still declining and sits just below the long-term average of 65.2%. The rate bottomed out during the second quarter of 2016 at 62.9%. The largest gains in homeownership came from households under the age of 35 and in the 35 to 44 age cohort.

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