How you feelin’?
Consumers and businesses seem to be blissfully unaware of the signs of a slowing economy
Consumer and business spirits rebounded from the doldrums earlier this year but appear blissfully ignorant of the underlying slowdown in the economy. The NFIB Small Business Optimism index bounced back in April, reaching a four-month high. Regional manufacturing surveys look more buoyant. And consumers felt even more upbeat with consumer sentiment for April exploding to a 15-year high. Undoubtedly, at least some of this resurgence in optimism stems from moving past disruptions earlier in the year. The equity market regained all its lost ground from late last year while the outlook for the global economy has somewhat improved. And the labor market remains at its tightest level in half a century. The unemployment rate still sits at 3.6 percent while weekly unemployment claims show no sign of trending upward despite some recent volatility.
While the outlook for the global economy seems more upbeat than earlier this year, global growth is slowing, producing some headwinds for U.S. exporters.
Yet, more visible signs of a slowdown in the U.S. economy are emerging. Fiscal stimulus is wearing off, as we expected. Both headline and core retail sales fell below expectations in April, reversing a strong increase in March. Industrial production for April also surprised, falling well below expectations. And while the outlook for the global economy seems more upbeat than earlier this year, global growth is slowing, producing some headwinds for U.S. exporters.
The implementation of increased tariffs by the U.S. on Chinese imports also produces a minor restraint on U.S. growth. But risk in policy now lies on the downside, a reversal of just a few weeks ago when apparent progress assuaged fears of a trade war. While we believe that current trade policies should not produce catastrophic results, the risk lies with the impact that trade could have via expectations, particularly if trade restrictions intensify before easing. First, while tariffs have only a limited, one-time impact on inflation, they could alter inflation expectations of consumers which could produce a more permanent change in inflation. Second, if sentiment on Wall Street and Main Street sours because of trade restrictions, that could exacerbate the current slowdown. If bad enough, such a pullback in sentiment could result in a recession. Thankfully, the news on trade did not all fall into the negative column last week. The administration backed away (at least temporarily) from new auto tariffs that would have impacted Europe and Japan at a time when their economies are growing more slowly than the U.S. economy. And the administration agreed to exempt Canada and Mexico from the steel and aluminum tariffs implemented last year. That helps to clear the way for ratifying the new NAFTA, which would most likely not occur with those tariffs still in place.
While trade certainly presents some downside risks, our base case does not see enough deterioration to warrant a cut this year.
Fed speakers in the spotlight this week
Several Fed speakers, including Chairman Powell, will take the spotlight this week. The markets are looking for more evidence of the Fed’s direction on rate policy. So far, the general sentiment from the Fed appears to indicate that most officials seem content with the current policy framework. Officials have little appetite to alter the current policy stance without more evidence of an acceleration in inflation or a more pronounced slowdown in the economy than we are currently anticipating. Therefore, we continue to expect no change in Fed policy this year despite the futures market looking for a rate cut of 25 basis points. While trade certainly presents some downside risks, our base case does not see enough deterioration to warrant a cut this year. And Fed officials now seem more willing to tolerate inflation above their target rate of two percent, which increases the threshold for raising rates. The yield curve remained inverted for most of last week, after inverting again briefly near the end of the week before last. We do not put too much faith in any one indicator in isolation but the number of days with an inverted yield curve are starting to add up. At a minimum, the inverted curve signals concern about growth in the economy in the face of potential obstacles and risks.
What else we are watching this week
While Fed chatter could dominate headlines, durable goods orders for April should show a pullback, reversing a relatively strong increase in March. That should mirror what we have seen from other economic indicators, further signaling the fading impact of last year’s fiscal stimulus. And existing and new home sales for April should provide some direction on how changes in mortgage rates are impacting the market.
What it means for CRE
For commercial real estate (CRE), the likely economic slowdown should not greatly impact the market. A slowdown in rent growth and vacancy compression is already underway, reflecting the underlying trend in the economy, not the period-to-period changes. Trade policy presents more of a risk. As currently constituted, trade policy should impose only minor restraints on the CRE market. But the more notable risk comes from a decline in sentiment. If sentiment turns down, restraining growth or causing a recession, then CRE of all types could suffer. And if temporary inflation pressures from tariffs beget greater inflationary expectations, the increase in the prices of goods could become a problem for retailers.
Thought of the week
In the U.S., a strong negative relationship exists between household income and time spent using electronic devices.