Economic Insights: Markets growing concerned
A simmering trade war and stagnant interest rates make for increasingly nervous markets as the picture clears up for commercial real estate
Markets growing concerned
Markets are growing increasingly concerned about the impact that the trade war between the U.S. and China will have on U.S. economic growth. Equity markets pulled back last week as it became more apparent that the trade conflict looks more durable than previously perceived. The Treasury market showed similar concern. The 10-year Treasury yield fell below 2.3 percent to its lowest level in roughly 19 months. And the yield curve remains inverted with the 3-month yield consistently higher than the 10-year yield for a good portion of the last couple of weeks.
All of this reinforces our view that underlying economic momentum is slowing, and we expect economic growth in the second quarter to fall well below first quarter’s growth rate.
Increased trade tensions arrive at a time when signs of slowing in the economy abound. New and existing home sales for April both disappointed despite the recent pullback in mortgage rates. While low inventory and affordability remain the key reasons volumes remain relatively low, we still would have expected better results because of the pullback in mortgage rates. Additionally, durable goods orders declined as expected in April but revisions to the March data came in negative. Of course, lackluster global growth outside the U.S. remains a noteworthy headwind. All of this reinforces our view that underlying economic momentum is slowing, and we expect economic growth in the second quarter to fall well below first quarter’s growth rate.
The Fed’s minutes from its most recent meeting supported our view that the Fed believes the recent weakness in core inflation is transitory. That confirmed comments from Chairman Powell earlier in the week. But the Fed also appeared a bit concerned that inflation could sit below its target rate of 2 percent in the medium term despite their seemingly newfound willingness to let inflation rise above the target rate. This week’s release of core inflation, as measured by the personal consumption expenditures (PCE) index for April, should provide more clarity on that subject. While we expect core PCE to rebound after some recent weakness, the year-over-year growth rate should nonetheless remain the weakest in roughly a year and a half. And while the Fed focuses on core PCE inflation when setting policy, we note that core PCE has recently slowed more than other inflationary indexes, including the consumer price index (CPI).
Unless something significant changes, the Fed looks likely to stand pat on rates in 2019 because growth remains too strong to ease while inflation remains too weak to tighten.
The Fed also seems willing to look past any transitory impact on inflation from increased tariffs. In the short run, tariffs can boost inflation though higher prices, but these function as a one-time increase that becomes part of the base used to calculate inflation — the effect does not persist. And as trade wars slow economic growth, that slower growth tends to have a deflationary impact on pricing. The Fed will not likely get fooled by any upward pressure on pricing from trade disputes. All of this reaffirms our view that unless something significant changes, the Fed looks likely to stand pat on rates in 2019 because growth remains too strong to ease while inflation remains too weak to tighten.
What else we are watching this week
Consumer confidence for May should rise, mirroring the increase recently observed in consumer sentiment. The second estimate for first quarter GDP growth should show a slight revision downward, but still register greater than 3 percent. Personal income likely accelerated a bit in April while personal spending likely cooled after a strong showing in March. Headline PCE inflation likely rebounded, pushed by higher energy prices.
What it means for CRE
For commercial real estate (CRE) the short-term outlook still looks favorable. But two key questions now occupy our minds. First, how much will the trade war impact economic growth and consequently the CRE market? The answer to that questions depends upon how far along the trade war progresses. We never resided in the grand détente camp, even when things looked slightly more optimistic. At this juncture, the probability of trade barriers increasing sits above the probability of tensions easing slightly with both sides increasingly dug in. Second, will the Fed sitting on hold engender an asset bubble, including CRE? We intend to delve into this topic in June, but increasingly others are beginning to wonder the same thing. For now, we do not see signs of a CRE bubble, but that does not mean one is not coming. More on this next month.
Thought of the week
According to a recent study, the current in-place tariffs on Chinese imports will cost the typical U.S. household $831 on an annual basis.