Economic Insights:
Progress or not?

The clock is ticking on trade negotiations with China—with potential fallout that could affect commercial real estate. 

October 14, 2019

Progress or not?

After the resumption of trade talks last week, the administration announced a “substantial” phase-one trade agreement with China. Tentatively, China would promise to enforce intellectual property rights and import roughly $40 to $50 billion in agricultural products from the U.S., while the U.S. would delay the scheduled October 15 increase in tariffs from 25% to 30% on $250 billion of imports from China. While markets appeared to cheer the news, as always, the devil remains in the details. And thus far the details are proving more nettlesome. As details emerge, it appears that the administration has not actually reached a deal and that China wants to continue talking before agreeing to even this limited deal. But beyond that, even if the deal goes forward it largely follows our expectations – limited in scope, rather than a grand détente. Such a limited deal will do virtually nothing to remove the trade policy uncertainty and concerns of business leaders—a key factor that has held back investment and negatively impacted the U.S. economy in the second quarter. And the direct impact to the economy from this potential agreement would be limited, probably removing 10 basis points (at most) of restraint on economic growth when existing tariffs are already imposing 40-50 basis points of restraint. More importantly, the deal did not address the potentially more damaging imposition of 15% tariffs on roughly $150 billion of consumer imports from China, scheduled to take effect on December 15. The administration will need to address this issue in subsequent negations. In sum, we still see the trade environment negatively impacting business sentiment, investment, production, and potentially even personnel decisions.

Fed helps to steepen yield curve

In addition to the boost in sentiment from the potential trade deal, the markets also received a shot in the arm from the Fed’s decision to again expand its balance sheet. The Fed made clear that the move did not represent the start of a new round of quantitative easing (QE). Instead, it marks an increase in reserves on the balance sheet intended to meet demand for xcurrency. The Fed will begin buying $60 billion per month in Treasury bills starting on October 15. The future path beyond the next month seems uncertain, especially with the Fed taking on a more dovish stance. The futures market still expects the Fed to cut rates by 25 basis points in two weeks. But the announcement of the purchases, along with the positive feelings from the trade announcement, caused the 10-year/3-month Treasury curve to steepen and normalize (and not sit inverted) for the first time since July 31.

Modest inflation provides cover to Fed doves

Modest inflation data likely gives the Fed doves cover, but the minutes from last month’s meeting showed that Fed officials remain divided on whether to cut rates, even as they concede that downside risks to the outlook have intensified. Data from the producer price index (PPI) showed unexpected declines with headline producer prices experiencing their second-largest drop since September 2015. Core producer prices did not change. As a result, year-over-year changes in both headline and core inflation declined, with core hitting its slowest pace since October 2016. On the consumer side, the consumer price index (CPI) both headline and core prices rose less than anticipated. Core CPI was running hot in recent months, so some cooling was expected. Year-over-year, core CPI remains at 2.4%. Clearly, prices are not collapsing, but are also not signaling that prices are heating up again.

What it means for CRE

For commercial real estate (CRE), we have not yet seen a meaningful drag on fundamentals or investment volumes from trade policy uncertainty despite its impact on other industries. Fundamentals during the third quarter showed little sign of trouble across any of the major property types. Therefore, we see little direct benefit from marginal progress on trade. We remain concerned that larger unresolved trade issues could eventually begin to more directly impact CRE but that has not yet occurred. For CRE investment, the increase in rates and the steepening yield curve should also not have much impact. Volumes remain relatively healthy with rates still at low levels and market fundamentals remaining firm. In the U.S. year-to-date investment was flat, reaching $341 billion through the third quarter. Importantly, a surge of liquidity into the industrial sector upheld overall performance. Year-to-date industrial volumes surged 33% due to the $18.7 billion sale of a large portfolio that constitutes the largest private real estate transaction on record. If the market were truly concerned over trade, the industrial marketplace would not perform so well.

What we are watching this week

Several Fed officials will speak this week ahead of the quiet period that begins on October 19. Additionally, retail sales for September should shed some light on how well the consumer is faring. The consumer has driven economic growth in recent months. We expect another firm showing in September.

Thought of the week

The delinquency rate on credit cards, excluding the 100 largest banks, increased by 60 basis points in the second quarter and the spread of delinquency rates between the 100 largest and all other banks stands at 390 basis points, an all-time high.

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