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Taking things in stride | Economic insights

January 23, 2019

Taking things in stride

Financial markets have rebounded since bottoming out in December, effectively reversing the declines from 2018. This occurred despite any number of newsworthy events that could have (and likely would have late last year) caused the market to react negatively. Yet the outlook remains largely unchanged, save for a few important domestic developments. On the positive side of the ledger, the Fed has changed its projection for rate hikes and softened its language in both its statement and in public speeches since its last meeting in December. Markets that once thought that the Fed was raising rates too quickly looks favorably on these changes. And trade negotiations with China are progressing, or at least that appears so to outside observers based on recent reports of progress in negotiations. While current tariffs are impacting the economy in a marginal way, the escalation of trade barriers in the absence of a deal would create more of a headwind for economic growth. Markets have largely cheered these (seeming) developments.

The shutdown, which we write about more in-depth our Primer on the Federal Government Shutdown, this week, now stands as the longest on record.

On the negative side of the ledger, the federal government has remained partially shut down since December 22nd, right around the recent nadir of the equity market.

Yet, the market has largely ignored this development. Thus far, that feels about right, with the damage from the shutdown looking limited. But the longer the shutdown persists, the more it will negatively impact the economy and not just on a cumulative basis. Incrementally, we estimate that the shutdown is currently reducing annualized GDP growth by roughly 25 basis points per month. But that amount will increase over time as consumer and business sentiment and behavior changes and negative effects become more widespread.

Underlying growth still slowing

Yet despite these changes, underlying economic growth, domestically and globally, is undoubtedly slowing. In the U.S., it will take time before we know real GDP growth for the fourth quarter of 2018. The data, set to publish on January 30, will release at a later date – even if the government reopens before then (a specious proposition given the impasse in Washington) the shutdown prevented the government from collecting the data and conducting the surveys needed to make the first estimate. The Fed’s beige book, helpful in a time of limited data releases, showed signs of continued economic slowing in early 2019.

Major economies of continental Europe, such as France, Germany, and Italy, are all showing signs of a marked slowdown.

Turning to the rest of the world, the data is clearly showing signs of a widespread slowdown.

Germany has avoided a technical recession thus far, but its pace of slowing has come as a bit of a surprise. And recession might have already gripped Italy. In Asia, China grew in 2018 at its slowest rate since 1990 and Japan likely experience a notable slowdown as well.

Sentiment starting to turn

Against this backdrop, it appears that sentiment is starting to turn. Throughout the last two years, sentiment raced ahead of underlying data. Business appeared more sanguine than at any time since the vertiginous heights of the dot-com era while consumers’ spirits looked buoyant. Yet, recent survey data shows signs of concern. Recent business surveys have weakened a bit while the most recent reading on consumer sentiment for January showed the largest decline since December 2012.

The shutdown, the gyrations in the public markets, and signs of economic slowing (or at least stories about it) dampened consumers’ spirits.

Consumers are still buffeted by a strong labor market, accelerating wage growth, and declining energy prices, but optimism could have passed peak.

Political risk at decades-high levels

We view 2019 as a year of heightened political risk, potentially the highest in decades. There’s also no shortage of other risks. Brexit took center stage last week, with the UK government’s latest plan shot down by parliament. With two months to go, the outlook remains uncertain. The U.S.-China relationship has turned more adversarial. Even beyond trade, theft of intellectual capital, forced turnover of corporate secrets for market access, and rising tensions in the now militarized South China Sea have changed the relationship, a largely accommodative one for the last 40 years of China’s ascent. Populism remains on the march around the world, even aside from the noteworthy developments in the U.S. and UK. Populists could make their presence felt in parliamentary elections in continental Europe in 2019. The ongoing shutdown in the U.S. reflects the more contentious state of affairs in Washington now that the Democrats control the House of Representatives. Even once the shutdown ends, this will not change. We expect more investigations into the administration under the current House the findings of which could further roil sentiment.

What else happened last week

Inflation for December, measured by both the producer price index (PPI) and import prices, generally showed the same trend. Declining energy prices put downward pressure on headline inflation while underlying pressures stabilized core inflation. Several data releases did not publish due to the shutdown. We expect it will likely take months before we are back on a normal publishing schedule.

What we are watching this week

We expect a very limited schedule this week with the shutdown. Existing home sales for December should show a decline while initial unemployment claims could see some upward pressure from shutdown fallout.

What it means for CRE

Commercial real estate (CRE) is undoubtedly slowing. But the magnitude reflects the general slowdown in the economy. Vacancy rates are gradually rising, but marginally. Rent growth is slowing but remains positive and in excess of inflation. Pricing remains firm with little upward pressure on cap rates. We still foresee 2019 as a positive year for both the economy and CRE, with some slowing. But risks abound, with the shutdown the most immediate. The longer it persists the greater it will reduce economic growth and impact the CRE market as we detail in our Shutdown Primer. We remain cautiously optimistic, but cognizant of rising risks.

Thought of the week

In the fourth quarter, the U.S. government borrowed as much as it did in all of 2006.

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