Following the trends

We’re still seeing momentum in the economy, but CRE remains in a gradual slowdown. When will things turn around?

March 08, 2023
  • Ryan Severino
  • Trends still mostly positive
  • Bright spots in durable goods and construction
  • Housing still tethered to mortgage rates
  • ISM indexes still showing expansion
  • Economy and CRE waiting for the Fed

The data released last week generally followed the underlying trends we have discussed in recent weeks. Momentum in the economy persists, even with some variation by sector. Consumers remain wary, but that has not yet impacted their desire to spend. And the housing market remains tethered to mortgage rates. Has any of this impacted our outlooks and what does it mean for commercial real estate (CRE)?


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Durable goods orders seem…durable

Headline durable goods orders declined more than expected in January. But the details looked far more positive. Orders excluding transportation (which are quite volatile) outpaced expectations, increasing by its largest gain since March. And core capital orders also exceeded expectations. Core capital shipments also increased. Overall, the data supports our view that the economy is proving more resilient than people expected at the start of the year. Yet, as with many other indicators, resilience does not mean acceleration. Momentum in the economy is slowing, even if it isn’t deteriorating as quickly as many anticipated.

The state of housing

The pending home sales index (PHSI) shot up 8.1% in January, well above the consensus expectation, and rising at its fastest rate since June 2020. Although the year-over-year change remains starkly negative, the data serves as a reminder of how sensitive the market has become to mortgage rates. The yearly sales decline reflects the notable increase in mortgage rates over the last year. But the monthly jump primarily reflects the pullback in mortgage rates over the last two months, which helped to improve affordability. With mortgage rates moving higher in recent weeks, this momentum could prove ephemeral. Yet greater stability in mortgage rates, coupled with declining prices, could support the housing market. But overall, home sales will likely remain restrained by higher mortgage rates for some time. Many homeowners are locked into lower rates and will likely remain hesitant to sell. That should continue to limit existing home sales (most of the market) and make new homes a more plausible option for buyers.

With mortgage rates up over the last year, housing prices continue to fall. The S&P/Case-Shiller 20-city home price index declined again in December. The year-over-year change remains positive but has slowed to its weakest increase since July 2020. Similarly, the Federal Housing Financing Agency (FHFA) home price index continued to decline in December but shows slowing year-over-year increases. While lower prices should eventually lower the barrier to home purchases, in the short run the market should remain most responsive to mortgage rates. But the falling prices should help bring down inflation in the future. Shelter now represents roughly 35% of the consumer price index (CPI). Although it takes time for slowing shelter costs to feed through to CPI, declining shelter cost should nonetheless prove a significant factor in slowing inflation later this year.

Constructing shift

Construction spending remained relatively weak in January, coming in below consensus. Residential construction spending remains relatively weak with the housing market coming under pressure. Public construction spending also disappointed. But spending on private nonresidential construction surprised to the upside and provided a bright spot in the report. While one month does not make a trend, nonresidential construction spending reached a nominal record high. Historically, this spending peaks prior to or at the start of recessions so we will watch this space closely in the future.

Making sense of consumer confidence

The Conference Board’s consumer confidence index declined in February, coming in below consensus expectations. That marks the second consecutive month of decline, pulling back to the lowest level since November. Respondents’ views of the current situation improved, largely due to the strong labor market. But their view of the future took a negative turn. Broad expectations for jobs, incomes and business conditions all turned more pessimistic. Much of how consumers feel will come down to the battle between their employment situation (including wage growth) and inflation over the balance of the year.

“Much of how consumers feel will come down to the battle between their employment situation (including wage growth) and inflation over the balance of the year.”

ISM indexes offer mixed view

Both ISM Manufacturing and Services Indexes for February showed little change, but they continue to tell a divergent story. The services index surprised to the upside. That sector of the economy continues to fare relatively well, signaling ongoing expansion despite higher interest rates. Survey respondents seemed generally optimistic about business conditions. Meanwhile the manufacturing index continues to signal contraction. Unlike services, the manufacturing sector faces challenges in the form of slowing demand and, relatedly, higher borrowing costs. Together, the ISM indexes signal continued expansion in the economy, in line with other recently released data.

What it means for CRE

Nothing we see in the data alters our view of a resilient economy in early 2023. Over the last couple of months data has generally surprised to the upside. A holistic view suggests that the economy continues to expand at a moderate rate. But that presents two important points. First, this does not suggest a slowdown isn’t coming. We still firmly believe one is. Second, as we mentioned last week the resilience is a net negative because it puts pressure on the Fed to keep raising rates. That’s not to suggest an earlier slowdown would be preferable. It likely would not, but just present slightly different timing. While inflation is decelerating both the economy and the CRE market find themselves in a gradual slowdown. Rapid deceleration in inflation would present the best solution to what ails the economy and CRE market, but that seems a distant prospect. For now, slowing will remain the order of the day. Don’t expect too much from the economy and CRE market until inflation falls enough to shift the Fed’s messaging, likely in the latter half of this year.

“Nothing we see in the data alters our view of a resilient economy in early 2023.”

Thought of the week

The doubled-edged sword of resilience in the economy seems pervasive around the world. In recent weeks, composite PMIs have improved, reflecting better economic performance. But that also likely means tighter monetary policy around the world, putting pressure on bond and equity markets.

Contact Ryan Severino

Chief Economist, JLL