The highs and lows of this expansion

Quick takes:

• CPI inflation pushes higher
• Unemployment claims hit record low
• Shutdown off the table, for now
• Fed in focus this week
• CRE closing out a fine 2021

Data released last week demonstrated the highs and lows of this current expansion. While all expansions exhibit some unevenness, the recent data presents a bit of a twist. One multi-decade high is generally perceived as a negative and one historical low is perceived as a positive. Yet, they both connect in a way that embodies the somewhat confusing nature of the current economic environment. 

CPI inflation hits 39-year high

Data released last week confirmed beliefs that inflation still has some room to run before decelerating. The headline consumer price index (CPI) for November reached roughly 6.9% year-over-year, the fastest such increase since June 1982. Meanwhile, the year-over-year change for the core CPI neared 5% in November, a 13-year high. The underlying cause remains the same – aggregate demand (AD) in the economy continues to grow faster than aggregate supply (AS). As we have previously highlighted, goods consumption accelerated markedly during the pandemic and remains up more than 15% relative to its pre-pandemic peak. Meanwhile services consumption plummeted during the initial stages of the pandemic and remains down roughly 1.6% versus its pre-pandemic peak. Pandemic or not, the global supply chain, reliant on concepts such as just-in-time inventory and comparative advantage, cannot cope with such a strong, sudden, and unexpected change in consumption patterns. Meanwhile, the supply chain remains disrupted by the pandemic, further exacerbating price pressures. Additionally, low base effects are also contributing to strong year-over-year inflation. Tepid inflation during 2020 restrained price increases. That stands in comparison to June 1982 (for example) when year-over-year CPI exceeded 7% even though it had been growing at a double-digit pace throughout most of 1981. 

Low Base Effects

We see inflation unfolding in phases:

(1)    First phase – Year-over-year inflation should remain elevated through the first quarter of 2022 because of low base effects. Monthly inflation did not meaningfully accelerate until March-April once the combined impact of fiscal stimulus plus vaccination began to unleash a surge in AD on the economy.

(2)    Second phase – Once higher base effects kick in during the second quarter, year-over-year inflation should decelerate, but remain elevated as AD should remain robust while AS growth continues to catch up.

(3)    Third phase – Through year-end 2022 AD growth should slow, and consumers should revert to more normal consumption patterns with demand for goods slowing and demand for services increasing. Meanwhile AS growth should accelerate as supply-chain issues should slowly resolve, even though we expect some inputs to production to remain relatively scarce and relatively expensive.

(4)    Fourth phase – Over the medium to long term, investment in technology should boost productivity which should also help to restrain inflation. 

Ultimately, we still expect year-over-year CPI inflation to settle in above the 1.7% average annual rate from the last business cycle, but well below rates observed in recent periods. 

Weekly unemployment claims fall to all-time low

Weekly unemployment claims for the week ending December 4 reached a record all-time low. While seasonal effects are likely playing a bit of havoc with the data, the downward trend reflects the tightness in the labor market observed in other key metrics. A tight labor market continues to put people to work, generate strong wage growth, and fuel strong consumption and AD in the economy. Additionally, consumer sentiment for December rebounded after some recent weakness. We continue to note that despite low consumer sentiment, it is not impeding their ability or desire to spend money, which is somewhat ironically helping to fuel inflation.

Policy lands in the middle of it all

After Congress likely avoided a government shutdown by passing funding through February 18^th, the focus will shift to the Fed and monetary policy this week. The FOMC’s statement and Chair Powell’s press briefing should reflect a more hawkish stance with the inflation readings giving the Fed cover to accelerate tapering, with quantitative easing (QE) potentially stopping by the end of the first quarter, a quarter sooner than many anticipated just a month or two ago. We remain hopeful that the Fed will retire the word “transient” which we have disdained throughout this period. We continue to prefer more standard economics’ time conventions with firmer definitions.

|  What else we are watching this week  |

Both the headline and core producer price indexes (PPI) for November should accelerate again on a year-over-year basis. We expect another solid month for retail sales in November, reflecting an elongated holiday shopping season. Housing starts should rebound in November while permits for the month should change little. 

|  What it means for CRE  |

With just half of a month left in 2021, commercial real estate (CRE) has performed largely as we anticipated for the year. While the quarter remains incomplete, data thus far indicate that the underlying trends observed during the year remain intact. Industrial continues to push farther into expansion territory with record-low vacancy rates and strong rent growth. Retail and multi-housing continue to recover with vacancy rates now generally declining and rents increasing. Office has not yet reached stabilization, which should likely come in 2022, but the pace of deterioration has slowed, offering hope for the future. Investors retained confidence in the asset class, keeping prices elevated and holding cap rates at incredibly low levels. In sum, the market is experiencing a stronger and faster recovery than during the previous business cycle. 

|  Thought of the week  |

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