How slow did we go?

Quick takes:

• GDP growth set to slow in 3Q
• Disruptions seem temporary
• Consumer sentiment stabilizing
• Outlook for the economy remains positive
• CRE seeing past temporary blemishes

This week we will receive our first look at third quarter GDP growth. Expectations have fallen to very low levels over the last few months, with a combination of factors combining to weigh on the economy. Yet, we continue to see the third quarter more as a speedbump than a roadblock and believe the economy will accelerate heading into the end of this year and 2022. The economy is shifting gears and moving from recovery to expansion, even if some bumps in the road remain. 

Notable headwinds

As we have previously discussed, the economy faced a notable combination of headwinds during the third quarter. The Delta variant surged in the U.S., pushing the pandemic back to levels unseen in months and slowing economic activity that required personal interaction. Consumer interest in dining out reduced reservation activity and caused job losses in the food services and drinking places category for the first time since late last year. Consumer interest in travel also dropped, as evidenced by declining TSA checkpoint figures and hotel occupancy data. And broad retail activity wavered during the quarter after a tremendous run earlier in the year but remained elevated.

Retail Sales Faltered in Recent Months

Restraints on the supply side of the economy also limited economic growth. This is somewhat connected to the Delta variant and a resurgent pandemic. Some countries around the world that manufacture many of the goods that we consume took production and distribution facilities offline during peaks in transmission. Other industries faced not only temporary pandemic-related restrictions on production, but also more permanent ones. For example, some industries such as energy face structural declines in investment which limits production.  We continue to see the labor shortage as the key structural restraint on the supply side of the economy. 

Lastly, the combination of demand and supply has pushed inflation up to levels unseen in decades. While we don’t see inflation as the bogeyman that some do, higher prices can dissuade some consumers and businesses from purchasing certain good or services. But inflation during this cycle remains driven by aggregate demand growth exceeding aggregate supply growth, not a supply shock. Across various metrics, demand and consumption remain elevated and supply is struggling to keep pace. Therefore, we see inflation producing a moderate impact on GDP growth and not a repeat of what occurred during the 1970s when a legitimate supply shock raised prices and lowered GDP.

Taken together, these factors likely limited growth in the third quarter. But the Delta wave of the pandemic is already abating, supply-side disruptions continue to resolve as companies and the supply chain adapt and evolve, and inflation appears to have peaked (though this is different from deceleration). Growth should accelerate once again this quarter as the economy moves past these temporary disruptions. 

|  What else we are watching this week  |

Consumer confidence and sentiment for October should both tick up, but consumption already looks set to rebound during the fourth quarter. The employment cost index (ECI), a broad measure of compensation, likely increased at its fastest quarterly rate in almost 18 years during the third quarter, reflecting growth already observed in other wage metrics. Personal spending growth for September likely decelerated, due to the same factors that slowed third-quarter GDP growth. 

|  What it means for CRE  |

Commercial real estate (CRE) continues to look to the medium-term and past temporary disruptions. Leasing activity across property types continues to rebound. Tour activity is trending upward. Rents and vacancies are stabilizing across property types and geographies, though some are leading, and some are lagging. Pricing across property types remains elevated while cap rates hover at low levels. If CRE viewed the disruptions observed during the third quarter as more permanent, that would get reflected in both space-market fundamentals and capital markets data. The fact that we see it reflected in neither demonstrates and supports our cautiously optimistic view of the asset class as the economy moves from recovery to expansion. 

|  Thought of the week  |

In 2019, the tax-to-GDP ratio in the U.S. stood at 24.5%, roughly 900 basis points (bps) below the average in the Organization for Economic Cooperation and Development (OECD), a group of mostly rich countries.