We’ve reached a pivotal point for the economy. For commercial real estate, all eyes are on inflation and the job market
- Ryan Severino
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- Fed raises 50 bps as expected
- Job market remains strong
- ISM indexes still showing expansion
- Inflation data set to moderate
- CRE still positioned well
We have reached a pivotal juncture for the economy. That seems like a feature and not a bug in this current cycle. But data from last week and this week show us not just where the economy has been but where it could likely head in the coming months. A few key items are playing breakout roles as we dig into data from the second quarter.
Back to the future
Last week the Fed decided to hike its key benchmark policy rate by 50 basis points (bps), the first such hike in 22 years. Chair Powell also signaled that other rate hikes of 50 bps will likely occur over the next couple of meetings as the Fed looks to head back to a neutral fed funds rate, which we estimate at roughly 2.5%. The Fed also indicated that it will begin reducing its balance sheet (both Treasuries and MBS) next month. That should knock hundreds of billions of dollars off this year and potentially a trillion more dollars next year. That should put some marginal upward pressure on yields, particularly at the long end of the curve. Higher rates should (in theory) dampen demand for interest-rate sensitive goods and services and help to alleviate inflationary pressures. The Fed clearly believes that the economy can digest these higher rates, even as it decelerates from last year’s torrid pace. Why?
“Higher (interest) rates should (in theory) dampen demand for interest-rate sensitive goods and services and help to alleviate inflationary pressures.”
9 to 5
Because the labor market remains robust. Net jobs gains in April totaled roughly 428,000, matching the downwardly revised figure from March. As we mentioned last week, net job gains remain remarkably consistent. Year to date, the economy has already added a net 2.1 million jobs and 6.6 million over the last year. The labor market has gained back almost all the jobs lost during the downturn and remains on pace to complete that task over the next few months. If so, that would mirror the labor market recovery from the S&L Crisis recession of the early 1990s and greatly exceed the labor market recoveries from both the dot-com implosion and the global financial crisis. The unemployment rate in April held steady at 3.6%, just 10 bps above the level from February 2020 before the pandemic. Although weekly unemployment claims have recently ticked up, they remain near half-century lows.
Despite such a strong labor market recovery, demand for labor continues to outstrip supply. Open jobs reached a new record high in March of 11.5 million, with roughly two open jobs for each unemployed person. Such a demand-supply imbalance continues to push wages higher. Yet, we still see little evidence of a wage-price spiral with wage gains slowing on a monthly and year-over-year basis in April. The labor force participation rate provided the one weak spot, with a decline during the month. But we see this as blip – the strong labor market continues to pull workers back, including retirees.
| What else happened last week |
Both the ISM Manufacturing and Services indexes for April declined but remained well into expansion territory. The trade deficit reached a record in March, reflecting the strong detraction from growth observed in the GDP data from the first quarter. Construction spending during March increased slightly, but that followed healthy upward revisions to the two prior months. Productivity in the first quarter declined, continuing its somewhat erratic pattern in recent quarters.
| What we are watching this week |
All eyes will focus on inflation this week. A pullback in energy prices during April should help slow gains in the headline consumer price index (CPI). Continued declines in auto prices should alleviate pressure on the core CPI. Meanwhile, the robust inflation from April 2021 will drop out of the 12-month change and simply become part of the base for calculating inflation. Consequently, the April data should show that core and headline CPI slowed on a year-over-year basis. Two more months of high inflation (especially core inflation) will also drop out the 12-month calculation over the balance of the quarter. That should support our long-held belief that inflation would slow during the second quarter of 2022. If so, then March should represent the high watermark for inflation during this cycle. We do not expect a rapid deceleration but any alleviation in pricing pressure would help. The producer price index (PPI) for April should continue to show high inflation, but the monthly increase should slow after energy prices boosted inflation in March. We expect a similar trajectory to CPI, with slowing in the coming months. Finally import prices from April should remain elevated amidst ongoing supply-chain disruptions.
“…inflation (will) slow during the second quarter of 2022.”
Ready to drop out
| What it means for CRE |
The health of the overall economy remains paramount for commercial real estate (CRE). In the face of rising interest rates, a robust economy should continue to support space-market fundamentals and healthy performance. The labor market remains key to the health of the economy. With employment gains in leisure and hospitality, transportation and warehousing, business and professional services, financial activities, and retail trade, all major property sectors had something to cheer. Continued support from the economy should help CRE weather increases in interest rates. Meanwhile, slowing inflation should take some pressure off the sector, even though CRE still boasts an imperfect inflation hedge.
“Continued support from the economy should help CRE weather increases in interest rates.”
| Thought of the week |
Mother’s Day spending this year should total roughly $32 billion.