More complex than ever

Quick takes:

• Complexity in the economy increasing
  
• Last week’s data was a mixed bag
• Omicron variant complicating outlook
• Better clarity over the coming weeks
• CRE remains focused on longer term

Understanding the economy, a highly complex system, often proves challenging. Sometimes data and information provide a clear forecast, sometimes they give a contradictory message, and sometimes they  remain unclear, ambiguous and uncertain. We received the latter two last week, reminding us why this kind of analysis remains important yet imperfect.

A mixed bag

Last week’s data provided some conflicting signals, even though the overall trend in the economy remains positive. Weekly initial unemployment claims fell to their lowest level since 1969 when the labor market was much smaller. While seasonal factors likely overstated the fall in claims, the downward trend signals ongoing recovery in the labor market. Real GDP growth for the third quarter increased by 10 basis points (bps) to 2.1% with the most recent revision. Though still well below readings from the first half of the year, data indicates that growth accelerated in the fourth quarter. The savings rate declined to a pandemic-era low of 7.3% while personal income increased again in October. The combination of the two helped to fuel an increase in consumer spending in October that exceeded expectations. 
 

Yet, somewhat contradictorily, consumer sentiment in November declined to its lowest level since November 2011. Though we focus on what people do and not what they say, the low reading reflects concerns over inflation which data showed remains elevated. The headline personal consumption expenditures (PCE) index for October grew 5% year-over-year, the fastest rate since November 1990. Meanwhile the core PCE, the Fed’s preferred measure of inflation, grew by 4.1% year-over-year, the quickest pace since January 1991. 

Demand in command

Through the fog of the data, the economy continues to expand. Growth is rebounding from its lull in the third quarter while the labor market continues to recover. And even inflation reflects mostly positive developments. While inflation is weighing on consumers’ spirits, inflation exists because consumers continue to spend money. As we discussed two weeks ago, aggregate demand in the economy is growing faster than aggregate supply, pushing up the price level as the economy expands. While not discounting the real impact inflation can have, inflation exists because consumers are spending money (and spending it in different ways). As we have also mentioned in previous weeks, while the supply-chain issues capture many headlines, imports stand at record levels. 
 

But consumption patterns changed notably during the pandemic. With consumers preferring to stay home, spending on goods increased markedly starting in the third quarter of 2020. As of the third quarter, real spending on goods increased 15.3% relative to its pre-pandemic peak. Meanwhile spending on services contracted sharply during the second quarter of 2020 and remains 1.6% below its pre-pandemic peak.  Such an abrupt change in spending habits was clearly not anticipated and now global supply chains are struggling to keep up. Retailers continue to struggle to keep inventory on shelves to satiate consumer demand.

Goods spending up, services spending still down
 

To make matters worse

On top of all that, the emergence of the Omicron variant adds a new, uncertain variable into the equation. While far too early to say anything definitive about its impact, markets last week chose to act first and ask questions later. Both the equity markets and the oil market pulled back notably. Once we know more about this variant, we can assess its impact on the economy. But for now, it shows the continuing complexity of this analysis. For example, if this variant causes demand to fall and economic growth and job growth to slow, but inflation also contracts notably, would consumers perceive this development as a positive or negative outcome? We will have more to say on this issue when we know more, but for now it serves as a great example of why analyzing and forecasting the economy remains incredibly challenging.

|  What we are watching this week  |

The unemployment situation for November should show another solid increase in jobs, reflecting the reacceleration in the economy after the third quarter lull. The unemployment rate could decline slightly as the labor market tightens further while wage growth should continue at a brisk pace. Both the ISM Manufacturing and Services Indexes for November should show continued expansion in the economy, particularly Services which looks set to rebound. Consumer confidence for November likely declined, due to apparent concerns over inflation.

|  What it means for CRE  |

Commercial real estate (CRE) continues to have a bright outlook, looking past any short-term disruptions and focusing on the longer-term expansion in this cycle. Impact from the new variant remains unclear but should become more apparent in the coming weeks. But like most things in the economy, any impact will almost certainly prove positive for some property types and markets and negative for other property types and markets. Nonetheless, the longer-term outlook for the economy and CRE remains favorable with fundamentals continuing to improve and pricing remaining robust. 
 

|  Thought of the week  |

After spiking during 2Q2020 to 67.9%, the home ownership rate as of the third quarter stood at 65.4%, almost exactly in line with its long-term average.