Subject to interpretation

December 05, 2018

Part one

It seems that we were a bit too prescient when we subtitled a section of last week’s Economic Insights “Do You Hear What I Hear?” Commentators have broadly interpreted Chairman Jerome Powell’s speech to the Economic Club of New York as a dovish signal, particularly his suggestion that rates sit “just below” neutral. This comment appeared to mark a shift from the Chairman’s recent statements in October, when he stated that “we’re a long way from neutral.”  But not everyone took his comments so dovishly, including us. The key lies in the specific wording because the chairman’s statements do not directly contradict each other. In October he was speaking about the Fed’s specific point estimate while last week he was talking about a broad range of estimates. Estimates for the nominal neutral rate generally fall across a range of roughly 2.5 percent up to around 4 percent; the current effective Fed Funds rate sits near 2.2 percent. Viewed from that perspective, depending upon one’s estimation of the neutral rate, we could simultaneously be both a long way from neutral and just below neutral. Our proprietary model estimates that the nominal neutral range currently falls in the 2.75 percent to 3.0 percent range.

Markets, however, took an unambiguously positive view of his comments last week, causing the stock market to surge and reducing expectations for future rate hikes after this month. We see this as an overreaction but concede that markets also likely overacted negatively to his statement in October.

Lost in the euphoria lies an unspoken, but important fact. If we really are nearing the neutral rate then underlying potential economic growth remains low, which agrees with our view that economic growth is slowing toward potential growth as fiscal stimulus fades.

We continue to foresee a rate hike of 25 basis points this month and then 2 or 3 more next year. But we will need to see how the data unfolds over the next quarter -- particularly the forecast and statement from the Fed’s next meeting in two weeks --to refine our view. The Fed itself continues to move toward data dependence and away from forward guidance.

Part two

Last week the G20 meeting was held in Argentina. More than the meeting itself, attention focused on the side meeting and dinner between the U.S. and China because of the ongoing escalation in trade tensions during 2018. The event unfolded in line with our expectations, as the two sides did not reach a grand détente. Instead, the U.S. and China agreed to temporarily halt further escalations for 90 days. This included delaying the impending increase of tariffs on Chinese imports worth roughly $200 billion from 10 percent to 25 percent on January 1. 

Similar to Chairman Powell’s statement, markets largely cheered this outcome, but we take a more cautious stance. This agreement merely pressed pause on further escalation. Trade agreements are notoriously difficult to hash out, especially during a brief period such as 90 days.

For now, we continue to see the existing trade restrictions having a mildly negative impact on the economy and commercial real estate (CRE) market (notably industrial) with risk remaining to the downside.

Inflection point?

Anyone looking for leading signs of a slowdown and insights into what the Fed might do over the next year should pay attention to initial unemployment claims. Any sign of slowing in the labor market, which would likely cause the Fed to ease up on the pace of rate hikes, would likely show up first in the claims data before reaching the employment figures. Over the last few weeks, initial claims have crept up from the recent half-century lows.  Though the claims data often proves volatile, if unemployment claims data leads slowing employment gains, that would provide us with a meaningful sign of slowing in the economy.

What we are watching this week

Speaking of employment, the monthly employment release this week should show job gains of roughly 200,000 for November.

We expect little change in the unemployment rate while hourly earnings growth should hold above 3 percent for the second consecutive month.

We foresee a slight rebound in the ISM Manufacturing index for November while the ISM Non-manufacturing index should decline slightly. We expect the international trade balance for October to worsen for the fifth consecutive month, fueled by trade restrictions. Finally, we expect preliminary consumer sentiment for December to rise versus November’s reading, spurred by a tightening labor market and declining oil prices.

What it means for CRE

For now, with trade policy and monetary policy in a bit of a holding pattern, we are not altering our view on CRE. The outlook remains relatively healthy, but risk remains to the downside. Trade policy could become more restrictive which would slow asking rent growth and net absorption relative to our current outlook (which already includes some negative impact due to current trade policies). And while the market cheered a perceived slowdown in tightening by the Fed, recall that a slowdown in the pace of rate hikes likely means a slowdown in the underlying economy, a negative for CRE.

Thought of the week

The U.S. economy represents roughly one-quarter of the global economy, but U.S. equity market capitalization represents more than half of the global equity market capitalization.

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