What does it mean?
Certain data points carry more weight when it comes to what constitutes a recession; which ones might surprise you
- Ryan Severino
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- Does it matter?
- What’s the Fed to do?
- Labor market still strong?
- What matters for CRE?
“What does it mean?” That seemingly lightweight question carries a lot of significance, especially in the context of today’s economy. In particular, the word “recession.” The word has always proven more complex than it seemed, maybe never more so than now. The economic currents crisscross, with mixed signals and little clarity on what the data means. Against that backdrop, last week’s data and events only further muddied the waters.
What’s a recession?
In the U.S., the National Bureau of Economic Research (NBER) determines recessions. Period. Any other definition is academic. Most people who believe that we are currently in a recession quickly point out that we have seen two consecutive quarters of contraction. This informal definition dates to the 1970s when Julius Shiskin, then the Bureau of Labor Statistics commissioner, came up with it as a rule of thumb. Despite its frequent citation, this shorthand carries no official weight and has simply served as an easy guideline for the average person. Moreover
“…the evidence we have thus far of a recession seems rather flimsy.”
At the time of this writing, while official GDP figures show two quarters of contraction, the data remains ambiguous and unconvincing, due to some key factors. First, as we have previously mentioned the data itself is not signaling weakness. The first quarter’s contraction owed more to foreign weakness with net exports detracting from growth. Second, gross domestic income (GDI) should equal GDP due to the classic macroeconomic identity: Y = C + I + G + NX. Yet the GDI data showed growth in the first quarter. Third, based on the data as it now stands, the margin for error in the estimate of GDP suggests that there is a roughly 50% chance the economy actually grew in the first half of the year. Fourth, the data always gets revised and that will likely occur again. Fifth, of the six main criteria that the NBER uses to date recessions, all have increased over the last six months. This helps to illustrate why the NBER doesn’t jump to rash judgements about recessions the way some members of the public often do.
Only Services Contributing to Growth in 1H2022
But asking what constitutes a recession isn’t the right question. The more pertinent question centers around whether it feels like a recession – does it have the negative consequences of one? We have repeatedly discussed how people don’t like inflation and how the perception of inflation is influencing their responses to sentiment and confidence surveys. But by most objective criteria it fails.
“The economy sits near full employment, wages are growing briskly, industrial production is increasing, spending (even net of inflation) continues to grow.”
To be clear, we are not making a call on whether we are in a recession. But we are pointing out that beyond a very narrow notion of one, which we can’t even be sure is correct at this juncture, it doesn’t look or feel like one. Ultimately, the economy is slowing, faster than most anyone anticipated earlier this year, even if it is not contracting. Much of downside surprise in growth stems from noneconomic factors like war and the pandemic, namely through higher inflation and higher interest rates. That presents a challenge for central bankers tasked as stewards of the economy.
Last week the Fed raised the target rate by 75 basis points (bps) and has brought it ever closer to our (and many others’) estimate of neutral, somewhere around the 2.5% to 3.0% range. But what is neutral? Theoretically it is the interest rate that supports full employment while keeping inflation constant. Above that neutral point, rates often prove restrictive to economic activity. Below that point, it typically stimulates economic activity. The Fed has moved quickly to arrive here as it attempts to get a better handle on inflation. Moving back toward neutral during a period of high inflation seemed prudent. If demand is running too hot, as it seems, then taking some of the wind out of demand make sense. But what about the supply side and those noneconomic factors? While the Fed cannot control those, good news is emerging slowly on that side of the ledger. The much-maligned global supply chain is showing more consistent if not rapid improvement. And prices of some key goods, namely food and energy, are finally rolling over. While that does not mean a rapid deceleration in inflation, it likely means some is coming. The Fed’s higher rates are already having a desired slowing impact on the interest-rate-sensitive parts of the economy such as real estate, capital goods, technology and financial markets. Against that backdrop what will the Fed do? The next quarter of data should prove important on that front, but the Fed is likely discounting the GDP data in favor of inflation and employment. Will inflation abate? Will the labor market loosen? We believe the answer to both is yes, but likely not quickly enough to keep the Fed from another hike or two this year. How far past neutral it brings the fed funds rate will largely determine whether we officially end up in a recession.
| What we are watching this week |
Because services continue to drive economic growth, their labor-intensive nature is keeping the labor market tight. But we expect the Fed to continue to take the wind out of the sails of the labor market. Open jobs for June should show another decline. Jobless claims should continue their slow yet inconsistent ascent. Net job gains and wage growth for July should both moderate while the unemployment rate should hold fairly steady. Additionally, both the ISM Manufacturing and Services Indexes for July likely decreased amidst slower growth.
| What it means for CRE |
“We expect stronger economic growth in the latter half of the year. That should help the (CRE) sector as it navigates through a choppy period.”
The recession debate matters little for commercial real estate (CRE). The pace and magnitude of slowdown matter. We expect stronger economic growth in the latter half of the year. That should help the sector as it navigates through a choppy period. Our proprietary forecasting still shows general improvement in fundamentals, but the pace has clearly slowed, and divergences across property types and markets should widen in the coming quarters. Valuation has slipped amidst the ongoing uncertainty and will likely require greater clarity in economic and market direction before fully stabilizing.
| Thought of the week |
The most valuable interstate highway, ranked by value of annual trade-related activity, is I-80.