What do we know?

Quick takes:

• Halfway through 2022, growth has slowed
• External factors weighing on the economy
• Risks skewed to the downside
• Slower growth likely ahead
• Cyclical forces will weigh more heavily on CRE

After passing the midway point of the year, it seems a good time to stop and assess where we are as we get set for an important and uncertain latter half. Geopolitical events and the evolving pandemic played outsized roles during the first six months of the year. Where do we stand and what should we watch out for in the back half of the year?

Notable developments:

• Economic growth slowed notably. The U.S. economy generated its fastest growth rate in 37 years in 2021, clocking in at 5.7%. Three of the four quarters exceeded 6% growth annualized. Although the economy looked set to inevitably slow this year, the pace of deceleration caught most by surprise. Although first quarter weakness seems overstated: strong import growth and weak export growth really says more about domestic strength and foreign weakness.  And gross domestic income (GDI), which should mirror GDP, grew close to 2% annualized. But slowing in underlying components in the second quarter reinforce the deceleration narrative. 

• Labor market remained strong. Despite global turmoil, the labor market remained in an incredibly strong position with an acute labor shortage. Robust job gains, an unemployment rate near half-century lows, strong wage growth and a record number of open jobs persisted despite a slowdown in the economy. The strong labor market helped to power consumer spending and generate positive nominal and real consumption. 

• Supply chain still disrupted but easing. Supply chain pressures are easing, evidenced by improvement in a variety of metrics. The most comprehensive, the global supply chain pressure index, continued to decline through June and stands at its lowest level since last April.

• Inflation higher for longer. Inflation surprised on the upside during the first half of the year. Ongoing supply chain disruptions, fiscal stimulus, a relative shift toward goods consumption and the situation in Ukraine represent some of the key factors propelling inflation. While core inflation has cooled in recent periods, inflation remains uncomfortably high.

• The Fed gets more aggressive. The Fed began tightening in the first half of the year and has turned increasingly hawkish as inflation surprised to the upside. At its last meeting the Fed increased the fed funds rate by 75 basis points (bps) for the first time since 1994 and reaffirmed its more aggressive stance.

What to watch for:

• Inflation, inflation, inflation. Starting with the release of the June consumer price index (CPI) and producer price index (PPI) data this week, inflation will continue to drive policy and, ultimately, the path forward. June’s CPI should come in high once again. But the prices of some goods and services such as gasoline, commodities and autos are declining. Yet it will take time to show up in the overall data. We still expect inflation to decelerate throughout the balance of the year but remain elevated.

• Consumer sprits. Both consumer sentiment and consumer confidence remain at low levels, driven primarily by high inflation. We expect the first look at July’s consumer sentiment index to remain near its record low. While not yet a problem, if this causes consumers to alter their behaviors (e.g., reduce spending, demand greater compensation increases) then it could become a problem. Retail sales for June likely posted another strong gain, but prices continue to put pressure on consumers.
  
  
• Interest rates. The Fed has recently turned more hawkish, raising the terminal rate in its forecast to close to 4% in 2023, past our estimate of neutral. But the Fed has a poor track record of following through on its own forecast. The market, which also has a somewhat shoddy record, does not believe the Fed and maintains a less aggressive forecast. It assumes the Fed will back off as data continues to show slowing growth. We tend to side with the market. The Fed needs to keep convincing the market of its inflation-fighting prowess so it cannot say that it will start to back off if things slow too quickly. But history suggests that it would.
  
  
• Labor market. Though still strong, the labor market is showing tentative signs of slowing. Net job gains have slowed somewhat in 2022, wage growth has decelerated for two consecutive months, the number of open jobs has declined as of late and the unemployment rate has held steady for four consecutive months. The Fed clearly wants to take some of the wind out of the labor market’s sails. Initial jobless claims are inching up inconsistently. We expect the labor situation to remain healthy but tightening interest rates always present a slippery slope that could spill over into greater labor market damage.

Market less aggressive than the fed

|  What it means for CRE  |

During the recession, idiosyncratic factors largely drove performance of commercial real estate (CRE). Office faced challenges because of home (WFH) and return to office (RTO) issues that did not impact other sectors. Industrial benefitted greatly from consumers remaining at home and shifting relatively more of their spending toward goods and away from services. Retail benefitted from strong fiscal stimulus and a surging labor market. And housing of all kinds benefitted from a persistent lack of supply and strong demand driven by low interest rates. Different geographical markets have fared better or worse because of pandemic-related migration and working patterns. But that narrative should shift as the economy slows. Slowing economic growth should cause cyclical forces to start to weigh more heavily on sectors and markets. Though this will almost certainly not occur in a uniform fashion, virtually no corner of CRE will find itself immune. While not doom and gloom, expect cyclical forces to play a larger role over the next 12-18 months.

|  Thought of the week  |

The dollar and euro have reached parity for the first time in roughly 20 years.