Acronyms lead the Fed

Quick takes:

• GDP rebounds in third quarter
• ECI shows firm compensation growth
• PCE remains elevated
• Fed looks set for 75 basis points
• CRE ready for the next cycle

A trio of important acronyms last week will very likely lead the Fed to hike rates aggressively again this week. The data from last week signaled that the economy, for now, continues to run hot. Interestingly, it covered a few key aspects of the economy to provide a broad (if incomplete) picture of the current economy.

GDP

First up, GDP. The economy grew at a faster than anticipated pace during the third quarter, clocking in at 2.6% at an annualized rate. Consumers continued to spend, albeit at a slowing rate, even in the face of high inflation and higher interest rates. Net exports grew and positively contributed to growth for the second consecutive quarter. And government spending grew at a positive rate after contracting during the second quarter. But private investment contracted, with the details telling us much about the state of play in the economy. Investment in residential and nonresidential structures is plunging under the weight of higher interest rates. Yet companies continue to invest in equipment and intellectual property. Not only does such investment help in the short term but signals a vote of confidence by companies in longer-term prospects. 

GDP Growth, Overall And Select Components

ECI

The employment cost index (ECI), a broad measure of employee compensation, increased at another brisk rate during the third quarter. Although the quarterly and year-over-year changes slightly decelerated, they both remain at elevated levels, reflective of the ongoing (though slowing) excess demand for labor in the economy. That remains a sticking point for the Fed, which believes that excess demand for labor is contributing to compensation increases which in turn are fueling inflation. 

PCE

The last acronym up is the personal consumption expenditures (PCE) index for September, a key measure of inflation. The headline PCE index did not change on a year-over-year basis versus August. Meanwhile, the core PCE index, typically the Fed’s preferred measure of inflation, increased versus August’s reading. In a sign of slightly positive news, both year-over-year changes came in below consensus expectations. Nonetheless, with both readings hovering near four-decade highs, the Fed will view this as a sign of durable inflation.

Fed meeting this week

The Fed is meeting this week for its next-to-last meeting of the year. And we, along with most everyone else, expect the Fed to raise rates by another 75 basis points (bps) following the Fed’s communications. If so, it would represent the fourth consecutive hike of that magnitude, following March’s 50 bps hike. That would bring the target rate to a range of 3.75% to 4.00%, the highest since December 2007. Of the factors cited earlier, inflation will likely play the biggest role in the Fed’s decision, as it has in recent meetings. After the announcement, focus will quickly shift to the final meeting of the year in December and projections for the Fed’s actions then, particularly the question of raising 50 bps versus 75 bps. We remain concerned that the Fed is reacting to recent inflation readings and hiking aggressively despite the well-known lag between raising rates and the consequent impact on real economic activity and prices. 

|  What else we are watching this week  |

The employment situation for October should show an ongoing if inconsistent decline in net job gains, little change in the unemployment rate and further slowing in wage growth. Open jobs for September could also show another decline, more evidence of a cooling labor market. The ISM Manufacturing and Services Indexes for October both likely declined but should still show a broad economic expansion. 

|  What it means for CRE  |

Unsurprisingly, a cooling economy likely means a cooling commercial real estate (CRE) market. Increasingly, we see evidence of this across markets and property types. But corporate America’s optimism about the future should translate to CRE as well. While bumps in the road certainly lie ahead, CRE always persists through these periods and forward to better times. In a somewhat counterintuitive way, a contraction in CRE spending in the short-term often benefits the asset class more broadly when the economy turns around. As the economy heads into the next business cycle, demand for space grows faster than supply for space which causes market performance to improve. The pullback in investment, evident in the GDP data, contributes to this process. Therefore, we can already see the seeds of the next CRE cycle sown in current data. For those willing to look for them, opportunities will certainly abound. 

|  Thought of the week  |

According to research, the number of jobs offering remote work declined from roughly 20% in February to roughly 14% in October.