Catching up

Quick takes:

• Consumers pushing demand
• Supply still disrupted
• Inflation remains elevated
• Market responding to Fed’s signals
• CRE market still positioned well

After a short hiatus, the weekly Economic Insights return, providing a great opportunity to catch up on developments in the economy and their implications for commercial real estate (CRE). While the data reaffirm the big picture, the details change as we inch closer to our first look at GDP growth in 2022 and plunge deeper into the struggle that will determine the fate of this business cycle.

The labor market and consumers

As the primary component of aggregate demand (AD), consumption always looms large in the economic picture. A strong rebound in consumer spending pushed it back onto trend, even after the impact of higher prices. That stands in stark contrast to the previous recovery when spending remained muted for a prolonged period. Yet this occurred despite consumer confidence and sentiment hovering near levels last observed during the early stages of the previous recovery.

Consistent Net Job Gains

How? Because of strength in the labor market.   Net job gains have remained remarkably consistent over the last year, bringing overall employment toward its pre-pandemic peak. Strong labor demand has kept weekly unemployment claims hovering near record lows while the unemployment rate nears its pre-pandemic level. This has driven a resurgence in the labor force participation rate, including the return of retirees to the labor force as the pandemic has somewhat abated. Average weekly hours worked have held steady over the last year while wage gains remain robust. The combination of job growth, growth in hours worked, and hourly wage gains continues to drive real aggregate earnings, enabling consumers to continue to spend.

Supply chain

While AD continues to expand, aggregate supply (AS) struggles to keep up. Here we present some good news and some bad news. First, the good news: the New York Fed’s broad index of global supply chain pressures showed some easing with its most recent update in March. The bad news? The update only included data through February. Since then, two key events likely worsened supply pressures. First, the situation in Ukraine likely exacerbated shortages, notably in food and energy. Second, the Omicron outbreak in China is causing lockdowns of major cities and production centers that is also likely worsening supply disruptions. 

Inflation and interest rates

Unsurprisingly, with demand remaining robust and the supply situation still challenging, inflation continues to tick higher. Across various metrics, year-over-year inflation continued to reach record highs for newer measures while older measures hit highs unseen in roughly four decades. This accelerating inflation caused the Fed to become more hawkish, possibly including the first hike of 50 basis points (bps) since May 2000. Moreover, the Fed also seems intent on reversing quantitative easing (QE) into quantitative tightening (QT) at an accelerated rate. Although the short end of the curve remains near historically low levels, the Fed’s communication on both rate hikes and QT caused interest rates at the long end of the curve to spike. The 10-year Treasury yield has risen by roughly 100 bps since early March. Unsurprisingly, with demand remaining robust and the supply situation still challenging, inflation continues to tick higher. Across various metrics, year-over-year inflation continued to reach record highs for newer measures while older measures hit highs unseen in roughly four decades. This accelerating inflation caused the Fed to become more hawkish, possibly including the first hike of 50 basis points (bps) since May 2000. Moreover, the Fed also seems intent on reversing quantitative easing (QE) into quantitative tightening (QT) at an accelerated rate. Although the short end of the curve remains near historically low levels, the Fed’s communication on both rate hikes and QT caused interest rates at the long end of the curve to spike. The 10-year Treasury yield has risen by roughly 100 bps since early March. 

What we are watching this week

This week we will get our first look at first quarter GDP. We anticipate that growth should slow considerably relative to the fourth quarter. While consumer spending likely supported growth, the other major components – private investment, government spending, net exports – likely combined to restrain growth. Consumer confidence for April likely ticked a bit higher, in line with consumer sentiment. The employment cost index, a broad measure of compensation, should show another robust gain for the first quarter. 

|  What it means for CRE  |

The economic landscape continues to support space-market fundamentals. Industrial stabilized the quickest with vacancy peaking in the third quarter of 2020. Since then, vacancy has continued to reach record lows while rent growth has continued to exceed inflation. Fundamentals in the multi-housing market are exceptionally strong and the relatively shorter nature of leases is a favorable attribute in an environment of higher inflation. The retail market stabilized in mid-2021 and has passed the worst of the downturn. The office sector is drawing closer to stabilization. The national vacancy rate increased during the first quarter, but only by roughly 20 bps, while rents continue to modestly increase. Yet even here the performance looks uneven. Markets in the South remain the outperformers, with stronger improvement than gateway markets in the Northeast and West. Across all office markets, the flight to quality trend is incredibly strong, with high quality and new office assets garnering an outsized share of demand.  Greater clarity on the return to office, which should arrive in the coming months, should help support the market, even by simply removing some uncertainty.

|  Thought of the week  |

Thus far, little evidence of a wage-price spiral has emerged. Not only are wages trailing inflation, but in recent periods wage growth has decelerated slightly.