Stay the course

Quick takes:

• Through August our house view remains intact
• Inflation continues to ease
• Consumer spending remains resilient
• Closely watch the Fed this week
• Sweet spot ahead for CRE?

Last week data on two important indicators confirmed long-held beliefs that we have repeatedly asserted throughout the year. First, inflation readings through August continued to moderate, supporting our view that inflation would decelerate this year, even as it remained above levels from the last business cycle. Second, consumers spent at a healthy pace during August, supporting our view that consumers would remain resilient throughout 2021 and that nominal advance retail sales would set a calendar-year growth record this year. And while those two things might superficially seem contradictory, they hold with our view of an economy that is gradually managing its way through the release of pent-up demand and supply-side disruptions.

Inflation decelerating

We have consistently held the view that inflation would subside, not rise to levels like those from the 1970s, but rather settle into a range above that from the last business cycle. Through August we see little if any reason to alter that outlook. In August the headline consumer price index (CPI) increased by 0.3% - robust, but below expectations and well below the rate from recent months. Meanwhile, the core CPI grew by only 0.1%, meaningfully below expectations and the lowest reading since February. Why is inflation starting to ease when many thought it would remain elevated? Three key reasons:

1. Pent-up demand has eased over time and is subsiding as it does, returning spending to healthy but more normalized levels. Even high prices themselves are helping this process by dissuading some consumers from purchasing goods and services at elevated prices.
   
   
2. Supply-side disruptions remain but are slowly abating over time. Vaccination continues around the world, which helps prevent production shutdowns and companies are ramping up production that was taken offline in anticipation of weak demand during the pandemic.
   
   
3. Base effects are waning. Earlier this year, monthly and year-over-year growth occurred off low bases – relatively low prices that make it easier to generate larger percentage changes. As prices go up and the base used to calculate growth increases, sustaining equivalent percentage changes becomes increasingly difficult.

Consumer inflation abating

Yet, we do not expect inflation to rapidly decline toward the Fed’s flexible 2% target rate. Supply-side issues will take time to fully resolve – it always proves easier to turn production off than to turn it back on. And consumers should continue to spend at a healthy rate, but as pent-up demand is unleashed spending should revert to normal, healthy levels.

Consumers resilient

Speaking of consumers, they continue to prove resilient, a theme we have emphasized throughout this recovery. Advance retail sales for August grew by 0.7%, greatly surpassing the -0.7% that the consensus expected. Meanwhile core retail sales for August grew by a blistering 2%. While this follows a downward revision to the spending data from July, it nonetheless demonstrates the strength and resilience of consumers. While we foresee consumption continuing to shift from goods to services, we also foresee U.S. consumers remaining the main engine of global economic growth during the next business cycle. Measured in U.S. dollars, U.S. consumers by themselves (excluding private investment, government expenditures and net exports) would still constitute one of the largest economies in the world. That presents a lot of firepower to push global economic growth, especially if other parts of the world are facing various economic challenges. The increase in consumer sentiment in the preliminary September reading supports this view heading into autumn. 

WWTFD?

What will the Federal Open Market Committee (FOMC) of the Fed do when it meets this week? It will likely retain a cautious stance, but we anticipate that the FOMC will want to continue preparing the market for tapering. We do not expect an announcement on tapering until at least the fourth quarter, but the FOMC will try to manage expectations as best it can, trying to avoid any repeat of the “taper tantrum” from 2013 when the markets responded strongly to the FOMC’s announcement of future tapering of asset purchases which caused Treasury yields to spike. We will also be keeping a close eye on the dot plot, the unofficial forecast of the fed funds rate. Some voting members could alter their view on rates, ultimately producing a forecast that shows earlier and stronger rate increases than the previous iteration.

|  What else we are watching this week  |

Housing takes center stage on data this week. Housing starts and building permits for August should both increase slightly. Existing home sales likely changed little with risk to the downside while new home sales likely increased slightly. 

|  What it means for CRE  |

Commercial real estate (CRE) could potentially find itself in a sweet spot during this phase of the business cycle. Somewhat elevated (but not out of control) inflation could boost property cash flows without triggering rampant interest rate increases or a serious drag on economic growth. And while we expect economic growth to slow from its relatively rapid pace of growth in the first half of the year, slowing will occur over time. As consumers fully release pent-up demand (reverting to normal spending patterns) private investment should increase, helping to boost productivity and support-medium term growth. The combination of easing economic growth, moderate inflation, and still-low interest rates could boost the fortunes of CRE during the coming expansion phase of this business cycle. 

|  Thought of the week  |

The valuation of the entire cryptocurrency industry has reached $2.2 trillion dollars.