Going out with a bang

Quick takes:

• Best year for the economy since 1984
• Composition of growth changing
• Demand growth > supply growth
• Fed firmly signals new stance
• CRE ready to shine in 2022

Despite disruptions from Omicron in December, the US economy closed out 2021 with its strongest quarter of the year. That first look at fourth quarter GDP showed annualized real growth of 6.9%. That fell in line with our view that growth during the quarter would resemble growth from the first two quarters of the year (6.3% and 6.7%, respectively). That brought growth for 2021 to 5.7%, the fastest calendar-year growth rate since 1984. We will present our U.S. economic outlook next month but for now let’s dig deeper into the fourth quarter data.

Another Solid Quarter
 

Some hopeful signs in the details

In addition to the strong pace of overall economic growth, a few hopeful signs for the future emerged in the data. First, the composition of growth seems as if it is starting to shift. Private inventories, a portion of private investment, provided the greatest contribution to growth during the quarter as US producers continue to rebuild inventories drawn down by strong consumer demand. While supply constraints remain in place, notably the pandemic, the rebuilding of inventories offers hope for future production and demand satisfaction. Second, consumer demand provided indications that its composition could be shifting back toward pre-pandemic patterns. We have repeatedly noted that consumer demand during the pandemic shifted away from goods consumption toward services consumption, putting strain on a rather inelastic portion of the domestic supply chain. Yet, for the second quarter in a row, services spending outpaced goods spending. If that persists, that could alleviate some pressure on goods production and prices. Third, increased demand for goods (especially durable goods) also fueled an increase in imports (despite apocalyptic headlines about port backlogs) and a reduction in net exports as U.S. consumers purchased goods from any available source. But during the fourth quarter, the contribution from international trade balanced at neutral, or effectively zero. That represented the first non-negative quarterly contribution to growth from international trade since the second quarter of 2020. These reaffirm our positive outlook beyond Omicron and the first quarter. 

The price of growth

Yet for all the changes occurring to the composition of growth, the underlying dynamic remains the same. Namely, aggregate demand (AD) in the economy continues to grow notably faster than aggregate supply (AS) through the fourth quarter. And with that comes a cost in the form of inflation. December’s personal consumption expenditures (PCE) data showed that headline PCE grew by 5.8% year over year while core PCE grew by 4.9% year over year, the highest for both in roughly four decades. These roughly mimic what has occurred with other inflationary indexes such as the better-known consumer price index (CPI) and producer price index (PPI). 

The new-ish Fed

How will the Fed respond to this? Last week’s meeting fell in line with general expectations and reaffirmed a new more hawkish, nimble stance to tackle inflation. That contrasts with a more dovish, patient Fed throughout most of the pandemic. What does that mean practically?  The Fed effectively screamed from the mountaintop that a rate hike of 25 basis points (bps) will come at the next FOMC meeting in March and that the tapering of quantitative easing (QE) will end in March. Market expectations now reflect this new reality. While a “shock-and-awe” hike of 50 bps in March seems unlikely, expectations continue to shift toward four hikes of 25 bps each this year to address inflation. The risk for the Fed will now shift from doing potentially too little to doing potentially too much, especially because the magnitude of inflation will warrant more aggressive rate hiking than recent tightening cycles. Although we don’t expect the fed funds rate to rise too aggressively overall, we remind everyone that the cause of most of the typical post-war recessions remains when rates rise too much, causing financial conditions to tighten excessively, putting a damper on growth. That seems an unlikely near-term risk because of the usual lag between raising rates and their consequent impact on real economic activity. But over the medium term that risk is almost certainly increasing.
 

|  What else happened last week  |

During the fourth quarter the Employment Cost Index (ECI), a relatively broad measure of compensation, grew at its fastest rate since the second quarter of 1990. Durable goods orders seemed roughly upbeat, particularly core shipments. New home sales for December surprised to the upside while consumer confidence and sentiment declined as we expected.

|  What we are watching this week  |

Both the ISM Manufacturing and Services indexes likely declined in January but remain in expansion territory. We expect a relatively weak showing for job growth in January, tracking below recent months as Omicron restrains the economy. Nonetheless, the unemployment rate could tighten further, and wage growth could accelerate due to ongoing excess demand for labor in the market. 

|  What it means for CRE  |

Broadly, commercial real estate (CRE) remains on the recovery track in 2022. Economic growth remains above capacity pace which should continue to drive asking rent increases, concession burn off, and vacancy rate declines, all of which should propel net operating income (NOI) and cash flow. Meanwhile, even the specter of rate hikes should not scare the industry. Ample research and data continue to show that CRE remains one of, if not the absolute, best assets to address inflation and interest rate increases. After a strong 2021, CRE capital markets should hold up well in 2022 amidst a lot of capital and investor enthusiasm. 
 

|  Thought of the week  |

Bitcoin has fallen roughly 45% since its all-time high from November.