Inflation

Quick takes:

• Inflation upside surprise
• Consumer sentiment reaches record low
• Fed trying to balance risks
• Recession not the base case
• CRE still holding firm

We often bristle when a complex subject like economics becomes distilled down to overly simplistic or incomplete analysis. But the current moment feels like an exception given the predominance that one aspect – inflation – holds over the entirety of the economy. While the economy remains almost impossibly complex, much of what is occurring at this juncture connects to or from inflation. Moreover, it has seized control of the popular narrative, sometimes hijacking cool, objective discourse. Inflation is real, important and potentially serious. But much of the conversation concerning it these days is not.

Lofty Heights

Though superlatives have lost a bit of their punch at this point, we note that inflation continues to reach highs unseen in decades. It has many causes: supply disruptions, release of pent-up demand from prior periods, fiscal stimulus, low interest rates, the shift towards goods consumption, the ongoing pandemic, war. Yet we note two important points. First, energy, a known volatile component, drove upside surprise in the headline consumer price index (CPI) in May. In April, a decline in energy prices helped to pull inflation back somewhat, but high volatility cuts both ways. Second, and somewhat relatedly, core CPI (less food and energy) continued to slowly decelerate. May marked the second consecutive month of slowing. Because of the volatile nature of food and energy prices, core inflation outperforms headline inflation at predicting future inflation. Of course, the war in Ukraine is driving much of the rise in food and energy prices. In fact, the spread between core and headline inflation has widened since the war began in late February. In January 2021, core and headline CPI stood effectively equal. But they have diverged over time and as of May headline CPI exceeded core CPI by roughly 250 basis points (bps). 

Headline CPI Less Core CPI

Record Lows

While this inflation is not restraining consumer spending just yet, it is restraining the mood among consumers. In early June, consumer sentiment reached a record low. Yet, with sentiment data stretching back to the 1970s, we note that the economy fared worse (arguably if not objectively) at various points during that period. Then why so gloomy? Though hard to say for certain, consumers now get inundated with stories about inflation in ways that did not occur in the past. They are constantly reminded of it (often in incomplete and incendiary ways) in our modern news ecosystem. Clearly, consumers feel its real impact. And deteriorating wealth is certainly not helping. But should consumers feel gloomier now than during the late 1970s and early 1980s when inflation reached levels higher than recent months? Or during the GFC when the financial system almost froze, asset values plummeted and job losses totaled roughly 8.8 million? Or during the initial stages of the pandemic when consumers found themselves largely confined to their homes amidst roughly 22 million lost jobs? No clear answers to these questions exist, but such dour spirits feel somewhat incongruous with the overall economic picture (which remains robust) and somewhat misaligned versus other previous periods of economic trouble. Consumers are not running models, carefully balancing positives and negatives. Set in an ocean of click-bait headlines and sophomoric analysis, consumers find themselves on small analytical life rafts. 

Stuck in the middle

Stuck between high inflation and low consumer sentiment, the Fed finds itself in tight spot. Clearly, it feels compelled to raise rates to try to cool the economy. Signs thus far indicate it is having some early success. The Fed raises rates to tamp down the interest-rate sensitive parts of the economy such as financial markets, housing and durable goods. While housing values are still rising, other metrics signal cooling ahead. For example, mortgage application volume fell to its lowest level in 22 years. While the Fed would like to see more and broader cooling ahead, associated with its intentions to raise rates further, it will have to avoid going too far. As the Fed meets this week, look for at least 50 basis points (bps) of increase as the Fed flashes its inflation-fighting credentials, even if belatedly. 

Where to now?

The base case for the economy remains a slowdown. Even some of the most inflammatory commentators acknowledge that a recession remains a risk, not a certainty. Predicting a recession proves a fool’s errand. Those who make such predictions almost never offer specificity of timing or magnitude, which enables them to ultimately be correct. The more thoughtful among prognosticators carefully balance all factors, recognize the difficulty in such analysis (especially now), and offer detailed projections and associated analysis. Therefore, we note the skewed risks to the downside, continue to rerun our models as we receive new information, and merge quantitative and qualitive methods to provide useful, actionable intelligence, as our clients well know. For now, a slowdown in growth or a soft landing remains the most probable outcome. 

|  What it means for CRE  |

Commercial real estate (CRE) will go as far as the economy will take it. And that heading has not yet changed. Ongoing economic expansion is supporting space-market fundamentals across property types, to varying degrees. CRE is not unscathed by what is occurring, but we generally do not see signs of deterioration in leasing market fundamentals. Versus other asset classes, CRE is faring relatively well thus far across several criteria. We continue to use our proprietary scenario modeling to peer in the crystal ball and provide thorough, objective guidance. Increased downside risks? Yes. Certainty of calamity? No. 

|  Thought of the week  |

The National Retail Federation projects consumers should spend roughly $20 billion on Father’s Day this year. Happy Father’s Day to all who celebrate.