Lots to digest

ISM indexes mixed

The ISM manufacturing index declined more than expected in January. The index remained below 50, which signals contraction, for a third consecutive month. Manufacturing continues to weather the impacts from a slowdown in demand, higher borrowing costs and some ongoing supply disruptions. Similarly, construction spending in January came in far weaker than expected. The broad index and all subcategories showed monthly declines in spending, a sign of slowing in the economy. But the ISM services index rebounded, rising to 55.2, well above the consensus and once again signaling expansion. All components of the index increased, and services companies reported an increase in business optimism.

The Fed and disinflation

As expected, the Fed raised rates by 25 basis points (bps) last week. This represented the continuation of a slowdown from last year. After four consecutive hikes of 75 bps, the Fed raised by 50 bps in December. That takes the fed funds rate to a target range of 4.5%-4.75%, the highest since October 2007. Clearly, the Fed is responding to a slowdown in inflation. Chair Powell used the word “disinflation” more than a dozen times during his press conference and indicated that the Fed now sees that the disinflation process has started. But the ongoing strength in the labor market will likely keep the Fed on a tightening stance. The Fed remains fixated on services inflation because labor costs drive services costs.

The Fed continues to expect the terminal rate to reach above 5% and remain there for the balance of the year. Recent labor market developments reinforce this narrative. But despite ongoing Fed tightening, financial conditions have loosened in recent months. Yields and spreads have declined, the stock market is up from its October low, and volatility has eased a bit. Interestingly, Chair Powell did not really push back on the notion that financial conditions had loosened. But this loosening, coupled with such a strong labor market, increases the risk that the Fed continues to tighten and overshoot.

What it means for CRE

For commercial real estate (CRE), a downshift in rate hikes, more signs of disinflation, loosening financial conditions and a decline in volatility provide some modest optimism about 2023. While we do not want to overstate our optimism, clarity and transparency should help markets during a period of economic slowing. But the Fed holds the key. If the Fed does not push too far on rate hikes and adjusts its messaging accordingly, CRE markets should slow, but not implode. If the Fed remains singularly focused on driving inflation down to target by the end of this year, it certainly possesses the ability to do a lot of collateral damage to the broader economy and CRE markets. Interestingly, the strength in the labor market likely increases the chances of both a soft landing and the Fed overshooting.

Thought of the week

Ads for the Big Game will cost roughly $6 million to $7 million for a 30-second commercial this year.