Oh no Omicron

Quick takes:

• Pandemic still impacting the economy
• Inflation remains elevated
• Retail sales pull back
• Markets starting to shift
• CRE staying the course

Almost two years into the pandemic, Omicron continues to impact everything, including the economy. Tentative periods of improvement seem inevitably followed by periods of retrenchment, correlated with the intensity and pervasiveness of the pandemic. As we analyze data from December and early January, we see this pattern emerging again with the Delta variant giving way to Omicron which has caused a dramatic increase in cases and thrown a wrench into the economy. 

Propelling inflation

The consumer price index (CPI) for December continues to show upward pricing pressures. The headline CPI reached 7.1% on a year-over-year basis in December while the core CPI increased 5.5% year over year. Both represented their highest respective growth rates in roughly four decades. As expected, with the pandemic keeping many people home while also simultaneously disrupting production, prices for goods are rising much faster than prices for services. Additionally, both the producer price index (PPI) and the import price index also showed inflation remaining at elevated levels. Omicron will likely reinforce the underlying dynamics – strong demand for goods, weak demand for services, and supply disruptions – exacerbating inflation in the short run, even if the impact of the pandemic on the economy continues to lessen over time. 

Stymying sales

Even the robust trend in retail sales did not prove immune to the pandemic in December, but the impact occurred in complex ways. While headline retail sales registered its first decline in five months, the causes connect to the pandemic. Some holiday shopping took place in earlier months as consumers responded to warnings about supply disruptions. Some consumers likely balked at high prices, especially after doing a lot of holiday shopping earlier in the quarter. The supply disruption limited the absolute amount of goods available for purchase. And the rapid increase in cases with the spread of Omicron also likely dissuaded some consumers to shop in brick-and-mortar stores. Much of this backdrop should persist in the first quarter which should create volatile retail sales patterns. This should steady once the current wave abates, but likely not before that juncture. 

Sliding sentiment

Unsurprisingly, consumer sentiment backslid in early January. Yet the details show a stark, ongoing divergence between lower-income and higher-income households. The ongoing spread of the Omicron variant and still-elevated inflation weigh on the lower-income segment while an incredibly tight labor market and income growth are supporting the upper-income segment.

Adjusting markets

Public markets are adjusting to this new reality. The Treasury market has finally broken through 175 basis points (bps), a resistance level it neared multiple times over the last year. Many had anticipated higher bond yields that would reflect a higher-inflation environment during 2021. It appears as if that is now occurring with more entrenched inflation and a pandemic that continues to chart its own course. Consequently, public equity markets are adjusting, anticipating higher bond yields and a higher cost of capital that could bit into corporate earnings. Major equity indexes have recently pulled back from all-time highs and have struggled to find their footing amidst a worsening pandemic. 

Markets Feeling Pressure
 

|  What we are watching this week  |

After a rebound in November, both housing starts and permits likely slipped slightly in December. We expect little change to existing home sales in December due to limited supply of homes for sale. 
 

|  What it means for CRE  |

Commercial real estate (CRE) remains on a solid trajectory. Three of the four major property types have already likely passed their peak vacancy rate for this phase of the cycle. The other, office, should likely reach peak vacancy rate this year. Although we expect economic growth to slow from last year’s torrid pace, growth should remain well above potential, driving concessions and vacancy rates down, and asking rents up. With such strong support from fundamentals, valuation should hold up well, even in the face of rising interest rates. Omicron will likely continue to play havoc with economic data in the first quarter, but ultimately that should prove of little durable consequence to CRE.
 

|  Thought of the week   |

The NFL’s two extra wild card games should generate roughly $150-$200 million in additional revenue for the league.