Still firm

Quick takes:

• Economy remains on firm footing
• More signs inflation slowing
• Consumers power ahead
• Fed will be watching the labor market
• CRE positioned better than many think

Data released over the last two weeks showed an economy still maintaining momentum early in the fourth quarter. Heartening data also showed that inflation continues to slow, even with the economy sustaining momentum. While that does not guarantee a proverbial soft landing, it provides some comfort that such underlying strength could cushion the blow from any slowdown brought about by higher interest rates. 

Producer inflation slowing

The producer price index (PPI) for October showed inflation easing faster than anticipated. This surprise occurred on both a month-over-month and year-over-year basis. In a hopeful sign, the headline and key core indexes all demonstrated this pattern. Overall, it continues a pattern from recent months with producer inflation slowing under pressure from higher interest rates. While the Fed will quietly cheer this data, prices remain high enough to provide the Fed with cover to keep increasing rates in the near term.

Retail sales

Heading into the holiday shopping season, retail sales remain on firm footing. Retail sales for October increased at a much greater rate than expected. In addition to the headline growth rate, virtually all the key subseries outperformed expectations. Important for GDP growth, the control series (which excludes volatile components such as autos, gasoline and food) performed well. Strong retail sales continue to be supported by a tight labor market that is still creating hundreds of thousands of net new jobs per month while also generating firm wage growth. Healthy consumer balance sheets are also enabling consumers to spend. The use of credit has increased and will warrant closer observation in future periods as higher rates slow the economy and the labor market. But for now, consumers continue to do their job powering the economy. 

Consumers still spending
 

Durable Goods Solid

Durable goods orders for October came in above expectations. Of note, core capital spending came in well above expectations. While spending on overall durable goods is slowing, the core data strengthened to start the quarter. That provides a positive sign given the noteworthy increase in interest rates during 2022. This reflects national GDP accounting – spending on business investment and equipment is holding up well. Along with spending on intellectual capital, this reaffirms businesses’ underlying faith in the longer-term outlook for the economy. That also supports our view that beyond any slowdown in 2023, the economy remains poised to perform well once it has navigated its way through declining inflation and tighter monetary policy, neither of which should persist in the medium term.

Housing surprises

In another positive surprise, new home sales for October surprised to the upside. The number of new homes sold reached its highest level since August. The data proves volatile from month to month and the recent pullback in mortgage rates could incentivize some buyers. But the underlying trend remains downward in the face of higher mortgage rates, reflecting the pattern we also see in existing home sales which declined in October, continuing a trend for this year. Housing price data presents a bit more of a muddled picture. The median price for existing homes has declined in recent months, even as the year-over-year change remains positive. Meanwhile the median price for new homes ticked upward and the year-over-year increase remains robust. Therefore, the pricing data shows some pressure from higher rates, but likely not enough for the Fed’s liking. The Fed continues to see housing inflation as a key part of the inflation puzzle that needs to be solved.

In other encouraging housing news, starts and permits for October both came in greater than expected, even as both declined versus September. Construction activity is clearly feeling pressure from higher rates. As construction activity slows, this will complicate the housing inflation picture as greater supply would help to alleviate pricing pressure. Fed is apparently hoping for demand to slow faster than supply which should ease housing inflation.

What we are watching this week

The employment situation for November should show continued job gains, into the hundreds of thousands, and a tight labor market with little change in the unemployment rate and robust but slowing wage growth. Open jobs should remain elevated, above 10 million. The ISM Manufacturing Index should decline and could dip below 50, a sign of contraction in the sector. Personal income and spending should show increases while the core personal consumption expenditures (PCE) index, the Fed’s preferred inflation measure, should show continued modest slowing, in line with other inflation indexes. Home prices and pending home sales should show continued declines as the industry feels direct pressure from higher rates.

What it means for CRE

Commercial real estate (CRE) should likely mirror the economy. A slowdown already seems apparent in the data, but relative to previous cycles the industry finds itself in a stronger position. CRE is not suffering from widespread overbuilding. And with strength in the economy heading into next year, with only a moderate slowdown in growth expected, demand for CRE should not crater. That puts CRE in a position to weather any slowdown relatively well and positions it to capitalize on the subsequent reacceleration in the economy.  While performance by property type and market will almost certainly vary, CRE overall should fare relatively well versus previous cycles. 

Thought of the week

The futures market current expects a rate increase of 50 basis points (bps) at the Fed’s December meeting. If so, that would be the first increase of less than 75 bps since March.