Taking a breather

Quick takes:

• Pace of change remains rapid
• Fed reiterating hawkish stance
• Consumers still feeling glum
• Recession expectations seem overdone
• Economic backdrop could challenge CRE

After what felt like a sprint of economic data and events in recent weeks, last week seemed like a bit of a breather. Relatively few data points got released and no Fed meeting occurred. But what did transpire felt like more of the same: we heard more discussion from Fed officials about raising rates and more data confirming the dour mood of consumers. That leaves us in the same place but catching our breath and figuring out where things head next.

Strong Words

Last week Chair Powell, along with other Fed officials, reiterated the Fed’s more hawkish stance toward inflation following the Fed’s June meeting. He went so far as to say that raising rates to slow inflation could cause a recession. While most everyone knows this, such public admissions by the Fed have caused many to hear echoes of Paul Volcker and the Fed of the early 1980s when the Fed engineered a recession to bring down uncomfortably high inflation. Still, the market and economic forecasters remain skeptical that the Fed will follow through on their more recent and more aggressive forecast for the fed funds rate. Not only does the Fed have a poor track record on that front, but signs indicate that the economy is already slowing. If higher rates contribute to that process, especially with the Fed’s more aggressive stance in the short term, it could undermine their longer-term forecast. Nonetheless, we expect slower economic growth via reduced demand growth as the Fed tightens more aggressively. Of course, the Fed cannot do much, if anything, about the supply side of the economy. While we expect supply improvement over the next 12 to 24 months, it will not materialize immediately, keeping inflation relatively high even as the Fed slows demand growth.

Weak Spirits

With inflation running at rates unseen in four decades, consumer spirits remain dour. The consumer sentiment index reached its lowest level on record in June. While we have previously noted that it seems somewhat incongruous with the overall economic picture, consumers’ famous disdain for inflation clearly still holds. While such feelings have not prevented consumers from spending, negative feelings about inflation, set against a backdrop of rising rates and slowing growth, complicate the outlook. We have reached a juncture when certainty of a recession seems pervasive among both consumers and business leaders. That raises its risk because if consumers and businesses adjust their behaviors in anticipation of economic slowing it could become a self-fulfilling prophecy. For now, that remains a potential and not a reality. Healthy balance sheets (including pent-up demand from the pandemic), robust wage growth, and strong job growth continue to power spending by consumers. Business spending remains quietly stout, especially on core capital goods. That gives the economy some momentum and ability to withstand higher rates..

Nondefense Capital Good Orders (excl. Aircraft)

|  What else happened last week  |

Housing data played a prominent role last week. Sales for May came in mixed with existing home sales falling to its lowest level since June 2020. But new home sales surprised on the upside. Meanwhile, mortgage applications increased last week with purchase applications more than offsetting a decline in refinancing activity. Overall, with mortgage rates increasing so rapidly, we expect some slowing and dislocation in the housing market. 

|  What we are watching this week  |

With the overall mood turning more negative, we expect some upside surprise in data this week. As mentioned above, with business spending stout we expect upside surprise in durable goods orders in May. Even housing could see upside surprise with the pending home sales index. Consumer spending likely increased in May, even though consumer sentiment likely ticked down. And the manufacturing ISM for May should not change much and still reflect healthy expansion in the sector.

|  What it means for CRE  |

Like much of the economy, commercial real estate (CRE) is also trying to catch its breath and process the rapid changes that have occurred. In some respects, the rate of change feels faster than in decades, presenting a challenge for the industry and its participants, many of whom have never faced such an economic backdrop. For now, CRE overall continues to hold up well. But we are seeing tentative signs of slowing in some corners of the market. That would make sense given the uncertainty and rapidly shifting winds, as many market participants take a beat and plot their future course. But the path beyond now seems murkier to many. We still do not expect a recession in our base economic case, which should broadly support CRE. But we expect variation in performance across markets and property types. We objectively note that risks are rising, something market participants are clearly digesting.

|  Thought of the week  |

Defense spending should equate to roughly 3% of GDP this year. During the latter stages of the Cold War, it reached as high as 6%.