The data strikes back

Inflation still gradually slowing

Data from the personal consumption expenditures (PCE) showed that inflation continued slowing in February, as we anticipated. The Fed’s preferred measure, the core PCE, slowed versus January and grew less than expected. The year-over-year change pulled back to 4.6% from 4.7% in January. Meanwhile, the headline PCE came in as expected, decelerating versus January. The year-over-year change slowed to 5%, down from 5.3% in January. The slow pace of deceleration in the first half of this year will make the Fed’s job harder as it tries to balance price stability, full employment, and financial stability.

Income and spending up less than expected

Nominal income and spending grew by less than expected during February. However, with inflation gradually easing, real spending matched consensus expectations. Although real spending declined slightly during the month, it follows a brisk pace of growth in January and puts consumption on track for a relatively healthy first quarter. Meanwhile, the savings rate has bottomed and is slowly rising again, or at least stabilizing.

Housing still sliding

The Case-Shiller index for January showed the 7^th consecutive monthly decline in home prices. Meanwhile, although the year-over-year change remains positive, it is slowing, with the 20-city index expanding at its slowest rate since November 2019. The national index also showed year-over-year increases slowing over time. Declining home prices hold important implications. For housing itself, declining prices increase affordability, at least at the margin. That should help support transaction volumes in the face of higher mortgage rates. Indeed, February's pending home sales index defied expectations and increased instead of contracting. That marked the third consecutive month of gains.

But the slide in housing also means that disinflationary pressures will find their way into inflation indexes over time. Although that occurs with a lag, it will ultimately mean a more notable easing of inflationary pressures, likely starting in May or June.

Consumer confidence climbs

On the upside, the consumer confidence index for March surprised. Consumers felt more downbeat about the present situation, but not enough to offset increased optimism about the future as measured by the expectations component. Consumers also reported that jobs remained plentiful. Overall, the index remains well below pre-pandemic levels, with consumers facing both higher interest rates and elevated inflation. But a strong labor market continues to support consumers’ moods and spending patterns.

Banking seems quieter, but…

Meanwhile, the banking industry seems to have settled down after the tumult of recent weeks. But those events have demonstrated that aggressive interest rate hiking will frequently hold unintended consequences. More banking issues, such as bank runs, remain possible. With banks tightening standards and pulling back on lending activity, downside risks have increased. Thankfully, the economy remains resilient, buoyed by strong consumer balance sheets and a healthy level of business investment.

What it means for CRE

For now, the resilient economy outweighs the impacts on commercial real estate (CRE) from any recent banking and market disruptions. That’s not to say all is well, but so far, CRE is slowing along with the economy, as one would expect from such a procyclical asset class. Yet more cautious lending and tighter credit conditions mean restraints on demand and growth, which increases the headwinds for CRE. For now, the downside risk seems reasonable and manageable. Still, rising interest rates in such a dramatic fashion over the last year will almost certainly produce other unintended consequences along the way.

Thought of the week

After spiking due to the banking issues of recent weeks, Treasury yields quickly fell back to levels from early February.

Note: Economic Insights will be on spring break next week.