Uncertainty, Squared

Quick takes:

• Markets reacted quickly to geopolitical changes
• Rising prices increases inflation risks
• Fed unlikely to alter course
• Likely marginal impact on the economy
• No meaningful implications for CRE

The last two years of the pandemic forced the global economy to grapple with nearly (if not actually) unprecedented levels of uncertainty. The first true global pandemic in roughly a century collided head-on with the most integrated global economy in history. Though uncertainty concerning the pandemic has recently abated somewhat, the global geopolitical environment, specifically the Russian invasion of Ukraine, has once again thrown the economy into the deep end of uncertainty. The following ramifications do not represent an exhaustive list but seem probable given all we know at the time of this writing. Caution: some specific impacts and transmission channels remain unclear, and the situation is evolving daily.

Market fallout

The most immediate impact of the invasion fell on markets. Financial markets responded quickly over the last few weeks and are likely to remain volatile. Equity markets pulled back, reflecting concerns over poorer revenue and earnings growth in the future. Treasury yields decreased slightly due to a flight to security and quality and the yield curve flattened further. Yet commodity and input markets hold the most relevance to the U.S. economy. Energy (notably oil) took the spotlight with prices rising amidst increasing concerns over supply.  In the short run, the U.S. administration could dip into the Strategic Petroleum Reserve to blunt price increases, but that offers only limited effect. If price increases become sustained and disruptive, investors could increase shale output and the administration could relax restrictions on shale drilling. Such supply could come online relatively quickly. Yet other commodity markets also hold relevance. Prices of agricultural commodities, such as wheat and corn, have already increased. Inputs to building, such as steel and iron, could also see price increases. Neon and palladium, vital to the production of microprocessors, could also experience some price pressures. 

Overall, the market fallout adds marginal inflationary pressure at a time when inflation is already running at a four-decade high, which likely means slightly more upward pressure in the short term and the potential for high inflation sticking around longer. That could result in some slight drag on GDP growth, but thus far we see limited downside. Underlying momentum remains firm, the Omicron wave is abating, the labor market remains incredibly tight, durable goods orders continue to increase, and consumer spending remains robust. Risks line up squarely on the downside, but we expect minimal disruption at this juncture. If U.S. oil output does increase, then that could not only impact prices, but potentially help to offset any drag on the economy from higher energy prices. 
 

Fed on alert?

All of this comes with Fed Chair Powell set to provide his semi-annual testimony to Congress this week. While his words will get carefully analyzed, we do not expect any meaningful change in Fed policy associated with geopolitical changes. Inflation remains high (with the potential for upside) and the labor market remains incredibly tight (more or less satisfying that part of the Fed’s mandate). The Fed will almost certainly factor in the increased uncertainty, particularly the impact that higher energy prices could have on inflation. And it will certainly keep a close eye on financial conditions. But we still anticipate the first rate hike at the next FOMC meeting in March and likely three to four more rate hikes to follow this year. 
 

What else we are watching this week

The ISM Manufacturing and Services Indexes likely eked out small increases in February after pulling back a bit in January. We anticipate another strong employment situation report for February, with net job gains well into the hundreds of thousands, the unemployment rate remaining near 4%, and further wage increases. The trade deficit for January likely widened with continued strong demand for goods from U.S. consumers more than eclipsing foreign demand from U.S. goods and services by a wider margin. 

|  What it means for CRE  |

Thus far, we see little impact on commercial real estate (CRE). Because we anticipate little impact on the economy at this juncture, we do not currently foresee an outsized impact on CRE. CRE remains on track for another year of solid performance. But we caution that risks continue to line up on the downside and overall uncertainty has increased in recent weeks.
 

|  Thought of the week  |

The oil price has experienced a spectacular turnaround in less than two years, rising from a low of roughly -$38 p3r barrel in April 2020 to roughly $95 per barrel in February 2022.