Uneven road surface

Quick takes:

• Fast economic growth during 4Q
• Currently hitting some rough road
• Smoother ride ahead past Omicron
• Pandemic path remains unclear
• CRE revving up

If you have ever driven on a highway and rather quickly transitioned from a fast-driving, smoothly paved surface to a slower-driving, uneven surface, you know what navigating the economy feels like right now. After relatively smooth sailing through most of the fourth quarter, the economy veered right into the bumpiness of the Omicron variant. This week’s data releases should reflect exactly that downshift. Yet you also likely know that those uneven sections tend not to last very long and faster driving awaits on the other side if you keep driving.

The fast lane

This week we will receive our first look at just how fast the economy grew during the fourth quarter with the release of the GDP data. Growth should come in at a brisk pace, like the strong rates from the first and second quarters of 2021. Consumer spending should provide some fuel, even with Omicron disrupting consumption during December. Private investment also contributed to the bounce, including the increase in inventories, along with spending on capital equipment and intellectual property.  

The employment cost index (ECI), a broad measure of labor cost, likely also grew strongly during the fourth quarter. While the labor supply shortage garners many headlines, the incredibly robust demand, fueled by a strong economy, continues to help propel compensation upward.

The rough stretch

The growth in wages likely propelled personal income upward during December. Yet, nominal and real personal spending for December both likely contacted due to the impact of Omicron. Goods spending likely eased off the accelerator during the quarter while services spending could have come to a screeching halt with Omicron keeping people at home. Nonetheless, those levels of personal income and spending should prove enough to keep propelling both the headline and core personal consumption expenditures (PCE) inflation indexes. Both could reach levels last observed in roughly four decades, like performance of other major inflation indexes.  

Meanwhile, durable goods orders for December also likely contracted, following strong growth during November. A decline in transportation-related orders, particularly aircraft, likely pulled overall orders down. Lastly, both consumer confidence and consumer sentiment, two of the earliest indicators for January, likely continued their Omicron-induced slowdown.

Consumer Sentiment's Hairpin Curve

Fed as convoy leader

The Fed is effectively serving as our convoy leader as we all navigate this stretch of the economic highway together. As it meets this week, it will likely take the farsighted view that the disruptions to the economy should prove short-lived and that much faster driving lies on the other side of the Omicron wave, which already appears to be peaking in the U.S. Therefore, we expect little change to the Fed’s somewhat more hawkish stance. Undoubtedly, the Fed will monitor the current pullback in the public markets and keep a close eye on financial conditions. But ultimately, the Fed’s job remains the same –avoid too much Omicron rubbernecking and lead us to that smoother road ahead while keeping the economic engine from overheating and avoiding pumping the brakes too much. Maintaining a speed that accomplishes such a balance always proves challenging. But the current situation presents unique challenges because of the ongoing pandemic. Even if the Fed can carefully steer past the current slowdown, other stretches of rough road could lie further ahead depending upon how the pandemic unfolds. Everyone should keep the seat belt fastened.
 

|  What it means for CRE  |

Commercial real estate (CRE) remains one of the best vehicles to navigate such uncertain and challenging economic terrain. Even with some pandemic-associated bumpiness, we still anticipated that the economy should continue to expand at above-capacity pace this year, which should continue to drive the ongoing improvement and recovery in space market fundamentals across markets and property types. Improving fundamentals should drive net operating income (NOI) and cash flow. That will remain key in the performance of CRE – despite the widespread belief that CRE is sensitive to interest rates, the empirical data shows otherwise. While not discounting that the broad interest rate environment plays a role in performance, cap rates and valuations take their marks from the performance of the assets. 
 

|  Thought of the week  |

Housing inventory for sale is stalling, reaching a record low in December with just 910,000 homes on the market. Such low inventory is producing some rubbernecking via open houses, but volume remains stuck in stop-and-go traffic.