Waiting for this moment?

Quick takes:

• Is inflation slowing?
• Are consumers feeling more upbeat?
• Can retail sales still outpace inflation?
• How bad is productivity growth?
• Is all this good or bad for CRE?

The moment you’ve all been waiting for…maybe

Last week brought the moment so many have waited for: inflation is finally cooling off. Maybe. One data point in the headline consumer price index (CPI) does not make a trend and it remains too early to proclaim that inflation peaked. But other inflation readings are signaling peak (or past peak) inflation, even if a rapid slowdown remains unlikely. And more broadly, the numbers signal improvement from economic slowdown earlier this year. 

All about that pace

July’s inflation data is helping to solidify the idea that inflation is slowing. The headline CPI index showed no change during the month and the year-over-year change slowed versus June. The core CPI slowed more than expected and held steady versus June. Core CPI has slowly decelerated on a year-over-year basis since March. The producer price index (PPI) showed something similar. The headline PPI index declined during the month and slowed on a year-over-year basis versus June’s data. The core PPI increased by less than expected and slowed on a year-over-year basis. Additionally, headline import prices declined by 1.4%, the first monthly contraction of 2022 and the largest pullback since April 2020. Core (nonfuel) import prices also decreased. On a year-over-year basis, import price inflation decelerated for a fourth consecutive month. 

Combined, the inflation data suggests peaking on both a headline and core basis. Yet, some caution seems warranted. First, broadly speaking, some of the deceleration in recent periods, especially headline CPI, stems from energy which remains volatile. It can easily rebound, often due to noneconomic factors.  Second, we will need to see evidence over a longer period to determine if a deceleration trend has taken hold. Third, we do not expect a rapid deceleration in inflation even as it occurs. Some core inflation components, such as those related to housing, tend to operate on a lag which means more sustained pressure remains. Therefore, we expect the Fed to remain focused on inflation and continue to hike rates heading into the last third of the year. Nonetheless, the data appears more heartening than at any time since about a year ago when inflation seemed to be peaking.

More than a feeling

With inflation seemingly moderating in recent months, sentiment data marginally improved. The consumer sentiment index increased once again in early August, rebounding from its all-time low in June. Helpfully, inflation expectations have also eased which lowers the risk of such expectations becoming unmoored. But sentiment remains at very dour levels and it will likely take much more significant improvement in inflation to raise consumers’ spirits. Additionally, small business sentiment also increased slightly in July, even though conditions for businesses (such as the incredibly tight labor market) remain challenging. 

Finest worksong

Yet the most complicating and confounding factor in all this remains the labor market. While a tight labor market with strong wage growth would normally support consumer sprits, that is getting overwhelmed by the impact of inflation. The risk of a wage-price spiral remains low, but wage pressures are likely producing some force on demand-driven components of inflation. And the lack of productivity is raising the real input cost to producers, keeping their spirits in check. During the second quarter, labor productivity fell for the second straight quarter and drove the year-over-year change to its lowest in the post-war era. Meanwhile, with productivity falling and wages increasing, unit labor costs continued to skyrocket. Although the data proves rather volatile, through the quarterly noise the longer-term signal embedded in the data shows unit labor costs rising at their fastest pace in roughly four decades. This data suggests that unless productivity increases, the economy will have to pass some of this increase onto consumers, helping put upward pressure on inflation, even as it decelerates.

Unit Labor Cost

|  What we are watching this week  |

Retail sales for July likely increased but the pace is moderating as consumers continue to shift toward services and away from goods. Yet declining goods inflation in July bodes well for real retail spending. Industrial production and regional Fed manufacturing data should continue to look rather weak. Housing data also appears challenged. Homebuilder sentiment looks set to fall again. Starts and permits data should reflect an inconsistent downward trend due to higher interest rates. And existing home sales could see a slight rebound due to a recent pullback in residential mortgage rates.

|  What it means for CRE  |

As usual, the data gives us a somewhat conflicted impact to commercial real estate (CRE). Take inflation: on the one hand if slowing inflation means somewhat less Fed tightening, that could increase the chances of avoiding a recession and the negative impact on CRE. CRE remains an incredibly pro-cyclical asset class and a downturn in the economy would undermine the sector as it always does. Yet, CRE as an asset class provides an imperfect hedge against inflation, helping the asset class stand out in a crowded investment landscape.

The productivity data also presents a mixed picture. Weak productivity does not generally portend good outcomes from a macroeconomic point of view. However, if weakness here stems in some way from the increase in working from home/anywhere, that could present an opportunity for greater support for employees to return to offices which could help support demand for office space. Stay tuned. We will have more to say on that at a future date.

|  Thought of the week  |

Note: Economic Insights will be on vacation next week but will return the week of August 29.