Time To Shine

Highlights

?·????? Inflation down again.

·????? Economy stronger than thought.

·????? All eyes on labor.

·????? Interest rates unlikely to rise soon.

·????? Limited downside risk to CRE.

Welcome back readers to another edition of BGO 's The Chief Economist , my name is Ryan Severino, CFA and we've got a few things to discuss this week so let's get right to it!

By January, it had become obvious to us that pandemic-era inflation had fully receded. Sure, we thought we could see some lingering effects. But those came from technical considerations, not underlying dynamics. Nine months later, our assessment looks even more correct. Last week brought even more evidence that high inflation is over despite revisions to GDP data showing an even stronger economy. But despite our confidence, the Fed took a very circumspect approach, waiting until last week to cut rates. Given this information on slower inflation and a durable expansion, the Fed can now focus even more on the labor market. Does that mean clear skies ahead for commercial real estate (CRE) and what could derail our positive outlook?

Go Home

Last week brought another key measure of inflation showing its ongoing deceleration and reversion back to benign levels. Some yearly measures remain above the Fed’s target rate of 2%, but that reflects two (connected) things that we have repeatedly discussed this year.

We have consistently criticized the way that shelter inflation gets calculated in the US. It is highly flawed and is creating the illusion of higher-than-actual inflation.

If we measure inflation (including shelter inflation) the way they do in the Eurozone - harmonized inflation – then inflation sits well below the Fed’s target rate. Further reinforcing that notion, if we exclude shelter inflation (which the Fed has no ability to influence anyway) then overall inflation sits even lower than harmonized inflation.?

Also, base effects are causing the deceleration in yearly inflation to unfold slowly. But that is temporary. By early 2025, base effects will work in the other direction and inflation will slow more meaningfully. If we look at monthly inflation on a 3-month-rolling basis, we can clearly see this – inflation slowed meaningfully in the latter half of last year, temporarily bounced back up in the first half of this year, before falling back again. Of course, housing had much to do with that resurgence in the first half of this year. But even housing cannot hide the massive disinflation that has been occurring, especially in groceries and energy.

Go To Work

That brings us to the labor market. It has clearly slowed over the last year and a half, but not as much as the unemployment rate suggests. Other measures show the labor market remaining tight, if not as tight as last year. And to be fair, this is what the Fed wanted, a looser labor market. This week we will get a look at various measures of the labor market’s health which should show us just how loose things have actually gotten. The August JOLTS data should show job openings remaining near 8 million, above pre-pandemic levels. Initial jobless claims should remain at incredibly low levels. The employment situation report for September should have job gains near last month’s change. We expect little change in the unemployment rate. And average hourly earnings growth should remain healthy.

CRE Implications

Last week we were asked what could derail our positive outlook, specifically the forward path of lower rates which should almost certainly help the CRE capital markets. At this point, it would take something highly idiosyncratic, something like a full-blown, internecine trade war that caused a contraction in not just aggregate demand (AD) but also aggregate supply (AS). However, even under such an unlikely circumstance, it is unclear that AS would contract more than AD, causing inflation to accelerate meaningfully. And even if it did, it is entirely unclear that the Fed would raise interest rates. More likely, rates would just decline more slowly than we currently anticipate and more slowly than the Fed is forecasting. Why? Two key reasons. First, a trade war that would cause that much damage to global AS would almost certainly cause a recession. The Fed would hesitate to raise rates during a period when people would be losing jobs, especially after the last 30 months or so of high rates. Second, if inflation stemmed from trade policy, then higher interest rates would have little to no ability to offset that. If anything, they might just exacerbate the situation by further damaging AD without AS being able to adjust because it would be constrained by policy, not the market. While there are never any guarantees in economics, in such an improbable scenario, damage would be widespread, well beyond CRE. If so, then it could even be possible that CRE could fare relatively better than other asset classes since CRE valuations have been beaten down so badly over the last 30 months.

Thought Of The Week

More than half of U.S. states have taken steps to ban or restrict cellphone use in K-12 schools.

That's all for this week, but we'll keep these newsletters rolling in what should be a very busy stretch to year-end. Until next time!

Ryan S.

BentallGreenOak (“BGO” or “BentallGreenOak”) includes BentallGreenOak (Canada) Limited Partnership, BentallGreenOak (U.S.) Limited Partnership (“BGO U.S.”), their worldwide subsidiaries, and the real estate and commercial mortgage investment groups of certain of their affiliates, all of which comprise a team of real estate professionals spanning multiple legal entities.

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