Banks have tightened standards and pulled back on lending activity. Will this quiet banking issues?
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Data returns to center stage
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Inflation continues to moderate
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Housing market is still sliding
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Banking issues have quieted down
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CRE faces new downside risks
After a few weeks when banking-related stories dominated the economic landscape, data struck back last week. Despite the tumult inflicted by recent banking issues on markets, the underlying data trends slightly diverge from our previous view. But, as we previously noted, downside risk to the economy is increasing as the Fed tries to balance all three legs of its mandate. For now, resiliency in the economy remains intact, but it is increasingly getting tested.
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 7th 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.
The slide in housing also means that disinflationary pressures will find their way into inflation indexes over time
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.