Marcus & Millichap’s Post

Transcript

(upbeat music) - Hey, everyone. Last week we got some new inflation data that reiterates the likelihood of an impending rate reduction by the Federal Reserve. Honestly, I hope they get on with it so we can put this chapter behind us and move on to other significant trends affecting commercial real estate. But for now, inflation, the Fed, and interest rates are the key forces driving the commercial real estate sector. And when I talk to investors, this is the single top of mind issue they're focused on. So when I looked at this new data that came out, a couple thoughts crossed my mind. I thought about the Fed's dual mandate. First, they have to keep inflation under control. They can't let the economy overheat. Second, they have to keep people employed. They can't let the economy get too cold. So basically they're trying to keep the economy in the Goldilocks zone. But that brings up the second thing that crossed my mind. It seems like the Federal Reserve is scared of making a wrong decision. As a result, they end up waiting too long, then they have to over steer the interest rates. Years after the global financial crisis ended, most economists and business leaders thought the Federal Reserve should have been raising rates at a slow, but steady pace. But back then, under the leadership of Janet Yellen, the Fed took a very cautious approach. They waited until 2016 to begin their timid rate increases. Then when Powell took over in 2018, he started moving rates with purpose. Now, when the pandemic hit, the Fed did take decisive actions. I have to give them credit for that. They dropped the rates to zero and they started funneling stimulus into the economy. But when inflation started to surge in 2021, the Fed was once again very slow to take action. Remember the word transitory? By October of 2021, the headline inflation was already north of 6% and it was climbing fast, but the Fed didn't start to raise rates until March of 2022, and by then they missed their window and they had to hit the brakes really hard. Now it looks like inflation is making steady headway towards the Fed's 2% goal. But rather than initiating small measured steps, the Fed has once again held back. At the same time, we're seeing a lot of other economic indicators beginning to stall. Nothing serious yet, but several indicators are beginning to lean toward a possible recession. Inflation adjusted retail sales are basically flat, while both the ISM manufacturing and non-manufacturing indices are suggesting a modest contraction. We're also seeing downward pressure on consumer sentiment and the rate has begun to drift higher. So I fear the Fed will once again miss the opportunity to take measured steps, and instead they'll get caught behind the eight ball and have to overs steer the economy by making big rate cuts in the face of a sputtering economy. Based on the readings that came out last week, headline CPI is down to 3%, while core CPI is down to 3.3%. When the Fed talks about their 2% inflation target, they're not talking about CPI. They want core CPI to be around 2.5%. When they reference the 2% number, they're talking about core PCE and the last reading on that number came in at 2.6% with a very clear downward trajectory. I think the next reading, which comes out on July 26th, may come in below 2.5%. In addition to the headline year-over-year inflation number, I also track the trailing three-month average annualized inflation readings and those are pretty much landing in the target zone At this point. I also developed my own proxy CPI inflation metric that replaces the controversial owners equivalent rent with a combination of Zillow, single family, and RealPage apartment rent data, and that metric is also in the target range. So for real estate investors, I think we're getting very close to the event we're all waiting for. At the beginning of the year, a lot of people were speculating that there'd be three, four, or even seven rate cuts this year. At the time, I was suggesting two or three cuts would be likely, with the second cut happening in September. At this point, it looks like the first cut will be on September 18th, and depending on what happens with some other economic metrics like unemployment, I don't think we can rule out a second cut by the end of this year. I think we really need to pay attention to the unemployment rate though. If unemployment starts to increase rapidly, the Fed may have to oversteer again and do a 50 basis point reduction. I suspect that might be welcome news to commercial real estate investors, but I worry the Fed will have to start chopping rates because we're facing elevated recession risks. Now, all that said, I want to encourage investors to consider something. It looks like the inflation cycle is playing out. It looks like interest rates will come down a bit, not to where they were in 2021, but down some. And it looks like a soft landing is still in play. Now what? What's your investment strategy? What plans come to mind when you focus your eyes on the horizon? (upbeat music)