The Weekly Briefing - August 31st, 2020

The Weekly Briefing – August 31st, 2020:

In This Week’s Brief:

  • Fed’s New Strategy Would Allow Higher Inflation in Order to Boost Labor Market
  • Household Consumption & Income Up in July, Improved Sentiment Necessary for Further Gains
  • Looking for Signal Amidst Robust Year-Over-Year Declines in Transaction Volumes

Fed’s New Strategy Would Allow Higher Inflation in Order to Boost Labor Market

The Federal Reserve announced a major shift last week in its approach to setting interest rates that will provide the central bank with greater flexibility managing inflation in order to support the labor market. Rather than preemptively raising interest rates when inflation rises above 2%, the Fed will allow inflation to run above target to achieve an of 2% over the business cycle, especially following periods of inflation persistently below target. This change in the monetary policy framework suggests that interest rates will stay at low levels for longer than expected previously. The low-for-even-longer expectation for interest rates is likely to have meaningful implications for investor and consumer expectations. Going forward, these expectations could influence and encourage companies to invest and ramp up hiring more quickly, which would tamp down unemployment. For households, the low rates would translate into more affordable loans when purchasing a home or vehicle. The Federal Open Market Committee (FOMC) unanimously approved the new framework, which followed a year-long review of the Fed’s monetary policy strategy. The FOMC initiated the review after some critics said it moved too quickly to hike interest rates in 2018 when inflation remained unexpectedly low despite unemployment falling to the lowest levels in 50 years. Learning from the lessons of the past business cycle, the Fed has made it clear that the job market can remain tight without inducing significant inflationary pressure. However, the Fed will need to carefully construct its narrative around the new strategy; businesses and consumers often interpret rising inflation as a sign of a slowing economy. Under this new monetary policy framework, firms and consumers will have to examine carefully late cycle signals before ramping up saving and cutting back on discretionary spending.

Household Consumption & Income Up in July, Improved Sentiment Necessary for Further Gains

Household consumption jumped 1.9% during July compared to the month prior, rising even faster than personal income, which remained essentially unchanged at 0.4%. Although the increase was smaller compared to May and June, the growth in consumption signals continued positive momentum for the recovery even as it encountered headwinds, such as rising virus case levels, continued labor market churn, and the looming expiration of expanded unemployment benefits at the end of July. Despite the increase in consumption, many households remain cautious about their financial prospects, which may be tempering the recovery. Households continue to hold onto cash rather than injecting it into the economy as shown in the figure below. After three consecutive months of declines, the personal savings rate in July was still more than double pre-pandemic levels at 17.8%. Consumer sentiment surveys tell a similar story of general unease for U.S. households. The Conference Board Consumer Confidence index dropped 6.9 points in August to the lowest reading in several years, and the Univ. of Michigan Consumer Sentiment Index remains well below pre-pandemic figures even after a modest increase in the final August report.

Monthly Change in Personal Income & Expenditures and Savings Rate

Looking for Signal Amidst Robust Year-Over-Year Declines in Transaction Volumes

According to the July Capital Trends Report from Real Capital Analytics, total U.S. transaction volume in July 2020 declined 69% compared to July 2019. During this period where transaction and debt markets slowed significantly, the overall U.S. Commercial Property Price Index rose 1.5% YOY. While some sectors are seeing strong demand, such as garden multifamily and industrial assets, it is too early to presume that the current snapshot across sectors is where pricing will stabilize as conditions return to normal. While the marginal increase in pricing is well below the 7% YOY growth seen in 2019, the decline in transaction volume pales in comparison to the Great Financial Crisis. For example, the peak-to-trough decline in office transactions was 92.0% spanning Q3 2007 to Q4 2009. Similarly, peak-to-trough decline in multifamily transactions was 83.2% from Q4 2007 to Q3 2009. In comparison, between Q1 and Q2 2020, we saw declines of 67.2% and 68.1% for office and multifamily, respectively. While these represent meaningful declines, market participants are signaling that transaction and debt markets are coming back online with pricing durability seen across many sectors. As stability returns to markets and transaction volume continues to rebound, we expect to see more clarity on pricing.

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