Inflation is finally getting under some real control. Market expectations have normalized in tandem with the interest rate environment. One-to-two more rate hikes can be expected through the coming months, but the Fed has a real balancing act ahead of it. If it raises rates by too much while trying to control inflation, it could be accelerating the ship right into the iceberg. The economy is already in a mild recession or a slowdown; however, the household financial condition is strong. If we throttle and maneuver the ship correctly, while we may not be on-time to our destination, the proverbial ship still will get across the sea in good shape.
The effects of quantitative tightening are taking hold. The supply of money in the real economy has begun to contract and this has resulted in a real effect on inflation. On net, prices of goods are beginning to contract; however, the Fed has a long way to go in achieving target inflation of 2% year-over-year. While it is widely contested whether the economy is teetering towards, or is already in, a recession, the Fed has a very delicate balancing act ahead of it. If the economy is already in recession, the effects are rather mild. Likewise, a few more aggressive rate hikes could push the economy off the cliff. We expect one-to-two additional 25-to-50 basis point hikes through the next two quarters.
If the Fed accomplishes its tight rope act and no longer has need for additional aggressive rate hikes, it will bode positively for equity prices. The equity market is favorable towards compressing or stable rate environments. Thanks to such, 2023 is poised to be a year of positive returns for the market. Downside risks would be a deep recession with dwindling corporate profits and a sharp spike in the unemployment rate. Further escalation in the Russo-Ukrainian war also poses a massive potential headwind. Likewise, all else holding firm, we’re in for a better year than last.
For commercial real estate markets, balances have been very stable with even an uptick recently occurring. Despite the high interest-rate environment and increased deal scrutiny, commercial lenders have seemingly gone all-in on multi-family. This is likely a result of a multitude of factors: (1) uncertainty in the office-space asset class from the COVID-19 drive to hybrid / work-from-home labor model (2) increasing borrowing-costs for single-family housing units and (3) the wounds from the hotel demand-drop still healing. Through 2023, we expect there to be somewhat of a rebalancing act across CRE asset classes; however, multifamily will remain the shining star.
Even as we enter a major economic slowdown or a recession (to-may-toh / to-mah-toh), the positive news is that household balance sheets are extraordinarily strong when compared to the Great Lockdown and the Great Recession. This bodes well for household and consumer resilience if (when) the labor market takes a turn for the worse. Workers are well positioned to weather the storm without overextending credit. The balance-sheet condition will experience some deterioration, but the hull is strong enough that the proverbial ship will make it through to the other side.
One strong signal of the forthcoming balance sheet deterioration is an uptick in revolving credit balances. This is not a cause for total alarm but is certainly an early signal of the reversion in household balance sheet health to come. Where we’d see a rapid increase in revolving credit balances is under a scenario where the labor market falters at an unexpected pace. If the recession or slowdown is a ‘soft landing’, revolving credit utilization should stabilize, and household balance sheets will remain robust. This would be a scenario where the unemployment rate does not exceed 5.5%.
Eric is a Sales Director at Blooma where he helps originators, underwriters, and portfolio managers transform their CRE deal due diligence processes. Eric has a decade in financial services experience with most of his career spent at Moody’s Analytics where he was an associate economist and relationship management professional for financial services industry solutions. He holds his Bachelor of Arts with a dual-major in Economics and Biology from Bucknell University, a Master of Science in Economics from Lehigh University, and an MBA with concentrations in finance and analytics from Villanova University.