The Fed has given the U.S. economy a lump of coal for the holidays by raising its benchmark rate to the highest level in almost two decades and the housing market has gone cold. The frost will likely spread to corporate profits and then the labor market. While this winter economy will be particularly frigid going into the early quarters of 2023, no signs of structural economic weakness call for a fast melt.
On the heels of the 10yr-2yr Treasury Yield Spread inverting, the 10yr-3month spread has now also inverted, validating our expectations from last month that rocky waters lie ahead. As we enter the downturn, core inflation cools, and the Fed continues rate normalization, we expect investor confidence in longer-term treasuries to rise and the spread to widen into positive territory by mid-to-late 2023.
Rapidly rising mortgage rates in conjunction with inflationary-driven builder cost increases throughout 2022 has drastically cooled the overheated housing market. We expect single-family housing demand to remain elevated due to perpetually constrained supply; however, prices and volume of new originations have left Outer Space territory and returned to Earth.
This is Ground Control to Major Tom…
Multifamily has been a bedrock CRE asset class. While the single-family residential mortgage origination train has halted to a screeching stop, Multifamily loan balances keep chugging away. Rising rates and tapered demand for single-family home purchases will provide an upside lift to Multifamily housing demand. When compared to other CRE asset classes, in addition to single-family resi, we expect minimum volatility and sustained growth for Multifamily.
It’s a marathon, not a sprint.
Brakes are being pumped across the board for all asset classes of new construction. The cooled housing market, rate environment, inbound recession, and rising costs have builders wary. This is further exacerbated by the residual effects of the pandemic and the rapid digital transformation of the services sector, which has dampened demand for office-space. How the newly formed tug-of-war battle between the work-from-home, hybrid, and return-to-office models will impact new construction in the longer-term is to-be-determined by whichever ends up ultimately taking the lead.
Pandemic-driven uncertainty in CRE assets has continued to linger. Following the Great Lockdown, US-Based REITs have underperformed the S&P 500. As we exit the 2023 recession, and the US economy enters recovery territory, we expect the engines of commercial-space demand to fire-up. This will cause REIT price levels and returns to close the gap on the corporate equity market.
The largest negative societal effect of a recession is unemployment. The labor market has shown surface-strength resilience through the rapid-rate hike environment, but business confidence is brittle. The signals that the labor market could be in trouble are flashing red. First, housing market activity and house price compression. This is then followed by weakened output and compressing corporate profits. Finally, jobless claims and the unemployment rate then rise. We only have one quarter of declining corporate profits to observe, but the preceding signals of the housing market give cause for alarm.