$550 billion in commercial real estate debt will be a headache for the US

Emre ERGUL

1 – Economic growth is likely to slow in 2024 as the effects of monetary policy play out and post-pandemic headwinds fade.

We expect real GDP growth, also known as a soft landing, to tread the line between mild expansion and contraction for most of this year. After tracking better-than-expected real GDP growth of 2.8 percent in 2023, we forecast a below-trend growth rate of 0.7 percent in 2024.

Fiscal spending may shift from a positive contribution to a slight decline in 2023, with consumer spending likely to grow more slowly among the main components of GDP from now on. A sharp decline in business investment and housing activity in 2023 supported improved performance in 2024, although the outlook remained subdued due to higher interest rates; The strength of the service sector is likely to weaken in 2023

2- We assume that the rate hike cycle is over. If inflation continues its mild course in the coming quarters, we think the FOMC will begin to gradually normalize key rates in the middle of next year.

We expect a 25 basis point cut at each meeting starting in June, and the Fed funds target spread will increase to 4-4.25 percent by the end of 2024. At the same time, quantitative easing, the Fed’s second-round balance sheet program, is expected to remain flat. Quantitative tightening of $95 billion a month is estimated to remove about $1 trillion from the economy next year.

3- The American consumer may begin to bend, but not break. There are several reasons to expect consumer spending growth to slow next year from its strong pace in 2023: excess savings are fading, wage growth remains flat, savings rates are low and pent-up demand is weakening. Additionally, the resumption of student loan payments and the rise of substandard autos and millennial credit card delinquencies are signs of stress for some consumers.

On the other hand, household balance sheets and debt service levels remain healthy. Tight labor markets continue to support employment and thus income levels. Given cross-currents, we think consumer spending growth could remain positive overall in 2024, but at a slower pace than in 2023.

4 – Greater-than-expected fiscal support for the US economy in 2023 could turn into a slight headwind in 2024. The fiscal deficit roughly doubles from $950 billion in 2022 to $1.84 trillion (7.4 percent of GDP) in fiscal 2023. While the full size of this year’s deficit expansion would not be considered a stimulus in the classic sense, it is clear that the federal government is taking notice. Looking to 2024, we still expect the federal deficit to narrow to a whopping 5.9 percent of GDP; This reflects some austerity on the spending side, partially offset by higher interest costs on government debt.

5 While unemployment remains historically low; It may increase even more in 2024. Labor market dynamics are beginning to weaken, with wage growth slowing and unemployment rising slightly, along with declining turnover and temporary relief. While increased labor force participation and increased migration patterns boosted labor supply last year, the shortening of the work week also suggests that demand for labor has fallen.

Given the challenges of adding and retaining workers post-pandemic, businesses may be more reluctant than usual to lay off workers in a slowing economic environment. Even so, less hiring activity could be enough to push the unemployment rate up to a moderate 4 percent by the end of next year due to job losses. Already decelerating wage growth will further decelerate in the context of a softer labor market.

6 – Inflation trends are cooling but likely to remain above the Fed’s 2 percent target through 2024. Inflation, which reached a 40-year high in 2022, slowed significantly in 2023 on both a headline and core basis. Some categories saw more improvement than others. For example, core goods inflation fell from a peak of 12.4 percent in February 2022 to 0 percent in October 2023. Progress in basic services inflation, which includes the sticky housing category, was slower.

Core services inflation, which peaked at 7.3 percent in February 2023, remained at a high level of 5.5 percent in October 2023. We expect housing inflation to moderate in 2024 as the lag in market rents catches up with inflation. We expect core PCE prices, the Fed’s preferred measure of inflation, to rise 2.4 percent in 2024 from 3.4 percent in 2023.

7 Activity in the housing sector has fallen by 30-40 percent over the past 18 months due to rising mortgage interest rates. The U.S. housing market is effectively frozen, home affordability metrics are at 40-year lows, and 75 percent of mortgages are fixed at 4 percent or less. Real residential investment has fallen at a seasonally adjusted annual rate of 12 percent over the past six quarters.

Meanwhile, home values ​​rose 6 percent in 2023 to near all-time highs due to tight supply and historically low vacancies. With an already large decline in recent years, we believe the housing market is one area of ​​the economy that could perform better in 2024 than in 2023, even if near-term trends remain subdued.

8 Restructuring the global supply chain will take time. Over the past year, as inventory and transportation costs have decreased, supply chain considerations have shifted from short-term tactics to long-term strategies to minimize costs while ensuring durability.

Legislation passed in 2022, including the Chips and Science Act and the Inflation Reduction Act, provide onshore manufacturing incentives for certain strategic industries, including semiconductors and renewables. This led to increased business investment in high-tech manufacturing structures last year. More broadly, we expect global supply chain adjustments to continue at a cautious pace, as even the simplest changes are costly and complex.

9 Pressure on the commercial real estate sector is likely to intensify. The high interest rate environment and difficulties among small and regional banks are causing tightening lending standards and slowing growth in the long run. This occurs across all types of lending, but is most evident in the commercial real estate sector, where small and regional banks have significant exposure. With nearly $550 billion in commercial real estate debt due this year, losses for lenders and investors are expected to grow. While we do not expect this to be a systemic issue, reduced lending activity and potential investor losses could be an economic downside.

10 Geopolitical risks will continue to be in the foreground. Rising trade tensions with China, the ongoing Russia-Ukraine war, and conflict in the Middle East all point to continued uncertainties and risks through 2024. While the direct economic impact of the United States has so far been limited, a bigger risk is a supply shock. Given the already high tensions, this year’s US presidential election could have a greater impact on geopolitics than recent cycles.

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