April 27, 2018

  • Executive Summary: Gross Domestic Product (GDP) grew at an annualized rate of 2.3% in Q1—slower than the 2.9% registered in Q4 but above the 2.1% consensus estimate. The better-than-expected performance came even though the economy was rattled by volatile stock markets and the announcement of potential tariffs on certain imports. Slower growth compared to the prior three quarters was due to weaker contributions from personal consumption expenditure, non-residential fixed investment, exports and government spending. While a buildup in inventories added to growth, import growth, which slowed slightly, subtracted a little from overall GDP growth.
  • Fed Watch: The Fed has penciled in at least two more rate increases this year, and this outlook is unlikely to be affected by today’s report. Moreover, the Fed will recognize that Q1 growth rates tend to be weaker, owing to seasonal factors (although Q1 this year was above expectations), with growth usually picking up in the remaining quarters. Additionally, any increase in concern over fiscal policy (i.e., tax reform) and its effect on inflation will likely be reflected in the Fed’s projections.
  • Policy Implications: Tax reform may reduce the unemployment rate to as low as 3%, as private investment may increase and thus lead to further job creation and wage growth. On the other hand, productivity may continue to grow and the labor force participation rate could increase. We think that inflation will gently pick up and the risks are moderately to the upside. Likewise, expectations of higher budget deficits in the years ahead, steady growth in jobs, a modest uptick in wages and expectations about future growth and inflation recently pushed the 10-year Treasury yield to just under 3%—the highest level since December 2016.
  • Tax Reform: The recently enacted $1.5 trillion tax-cut package, which includes a sharp reduction in the corporate income tax rate to 21% from 35%, should boost the job market. However, gains will likely be modest, given that the timing of the stimulus coincides with the economy operating almost at full capacity.
  • Positives: 
    • Gross private domestic investment: Private investment was up by 7.3% in Q1 from 4.7% in Q4. This was driven largely by investment in structures, which increased to 12.3% in Q1 from 6.3% in Q4. Likewise, private inventories, which more than doubled to $33.1 billion, also added to growth. Business equipment investment, however, slowed to 4.7% in Q1 from 11.6% in Q4. The cut in corporate income taxes and the recent gains in crude oil prices should further spur spending on business equipment.
    • Imports: Import growth slowed to 2.6% in Q1 from 14.1% in Q4. Imports, which are generally a drag on GDP growth, subtracted a little from overall growth. However, imports will likely increase in the months ahead as personal disposable incomes have risen.
    • Disposable Income & Savings Rate: Personal disposable income increased 6.2% in Q1 from 3.8% in Q4. Likewise, the personal savings rate rose 3.1% in Q1 from 2.6% in Q4. 
  • Negatives:
    • Consumer Spending: Consumer spending grew by 1.1% in Q1, down from 4.0% in Q4. While holiday shopping likely bumped up consumer spending in Q4, severe winter weather likely slowed consumption in Q1. Spending on durable goods declined by 3.3% in Q1 from 13.7% growth in Q4. Steady gains in wages from a tightening labor market and higher take-home pays due to tax reform will likely lead to higher consumption in the quarters ahead.
    • Exports: Exports grew at 4.8% in Q1, down from 7.0% growth in Q4. The slower growth in exports was somewhat offset by the weaker growth in imports.
  • CRE Conclusions
    • Retail:  Although consumption slowed in Q1, the rise in personal disposable incomes and a strong labor market augurs well for consumers and retailers in quarters ahead. Retail sales continued to show steady growth in Q1.
    • Office: With the economy operating at or near capacity, employers will find it difficult to fill skilled positions from the current workforce. While a rise in participation would help, growth of the labor force will be limited due to the aging population. Likewise, the tax cuts might boost the job market, but gains will likely be modest given that the timing of the stimulus coincides with the economy operating almost at full capacity.
    • Industrial: While a slowdown in imports is good for the economy’s trade balance, it’s not a net positive for the industrial sector since imports use three times the space that exports do. However, with rising personal disposable incomes, consumers may spend more on imports in the months ahead.
    • Multifamily: Demand for apartments remains strong, but supply has gotten ahead of demand for Class A units. Rent growth remains positive for Class B/C units, but Class A rent growth has stalled. Solid economic growth should help renters’ pocketbooks and their ability to pay more. The new tax law should boost multifamily further as the “buy vs. rent” incentive now tilts further to “rent” with increased standard deductions boosting the lower end of the market and decreased mortgage interest deductions boosting the higher end.