What factors will most influence the coming recession?

December 2, 2022 4 Minute Listen

U.S. faces recession in 2023

Sharply higher interest rates will weigh on the U.S. economy in 2023. House prices and retail sales will decline and unemployment will rise. The U.S. dollar’s continued strength against other global currencies will further squeeze corporate earnings and export sales, limiting business investment. As a result, CBRE expects a recession in 2023, resulting in less real estate investment and leasing activity. Adding to the contractionary effects of tighter monetary policy is a weaker global economy. Elevated energy prices, the war in Ukraine and weaker housing demand will inhibit growth in 2023.

Figure 1: CBRE House View Economic Forecast, 2023

Source: CBRE Research, Q4 2022.

Although we expect a recession, we are not overly pessimistic. The U.S. consumer has low leverage and a relatively strong balance sheet. The digital economy and the reshoring of manufacturing—particularly semiconductor production—are two significant growth drivers.

Figure 2: Digital Economy GDP as % of Total GDP

Sources: U.S. Bureau of Economic Analysis, CBRE Research, Q4 2022.

Declining inflation in 2023 will provide a tailwind for the economy toward the end of the year. While the drop will be gradual and bumpy, CBRE forecasts that a slowdown in consumer demand, the easing of global supply chain bottlenecks and a weaker housing market will push inflation down to around 3% by year’s end. We expect that the Federal Reserve will scale back its rate hikes after interest rates peak at 5.2%. The economy should stabilize by the start of 2024 but the downturn’s impact on real estate will linger until employment growth resumes. For the first time in a decade, there is a chance of a buyer’s market in real estate.

Geopolitical improvements could ease recession’s impact

Assuming the Ukraine-Russia war ends next year, as many expect, commodity and food prices should come down. Energy prices will fall, though will not return to pre-war levels as countries continue to seek alternatives to Russian energy sources. China will continue to grapple with COVID, weakness in its housing market and structural shifts in its economy. However, it does not have to deal with high inflation and its current round of stimulus will boost growth in the Asia-Pacific region.

Risks and opportunities from recession

The precise fallout from rapidly rising interest rates is hard to predict, which in turn creates risk. Risky financial positions established amid the past decade’s ultra-low-interest-rate environment may be unsustainable, creating conditions for a financial shock that could lead to a credit crunch. This most likely will occur in highly indebted emerging markets, particularly in Latin America. On the upside, inflation in the U.S. could fall more quickly than expected as supply constraints ease and retailers move into deep discount mode.

Will higher interest rates significantly lower real estate prices?

There are concerns that real estate could be permanently repriced if interest rates remain high for the long run. This is unlikely. Long-term interest rates—typically measured by the 10-year U.S. Treasury yield—are driven by inflation expectations, the real interest rate and the “term premium”.

Inflation expectations should fall over the course of 2023 near the Federal Reserve’s 2% target. The real interest rate, determined by the supply and demand for capital in the global economy, likely won’t rise significantly due to demographic factors. The term premium is small and should remain constant.

In CBRE’s view, the 10-year U.S. Treasury yield will increase to around 3% from the 2.2% average over the past decade but will not be large enough to materially alter the investment landscape or fundamentally reset real estate asset values in the long term.

Figure 3: U.S. 10-Year Treasury Bond Yields

Source: CBRE Research, Q4 2022.

U.S. faces recession in 2023

Sharply higher interest rates will weigh on the U.S. economy in 2023. House prices and retail sales will decline and unemployment will rise. The U.S. dollar’s continued strength against other global currencies will further squeeze corporate earnings and export sales, limiting business investment. As a result, CBRE expects a recession in 2023, resulting in less real estate investment and leasing activity. Adding to the contractionary effects of tighter monetary policy is a weaker global economy. Elevated energy prices, the war in Ukraine and weaker housing demand will inhibit growth in 2023.

Figure 1: CBRE House View Economic Forecast, 2023

Source: CBRE Research, Q4 2022.

Although we expect a recession, we are not overly pessimistic. The U.S. consumer has low leverage and a relatively strong balance sheet. The digital economy and the reshoring of manufacturing—particularly semiconductor production—are two significant growth drivers.

Figure 2: Digital Economy GDP as % of Total GDP

Sources: U.S. Bureau of Economic Analysis, CBRE Research, Q4 2022.

Declining inflation in 2023 will provide a tailwind for the economy toward the end of the year. While the drop will be gradual and bumpy, CBRE forecasts that a slowdown in consumer demand, the easing of global supply chain bottlenecks and a weaker housing market will push inflation down to around 3% by year’s end. We expect that the Federal Reserve will scale back its rate hikes after interest rates peak at 5.2%. The economy should stabilize by the start of 2024 but the downturn’s impact on real estate will linger until employment growth resumes. For the first time in a decade, there is a chance of a buyer’s market in real estate.

Geopolitical improvements could ease recession’s impact

Assuming the Ukraine-Russia war ends next year, as many expect, commodity and food prices should come down. Energy prices will fall, though will not return to pre-war levels as countries continue to seek alternatives to Russian energy sources. China will continue to grapple with COVID, weakness in its housing market and structural shifts in its economy. However, it does not have to deal with high inflation and its current round of stimulus will boost growth in the Asia-Pacific region.

Risks and opportunities from recession

The precise fallout from rapidly rising interest rates is hard to predict, which in turn creates risk. Risky financial positions established amid the past decade’s ultra-low-interest-rate environment may be unsustainable, creating conditions for a financial shock that could lead to a credit crunch. This most likely will occur in highly indebted emerging markets, particularly in Latin America. On the upside, inflation in the U.S. could fall more quickly than expected as supply constraints ease and retailers move into deep discount mode.

Will higher interest rates significantly lower real estate prices?

There are concerns that real estate could be permanently repriced if interest rates remain high for the long run. This is unlikely. Long-term interest rates—typically measured by the 10-year U.S. Treasury yield—are driven by inflation expectations, the real interest rate and the “term premium”.

Inflation expectations should fall over the course of 2023 near the Federal Reserve’s 2% target. The real interest rate, determined by the supply and demand for capital in the global economy, likely won’t rise significantly due to demographic factors. The term premium is small and should remain constant.

In CBRE’s view, the 10-year U.S. Treasury yield will increase to around 3% from the 2.2% average over the past decade but will not be large enough to materially alter the investment landscape or fundamentally reset real estate asset values in the long term.

Figure 3: U.S. 10-Year Treasury Bond Yields

Source: CBRE Research, Q4 2022.

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  • EA is CBRE’s forecasting Research group, comprised of professional economists, data scientists and analytical experts.

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