Economic Watch: Easing Inflation Gives Fed More Flexibility on Rate Increases

Executive Summary

• The Consumer Price Index (CPI) rose by 7.1% year-over-year in November, less than the consensus estimate of 7.3%. Food and shelter costs drove the increase, while energy, used car and medical costs declined.
• Core inflation, which excludes food and energy prices, rose by 6.0% annually, slightly below estimates.
• Inflation has cooled in recent months but remains well above the Fed’s 2% target rate. After four consecutive 75-basis-point rate hikes, the Fed is expected to increase the federal funds rate by 50 basis points (bps) tomorrow.
• Rising interest rates and weakening macroeconomic conditions are weighing on growth. We expect a recessionary environment to take hold in early 2023. Financial market volatility and weaker growth will weigh on commercial real estate investment volume.

November CPI

Prices rose by 7.1% annually in November, up just 0.1% from October. Food prices rose 0.5% from the previous month and shelter rose 0.6%. There was price relief in some sectors, with month-over-month declines in energy (-1.6%), used cars (-2.9%) and medical care (-0.7%). Core inflation, which excludes volatile food and energy prices, increased 6.0% year-over-year and 0.2% from October. With core inflation beginning to ease, the Fed will likely lower the size of rate hikes to 50 bps from 75 bps at its meeting tomorrow.

Impacts on Commercial Real Estate

Multifamily

Consumer strength is beginning to deteriorate as excess savings from the pandemic are drawn down. This has led to rising apartment vacancy in recent quarters as well as slowing rent growth. We expect the reduction in rent growth will help lower inflation in coming months.

Industrial

Gasoline prices fell by 2.0% month-over-month in November after rising 4.0% in October. Lower gas prices will benefit the logistics sector, along with fewer supply chain disruptions as China begins to lift COVID lockdown restrictions. While a weakening economy will weigh on industrial real estate fundamentals, we expect the sector will remain relatively resilient.

Office

Professional services prices rose by just 0.1% month-over-month in November, while financial services prices fell 0.1%. Despite a tight labor market, we expect companies will decrease their hiring because of a deteriorating economic outlook. This will weigh on office leasing throughout 2023.

Retail

Prices for “food away from home” increased by 8.5% year-over-year and 0.5% month-over-month in November. Apparel prices also were up by 0.2% month-over-month despite retailers holding excess inventory. We expect a slowing economy and weaker consumer balance sheets will weigh on retail spending.

Hotels

Airfares fell by 3.0% month-over-month in November, while hotel average daily rates fell by 0.9%. While a worsening economy will reduce leisure and business travel in 2023, pent-up demand will remain a tailwind.

Looking Ahead

The year-over-year increase in November’s CPI was the lowest in 2022. Easing inflation will give the Fed flexibility to reduce the size of interest rate hikes in coming months. Following four consecutive 75-bp federal funds rate increases, we expect the Fed will raise the rate by 50 bps tomorrow. The Fed’s monetary policy will continue to tighten until inflation falls on a sustained basis.

CBRE forecasts that headline inflation will fall to 4.1% by year-end 2023 and the federal funds rate will peak at a range of 5.00% to 5.25%. Tighter financial conditions and a weaker macroeconomic environment will result in less investment and leasing activity, along with lower real estate values, over the near term.