Economic Update for February 12, 2024-Interest Rates, Employment, Office Occupancy Rates and More

US jobs growth of 353,000 far outstrips estimates. From the Financial Times: The US economy added 353,000 jobs in January, almost double consensus estimates.

Fed leaves interest rates unchanged but signals future cuts are likely. From the LA Times: Central bank makes clear its first reduction probably is months away, disappointing Wall Street traders. THE FEDERAL Reserve decided to keep its key interest rate unchanged at 5.4%, a 22-year high.  By Christopher Rugaber for the Associated Press. 

Interest rate cuts are coming. Just not yet. The Federal Reserve delivered that message Wednesday, first in a policy statement and then in a news conference at which Chair Jerome H. Powell reinforced it.

The Fed did signal that it’s nearing a long-awaited shift toward cutting interest rates, evidence that officials are confident that they’re close to fully taming inflation. No longer does its policy statement say it’s still considering further rate hikes.

Yet the officials made clear that the first rate cut is probably months away. Their statement cautioned that they don’t think it would be time to cut rates “until it has gained greater confidence that inflation is moving sustainably” to their 2% target.
Investors and some economists had been holding out the possibility that the Fed might cut rates as early as its next meeting in March. That now appears to be off the table.

The Fed kept its key rate unchanged at about 5.4%, a 22-year high. But the overall changes to its statement — compared with its last meeting in December — show that it’s moved toward considering rate reductions while still maintaining flexibility.

In December, the officials had indicated that they expected to carry out three quarter-point rate cuts in 2024. Yet they have said little about when those cuts might begin, and senior officials have stressed that the Fed will proceed cautiously.

The central bank’s message Wednesday — that it’s edging closer to cutting rates but not planning to do so anytime soon — disappointed traders on Wall Street. Losses in the stock market accelerated after Powell’s news conference began.

The change in the Fed’s stance Wednesday comes as the economy is showing surprising durability after a series of 11 rate hikes helped drastically slow inflation, which hit a four-decade high 18 months ago. Over the last six months, prices have risen at an annual rate of just below 2%, consistent with the Fed’s target level, according to its preferred inflation gauge. And growth remains healthy. In the final three months of last year, the economy expanded at a 3.3% annual rate , the government said last week.

The Fed is assessing inflation and the economy at a time when the intensifying presidential campaign is pivoting in no small part on voters’ perceptions of President Biden’s economic stewardship. Republicans in Congress have attacked Biden over the high inflation that gripped the nation beginning in 2021 as the economy emerged from recession. But the latest economic data — including steady consumer spending, solid job growth and the slowdown in inflation — has been bolstering consumer confidence .

At his news conference, Powell said the Fed welcomes signs of economic strength. But he said policymakers are seeking further evidence of a sustained slowdown in inflation.

Most economists have said they expect the Fed to start cutting its benchmark rate in May or June. Rate cuts would eventually lead to lower borrowing costs for America’s consumers and businesses, including for mortgages, auto loans and credit cards.

Labor costs are easing too. On Wednesday, the government reported that pay and benefits for America’s workers, which accelerated in 2022, grew in the final three months of 2023 at the slowest pace in 2 1/2 years .

The Fed appears to be on the verge of achieving a rare “soft landing,” in which it manages to conquer high inflation without causing a recession. Should the pace of economic growth strengthen, though, it could complicate the challenge for the Fed. A much faster expansion, especially one fueled by rate cuts, could potentially reignite inflation.

On the other hand, any evidence that the economy is slowing appreciably probably would accelerate the Fed’s timetable for rate cuts. And indeed, some cracks in the job market have begun to emerge and, if they worsen, could spur the Fed to cut rates quickly.

ECB holds interest rates steady at 4 per cent from the Financial Times: The European Central Bank has kept its key interest rate on hold at a record high of 4 per cent while signalling inflation was falling in line with its expectations.

Bank of England holds interest rates at 5.25% from the Financial Times: The Bank of England has held rates at 5.25 per cent for the fourth successive meeting and said it needs to see “more evidence” that inflation is falling before implementing cuts.

The U.S. economy is outdoing its counterparts overseas. During the October-December quarter, the 20 countries that share the euro currency barely avoided a recession , posting essentially no growth. Still, as in the United States, unemployment is very low in the euro area, and inflation has slowed to a 2.9% annual rate.

Although the European Central Bank could cut rates as soon as April, many economists think that might not happen until June.

The world is starting 2024 on an optimistic economic note, as inflation fades globally and growth remains more resilient than many forecasters had expected. Yet one country stands out for its surprising strength: the United States.

After a sharp pop in prices rocked the world in 2021 and 2022 — fueled by supply chain breakdowns tied to the pandemic, then oil and food price spikes related to Russia’s invasion of Ukraine — many nations are now watching inflation recede. And that is happening without the painful recessions that many economists had expected as central banks raised interest rates to bring inflation under control.

But the details differ from place to place. Forecasters from the Federal Reserve to the International Monetary Fund have been most surprised at the remarkable strength of the U.S. economy, while growth in places like the United Kingdom and Germany remains more lackluster. The question is why America has pulled out ahead of other developed economies in the pack.

The I.M.F. said this week that it expected the United States to grow 2.1 percent, a sharp upgrade from the previous estimate of 1.5 percent. Other major advanced economies are also expected to grow, albeit less quickly. The euro area is expected to notch out 0.9 percent growth, as is Japan, and the United Kingdom is forecast to expand by 0.6 percent.

Evidence of that strength continued on Friday, when a blockbuster jobs report showed that employers had added 353,000 jobs in January and wages grew at a rapid clip.

America’s outperformance has come from a combination of luck and judgment, economists said. 

Regional Bank Sell-off: From Andrew Ross Sorkin for the New York Times: The sell-off in regional bank stocks looks set to worsen this morning, after Moody’s cut New York Community Bancorp’s credit rating to junk status.

Fears are now rising among investors over the United States’ distressed commercial real estate sector. This comes as a crucial lifeline created during last year’s banking crisis is set to expire.

N.Y.C.B.’s shares plunged as much as 15 percent in premarket trading after the downgrade, before rebounding. The stock has plummeted roughly 60 percent in the past week after the lender reported dismal results, especially stemming from its exposure to souring commercial real estate loans.

Last year, N.Y.C.B. won the bidding for assets tied to Signature Bank, which failed shortly after the demise of Silicon Valley Bank. That pushed its assets above $100 billion, putting it into a new regulatory category, and subjecting it to more stringent capital requirements.

Bank jitters are spreading. The KBW Nasdaq Regional Banking Index, a collection of midsize bank stocks, has fallen nearly 12 percent in the past week as investors worry about lenders’ exposure to commercial real estate loan portfolios.

Plunging office occupancy rates and high interest rates are a big reason. The shift in working practices after the height of the coronavirus pandemic has roiled the commercial real estate market and lenders could face a “maturity wall” of as much as $1.5 trillion in commercial real estate loans set to come this year and next. (U.S. regional banks provide the bulk of such loans, putting them at particular risk.)

Officials have acknowledged that some banks may be at risk, but have downplayed worries of a wider crisis. “I believe it’s manageable, although there may be some institutions that are quite stressed by this problem,” Treasury Secretary Janet Yellen told the House Financial Services Committee yesterday.

Complicating matters, a funding lifeline expires next month. On March 11, the Fed’s Bank Term Funding Program will stop making specially low-interest loans to distressed lenders. The program was established last year amid the collapse of Silicon Valley Bank to help lenders shore up their finances on the cheap, and restore the public’s confidence in the wider banking system. The sinking share prices suggest that investors aren’t buying that message.

Office Occupancy (Not Vacancy) Rates: By Peter Coy for the New York Times: When Jerome Powell, the chair of the Federal Reserve, appeared on “60 Minutes” this past weekend, he said he wasn’t super-worried about the risk of a banking crisis triggered by defaults on office buildings and downtown retail. While acknowledging that the future is uncertain, he said that “it appears to be a manageable problem” for the biggest banks. He said “we’re working” with some smaller and regional banks that have “concentrated exposures in these areas that are challenged.”

As usual when it comes to the Fed, one has to decide whether to be reassured by its reassurances or worried that the folks in charge aren’t worried enough. I wouldn’t say a crisis is imminent, but I do worry that Powell and company are underestimating the risks. I’ve made four charts that explain my thinking.

First, people who discovered the benefits of working from home during the Covid pandemic aren’t continuing to come back. The rebound in working from the office has pretty much stalled, as the following chart shows. It’s based on data collected by Kastle Systems’ optimistically named Back to Work Barometer.
A chart showing office occupancy rates by metro area from Jan. 25 through Jan. 31 showing the lowest- and highest-occupancy days.

The low occupancy rate is a ticking time bomb for owners of office buildings. When leases expire, tenants won’t want as much space as they have now. Vacancy rates will shoot up. We’re already seeing that happen. Last month Moody’s Analytics announced that the national office vacancy rate rose in the fourth quarter to 19.6 percent, breaking the record of 19.3 percent that was set in 1986 after a period of overbuilding and was then tied in 1991 during the savings and loan crisis.

The need for office space wouldn’t decline very much if everyone came in on the same days and people still needed their old desks. In reality, though, as the chart above shows, occupancy rates are fairly low even on the highest-occupancy days. Plus, some employers are using the days when people are together in the office for team activities that don’t require as much space, Ryan Luby, an associate partner at McKinsey & Company, told me. He coauthored a report for the McKinsey Global Institute last year titled “Empty Spaces and Hybrid Places.”

Hardest hit are owners of Class B buildings (older, not so nice) because their tenants are upgrading to newly vacant Class A space as their leases expire, Alex Horn, the founder of BridgeInvest, a private lender, told me. “The A will make more money than before,” Ilan Bracha, a New York City real estate broker, told me. “Forget about just surviving. But the B and C, there’s no room for them.”

Investors’ fears were awakened last week when New York Community Bancorp, which is exposed to commercial real estate, including office buildings, reported a $252 million quarterly loss. Its stock lost 60 percent of its value from Jan. 30 through Tuesday. The S&P Composite 1500 index of U.S. regional banks fell sharply over concerns about the banks’ exposure to losses in commercial real estate, particularly office buildings. Real estate investment trusts in the office sector also fell.

Delinquencies on private-label commercial mortgage-backed securities on office buildings still aren’t historically high, but they’re back to where they were in 2017, as this chart based on data from Standard & Poor’s Financial Services shows.
A chart showing the delinquency rate on private-label commercial mortgage-backed securities secured by office buildings.

“The office market has an existential crisis right now,” Barry Sternlicht, the chief executive of Starwood Capital Group, an investment firm focused on real estate, said at the iConnections Global Alts 2024 conference last week, according to a Reuters report. “It’s a $3 trillion asset class that is probably worth $1.8 trillion. There’s $1.2 trillion of losses spread somewhere, and nobody knows exactly where it all is.”

Many building owners refinanced their debt when the Federal Reserve slashed interest rates to combat the Covid downturn. Their debt expenses are likely to skyrocket when their loans mature between now and roughly 2028. The Fed is planning to cut rates this year, but that will leave them still well above prepandemic levels. Goldman Sachs calculated in November that about a quarter of commercial mortgages are scheduled to mature this year and next barring extensions, the highest percentage since its records began in 2008.

An office building owner that doesn’t earn enough in rent to cover the mortgage will ask for or demand concessions from the lender. The building owner has some leverage in the negotiation because the alternative is a default that leaves the lender owning a building that it really doesn’t want, Jon Winick, chief executive of the loan-sale advisory firm Clark Street Capital, told me.

There are some offsetting positive factors. The recent decline in interest rates isn’t enough to prevent all defaults, but helps. Also this week the Federal Reserve issued its quarterly report on the opinions of senior loan officers at commercial banks. As this chart shows, there’s been a sharp decline in the share of domestic banks that are tightening standards for commercial real estate loans, which will ease stress on borrowers. Judging from its actions, the Fed seems to regard the banking crisis as having eased up: It is allowing its Bank Term Funding Program, which it began last March to give banks an easier way to borrow, to expire on March 11.
A graph showing the net percentage of domestic banks tightening standards for commercial real estate loans secured by non-farm, non-residential structures.

I’m somewhat reassured by this last bar chart, adapted from a financial stability report that the Fed issued in May. It does show that smaller banks — those with less than $100 billion in assets — are more exposed than the biggest banks to mortgages on office and downtown retail commercial real estate. But even for smaller banks, that exposure is a fairly small portion of their assets.
A bar chart showing mortgages on office and downtown retail commercial real estate and other assets.

The darker segment in the bar for smaller banks represents $510 billion in loans. It’s a lot, but still only about 7 percent of those banks’ total assets of $7.4 trillion. And while the value of those loans could fall further, it’s not going to zero. The ability of a bank to withstand losses on such loans “depends critically” on how big a share of the bank’s overall portfolio they account for, the Fed said in its financial stability report.

“Last spring’s mini banking crisis was triggered by surging bond yields and some flight of deposits,” John Higgins, the chief markets economist at Capital Economics, wrote in a client note on Tuesday. “We don’t see one being triggered this spring by C.R.E.,” or commercial real estate.

On the other hand, a recession, which can’t be discounted, would make matters significantly worse. Empty office buildings are going to be a big problem for banks — and for the wider economy — for years to come. We can only hope that the effect will be chronic rather than acute.
Elsewhere: Keeping Up With the Joneses — in the Netherlands

“Believing that one makes more money relative to peers causally and meaningfully increases self-reported happiness,” says a new study based on an experiment in which a randomly selected subset of Dutch people were asked to guess how much their peers earned and then were informed what the peers’ actual average earnings were.

People who came to believe they were relatively better off than they had thought became less supportive of income redistribution, seemingly because they decided that income differences incentivize hard work, according to the study, which was released by the National Bureau of Economic Research. The authors are Maarten van Rooij of the Dutch Central Bank, Olivier Coibion of the University of Texas at Austin, Dimitris Georgarakos of the European Central Bank, and Bernardo Candia and Yuriy Gorodnichenko of the University of California at Berkeley.