Although it seems that it was mainly technical factors that triggered the correction in the stock market, concerns about inflation have been the main cause of the nosedive in stock market prices. We have outlined such an inflation scenario and its impact on real estate investments.
In fact, the difference between current and trend economic growth is approaching zero, the growing demand for labor is pushing up wages and salaries, but it is still far from a sharp acceleration in inflation rates. Meanwhile, the US Department of Commerce’s recommendation in its investigation to restrict imports of aluminum and steel on national security grounds is a reminder that the risk of escalating trade tensions has a significant impact on investment Property.
We are not suggesting that risk probabilities have increased substantially in light of these events. However, we argue that increased volatility combined with uncertainties about the uncertain future of US trade policy is not an environment in which we should risk it all in one effort, but rather seek returns by looking for opportunities in the real estate market.
It would be more than natural that unjustified price appreciations are corrected over time. Some observers believe that rising inflation may have played a prominent role in the recent stock market sell-off. However, higher inflation points to an overheated economy and rising wages could squeeze profit margins. Obviously, neither case applies at the current time. However, historical evidence shows that periods when inflation begins to rise often create volatility in real estate markets, and returns are poor on average. Last, but most importantly, higher interest rates could affect real estate prices if they reflect increasing risk. Higher interest rates should be less relevant if they result from higher growth.
For now, we expect the implications of rising interest rates for the real estate outlook to be limited. However, a more persistent significant decline in house prices could be associated with somewhat slower growth, either because the economy anticipates a slowdown or because the economic downturn itself slows growth.
The impact of rising interest rates on growth also depends on the factors that pushed interest rates up. The increase in interest rates could be the consequence of a stronger growth impulse, in which case the economic consequences are understandably limited. However, if higher interest rates reflect rising risks, for example, then growth could suffer more significantly. Financial conditions remain very flexible and interest rates relatively low. This should continue to support economic growth.
Therefore, we maintain our scenario of sustained economic growth: (1) increased global economic activity, (2) increased fixed capital formation, (3) a very gradual tightening of monetary policy in the US. We recognize the risks of increased protectionism, as recent announcements are a reminder that trade frictions could escalate significantly. At this point, it remains to be seen what action the United States will take and how other countries may respond.
Since the start of the Great Recession in 2008, most have warned of the specter of deflation by deploying conventional and, more importantly, unconventional monetary policy measures. US inflation averaged about 1.5%, with a spread from -2% in mid-2009 to about 3.8% at the end of 2011. Currently, US consumer price inflation stands at 2.1%.
In the US, the government is embarking on a path of fiscal stimulus, and more trade tariffs and trade frictions may drive inflation higher. However, several factors are keeping underlying inflationary pressure contained for now, including still-cautious wage bargaining behavior by households, pricing by firms, and changes in the composition of the labor market. Furthermore, recent readings have likely overstated current price trends (the surprisingly weak inflation in 2017). Outside the US, wage and price trends haven’t changed much in recent months.
Against this backdrop, we do not anticipate any surprises over the course of 2018. The Fed is expected to gradually raise rates cautiously depending on the tightness of the US labor market, evidence of accelerating wage dynamics and the potential impact of higher financial market volatility in economic growth.
Furthermore, fiscal policy that fosters the competitiveness of US companies and attracts foreign direct investment, helping to raise the US potential growth rate, should also be dollar-friendly. At the same time, there are many factors that point to a glorious future for real estate markets.
According to the Federal Reserve Bank of New York, the current probability of a recession for the US economy is around 4%, rising to around 10% by the end of 2018. In our view, the gradual tightening of monetary policy , limited inflation expectations and cautious investment demand will keep real interest rates relatively low. Therefore, we prefer real estate investments in 2018.
