Not the Pitch CRE Wanted to Hear: Inflation Continues Its Windup

Inflation got even hotter in March according to the latest Consumer Price Index numbers. The seasonally adjusted month-over-month jump was 0.4%, as happened in February as well.

Non-seasonally adjusted year-over-year growth for all items was 3.5%. Energy and shelter together were responsible for more than half of the increase, with energy up 1.1% from February to March.

So-called core inflation, which leaves out energy and food because of their volatility, was up 0.4% month over month — as was true in January and February — and 3.8% year over year. Shelter was up 0.4%, both for rent and owners’ equivalent rent, and at more than 60% of the core increase was the largest factor in the growth. On an annual basis, shelter was up 5.7%. If residential rents start to increase, that could continue upward inflation pressure.

Although the CPI is not the most important metric for the Federal Reserve when considering changes in interest rates, it is still something they pay attention to. Strengthening inflation could be a factor that would play into further delays into rate cuts, with the irony that residential rents could help cement in higher financing rates, and thus costs for multifamily property owners, creating a positive feedback loop that could continue difficult financial conditions for the industry.

“While inflation has fallen from its peak, it still is above the Fed’s 2% target, stalling in the 3% range,” said Greg Friedman, managing principal and chief executive officer of Peachtree Group, in prepared remarks. “I believe there is a heightened likelihood that the Fed may postpone its first interest rate cut longer than anticipated, further dimming the outlook for multiple rate cuts this year. Interest rates will likely stay elevated until the Fed resolves whether 3% is effectively the new 2% target. Simultaneously, commercial real estate will continue to face massive headwinds as a higher interest rate environment will continue to recalibrate asset values and, in turn, open up new investment opportunities.”

The Fed could choose to see 3% as the new target, but in recent past when asked about a change in the 2% inflation goal, members of the Fed said that, although possible, that wouldn’t happen until after first achieving the lower level.

“The hotter than expected CPI report should place further pressure on fed funds futures, which have already dwindled from a projection of six cuts in 2024 to just two currently,” said John Lynch, chief investment officer for Comerica Wealth Management, in prepared remarks. “We look for the 10-year Treasury yield to break out of its trading range of the past 5-6 months, as traders position for higher-for-longer Fed policy.”

Or, as Chris Zaccarelli, chief investment officer for Independent Advisor Alliance put it in prepared remarks, “Goldilocks has left the building — inflation isn’t coming down anymore and rate cut hopes are going to be pushed off even further into the future. The Fed can look past any one report, but as we continue to see multiple reports in a row that are higher-than-expected, it becomes more difficult for the Fed to advocate cutting rates any time soon.”

Still, some remain optimistic, albeit much more cautiously. “We believe 3 interest rate cuts are plausible for 2024. Market pricing is beginning to reflect risks of even 2 cuts this year, but right now 3 is our base case,” said Blackrock’s Gargi Chaudhuri, head of iShares investment strategy, Americas. “Any more cuts would be because of a meaningful deceleration in the U.S. economy, which is not our expectation.” But she says that any cuts will be in the second half of the year and the new data “takes out the possibility of a June interest rate cut.”