By Philip Marey, Senior US Strategist at Rabobank
The 10 year US treasury yield has been moving sideways around 4.0% since Friday’s contradictory data releases from the US, with a stronger than expected Employment Report which was followed by a weak ISM services survey. We will probably have to wait until Thursday’s US CPI data for new direction.
Meanwhile, the office space vacancy rate in the US has reached its highest level since 1979. In the fourth quarter of 2023 19.6% of office space in major US cities was not leased according to data collected by Moody’s Analytics.
The increase in remote work since the COVID-19 pandemic has caused a large decline in demand for office space, despite increasing attempts to get Americans back in the office. What’s more, on the demand side the stock of office space in the US is the result of earlier booms in commercial real estate construction. The last boom took place between 2012 and 2017, when demand for commercial real estate loans strengthened. On the supply side, lending standards loosened between 2012 and 2015. This era coincides with a strong rise in the commercial real estate price index, which may have motivated banks to expand lending. Loan standards tightened during the pandemic, then loosened again when the economy rebounded, but have tightened since 2021.
Since the Great Recession, commercial real estate prices have more than doubled in nominal terms, but have moved sideways since 2021. This suggests that prices have reached a plateau. However, in recent years inflation has obscured the movement of commercial real estate prices in real terms, which shows a peak in 2021, but since then there has been a decline, almost to the level during the COVID-19 pandemic. In other words, commercial real estate prices are already failing to keep up with inflation. Is this an indication that the commercial real estate bubble is already deflating? With nominal commercial real estate prices remaining elevated, most of the nominal price correction is likely still to come. Since small banks are heavily exposed to commercial real estate, the enduring problems at small banks and the fragility of commercial real estate could provide a dangerous mix that could explode during a recession. For more details, we refer to The commercial real estate-small bank nexus.
Meanwhile, there is still the threat of a partial US government shutdown on January 19. On Sunday, Congressional leaders presented a deal on the top line figure for federal spending in fiscal year 2024 of $1.66 trillion. However, the deal between House Speaker Mike Johnson (Republican) and Senate Majority Leader Chuck Schumer (Democrat) was not received well by the hardliners among the House Republicans. First of all, they would have preferred a substantial cut to the spending level. In addition, many complain that the deal does not include increased border security measures, while some would have liked the inclusion of anti-abortion measures as well. However, Johnson has taken a bipartisan approach and therefore the deal has been made attractive to moderate Democrats and Republicans. Congress now has to approve the 4 appropriations bills needed to avert a partial government shutdown on January 19. The next deadline follows on February 2, when the remaining 8 appropriations bills are due.
