Many economists expect that inflation will rise at a faster pace in the U.S. this year than in recent decades. Doug Duncan, chief economist at Fannie Mae, spoke with Scotsman Guide about his expectations for inflation, as well what this outlook could mean for the domestic economy and commercial real estate market.
What is the outlook for inflation?
We expect that inflation will run above the Federal Reserve’s long-term target of 2% for all of this year and next year. How far above that really remains to be seen. In our current forecast, we have it running at about 2.5%, on average, over the next two years. If we’re wrong, it’s likely higher than our forecast.
What are the forces driving this?
Well, other than in World War II, we’ve never seen massive stimulus like we have today. In fact, the level is essentially where it was during World War II. In addition to that, we’ve got the Fed expanding its balance sheet both in mortgage-backed securities and Treasurys, and holding the federal funds rate close to zero. So, on monetary policy, it’s flooding the market with liquidity and holding rates very low with the intent of remaining very stimulative. At the same time, we have had tremendous fiscal-policy implementations.
On the supply side, there have also been global disruptions. In housing, you’re now seeing a rise in the price of materials, like lumber, steel and appliances. Prices for raw and finished goods are going up very rapidly simply because of disruptions in the supply chain globally. Ships are outside of ports waiting to get unloaded. You’ve had pandemic-induced changes in production processes, which have slowed them. So, you have tremendous stimulus on the demand side of the equation and you have got some restrictions on the supply side, and that’s the ticket to higher prices.
Why aren’t you predicting hyperinflation?
I didn’t say it wasn’t very unlikely. It’s just not our base forecast. We do have a scenario for higher inflation. Frankly, our leading alternative scenario for stress testing is a boom-bust scenario, because we’re going to see something on the order of 9% or 10% annualized [gross domestic product] growth in the second quarter [of this year] when all is said and done. And then we expect slowing later in the year and into 2022. But if there’s evidence of a significant unanchoring of inflation expectations, and the Fed has to tighten harder and faster, then that sets up the potential for a bust into the latter half of 2022.
Everything performs better in a non-inflationary market environment.
What is the worst-case scenario for rental properties, and if the boom-bust scenario plays out, what is the outlook for multifamily housing?
The worst-case scenarios are in those markets with rent control. Rent control doesn’t allow the market to adjust for real values. What happens is, the owner is getting paid back for rents with money that is worth less. It reduces their incentive to invest in the maintenance of the building or to build new buildings.
We have had a sort of mini experiment with that, with COVID and the loss of employment in the service sector, which heavily constitutes the renter population. There was an expectation that there would be a significant rise in evictions, but we just haven’t seen that yet. Part of that is because the moratorium is still running. But it’s also the case that some of the stimulus money has gotten to these households and allowed them to make some preparation to move before being evicted, so that it doesn’t impact their credit record.
If you’re not in a rent-controlled environment, then you would expect to see some rent increases to account for the loss of purchasing power from the rents. But if you get in a recessionary environment, you don’t have as much pricing power because of the reduction in the formation of new households and the consolidation of existing households during the downturn.
How would commercial real estate investors react to a period of high inflation?
If the economy is growing, and incomes are growing and are allowed to adjust for inflation, then things should go OK. But everything performs better in a non-inflationary market environment. ●