UBS Chief Economist: CRE Can Expect Low Inflation, More Rate Cuts

After three separate inflation waves, the U.S. economy has entered a relative low-inflation environment that should last for the foreseeable future and keep interest rates moving south.

That was the message delivered by UBS Global Wealth Management Chief Economist Paul Donovan at Global Real Estate Advisors' Middle Market Multifamily Forum Friday in Farmers Branch. The Federal Open Market Committee's 50-basis-point cut to the federal funds rate last week signaled to the market that the economy is on stable ground. 

And in good news for commercial real estate, Donovan said he expects rates to chase inflation on a downward glide.

“What I am now expecting ... is a quarter-point-per-quarter rate reduction, not to stimulate the economy but just to follow the inflation rate down,” Donovan said. “And we get the same sort of pattern in most of the other major central banks.”

CRE has mostly rejoiced about interest rates coming down after several years of elevation. But it might not be as pleased about other trends.

Robotics, automation, artificial intelligence and social media have all revolutionized how and where the world works and consumes, Donovan said. The changes could have a profound impact on the industry.

“What is happening in the global economy today is one of the biggest structural upheavals we have had in 250 years,” Donovan said. “This is not a small series of changes. This is what economists call the fourth industrial revolution.” 

Remote work is common in the UK, where Donovan lives, and the traditional office is likely to be heavily impacted by the ongoing shift. He said 40% of people work from home for a portion of their week, and 25% of London office jobs are fully remote.

That means companies like UBS are cutting back on commercial real estate.

“UBS doesn't need to provide real estate. It doesn't need to provide an internet connection, it doesn't need to provide electricity, it doesn't need to provide infrastructure,” he said, adding that many functions can be handled by a $10 app. 

“This process is changing how we think about investments because investment and consumer spending are already starting to blur.”

Over the last three years, the economy has suffered three inflation waves, starting with early 2021 as people came out of the pandemic, he said. Consumers didn’t feel comfortable with travel or restaurants yet, but they were interested in things like bigger televisions.

That sparked a surge in demand for durable goods, and manufacturing output hit record highs in the wake of the pandemic, though demand eventually dropped along with the price of goods.  

“So in March of 2022, U.S. durable good price inflation hit an all-time rapid high. Prices were rising over 20% a year,” Donovan said. “Over 20% is borderline hyperinflation. By December, durable good prices were falling, and we’d gone into deflation.”

The second spike came after Russia invaded Ukraine, and the third and most recent wave came due to profit-led inflation from retailers, Donovan said. Retailer profit margins went from 14% to 21% after they raised prices on goods. 

“What has happened in the last six months is consumers have started to rebel,” Donovan said. “Customer loyalty is being fragmented, and we're now starting, across many economies, to see consumer rebellion squeeze that inflation.”