Navigating The Storm While The Economy Cools

The Federal Reserve made a bold decision to raise interest rates 75 basis points, the biggest increase since 1994, as they aim to get the economy back on track and inflation under control. Recently, we’ve seen commentary advising us to expect a “hurricane” in regard to the future economic outlook. From my perspective, while there are certainly storms brewing, it’s important to note, whatever is to come won’t be like anything we’ve seen before. Keep in mind, hurricanes can be Cat 5’s destroying everything in their path or mostly Cat 1’s or 2’s creating great headlines, but without any significant damage.

When it comes to the possibility of recession – with positive metrics out there ie, job growth and high liquidity, it indicates the economy is hopefully robust enough to recover without heading into what we classically think of. Our information leads us to believe the headlines will turn into a soft landing with a much-needed slowdown or retrenchment of rising asset values.

As a banker, my perspective is often looked at through the lens of our clients. The businesses we work with are in an advantageous position – certainly in the lead up to any thought of a recession. For example, we can see that they have strong balance sheets, good liquidity, people are returning to retail and restaurants are full. There is a lot of positive impetus in the marketplace today.

That doesn’t mean we are in for an easy ride and there is no doubt we will continue to see signs of a slowdown and need one. The Fed could also plan to take a step back or two along the way as we don’t know how the economy will react to all of these changes. Additionally, if they move forward with their plan to reduce the liquidity as outlined, by September, I believe they’ll be removing $100 billion a month from the money supply, shrinking the amount of cash on folks’ balance sheets.

As a builder turned banker, I’m particularly tuned into our construction clients, who are similar to other industries, are dealing with various pressures right now, whether that be higher fuel prices, inflation or lingering supply issues. We are in an environment where consumers are going to have less disposable income. Inflation is eating into what people have leftover to spend, so being as efficient as possible and figuring out if there are ways in which they can deliver either the same product or similar products for less money will be the key to survival. Some interesting trends in construction that play into cost savings are not new but are starting to take shape like prefabricated housing and prefabricated panels. Higher levels of pre-built manufacturing are more popular now as opposed to custom built or built on a job site providing a solution to limitations caused by issues with labor and trucking.

Something else we’re starting to see a lot more of is ‘material escalation outs in contracts’ – meaning if there’s material inflation, wage inflation, or even delays, adding a clause into a job contract is a contractor’s new form of protection.

From a lending capacity, we can also expect to see lenders become a lot more conservative in their approach moving forward. Taking into consideration the increased price of materials and labor in their valuation of a project will be crucial to establish whether the profitability for the future is accurate for a lender.