As we approach the end of 2024, the slight uptick in November's inflation rate to 2.7% year-over-year is unlikely to derail the Federal Reserve's ongoing rate-cutting cycle. While it signals persistent inflationary pressures, particularly in key areas like transportation and food, the broader economic context suggests that the Fed will proceed with its plan to reduce the federal funds rate in the near term. This, in turn, is expected to support commercial real estate investment activity, but the overall economic recovery may still face headwinds.
The November Consumer Price Index (CPI) figures revealed a familiar narrative: inflation remains present, but the trajectory is gradually moving in the right direction. Core inflation, which strips out volatile food and energy prices, held steady at 3.3%, reflecting a still-elevated price environment, particularly in services like motor vehicle insurance and medical care. However, the most encouraging development was in shelter costs, which saw the smallest annual increase since February 2022, clocking in at 4.7%. This is a promising sign, particularly since shelter makes up such a significant portion of the CPI.
While rising transportation costs (up 7.1%) and food prices (up 2.4%) are worrying, energy prices declined by 3.2%, offering a bit of relief to consumers. This mixed bag of data suggests that the inflation situation remains complex. It’s clear that while some areas of the economy are seeing price stabilization, others continue to experience upward pressure. For instance, despite recent dips in energy prices, service-sector inflation continues to rise, with medical care and motor vehicle insurance seeing double-digit increases.
Despite the complexities, the Federal Reserve is expected to reduce the federal funds rate by 25 basis points in the coming week, signaling its commitment to supporting economic growth as inflation moderates. With core inflation remaining above the Fed’s target of 2%, it’s clear that the central bank isn’t about to declare victory just yet. However, the anticipated rate cuts are expected to be slower as the Fed navigates a delicate balance between curbing inflation and supporting economic recovery.
The key takeaway here is that although inflation remains above the Fed’s target, the central bank's decision to continue its rate-cut cycle suggests confidence that inflationary pressures will subside shortly. While the service sector continues to grapple with higher costs, productivity gains and a softer job market are expected to contribute to a gradual slowdown in unit labor costs, which should, in turn, ease inflationary pressures in 2025.
The impact on commercial real estate (CRE) investment activity is worth highlighting. A slight reduction in the federal funds rate should provide some relief for investors, as lower short-term interest rates tend to make financing more affordable and attractive. However, the current environment remains challenging. While the anticipated rate cuts will likely stimulate investment activity, the 10-year Treasury yield, which has remained above 4%, will act as a significant counterbalance, moderating the pace of recovery in CRE. Higher long-term interest rates will continue to influence investment decisions, as they drive up borrowing costs and reduce the appeal of more speculative projects.
In terms of real estate markets, the outlook for 2025 is mixed. On the one hand, lower short-term interest rates will help stimulate activity in the commercial space, encouraging new investments. However, the shadow of persistently high long-term yields and a still-uncertain inflation outlook will dampen overall investor enthusiasm. In particular, regions and sectors of commercial real estate that rely on heavy capital expenditure and long-term financing will feel the sting of these higher rates more acutely. While investor activity is likely to increase in 2025, it may not be as robust as it would be in a more favorable interest rate environment.
Looking ahead, the inflationary landscape in 2025 should see continued improvement, though progress will be gradual. The hope is that the Fed’s cautious approach to rate cuts will lead to a more sustainable recovery, with inflation eventually approaching the 2% target. However, if geopolitical factors or ongoing supply chain disruptions introduce further inflationary pressures—particularly through tariffs on imported goods—the path toward this goal could take longer.
Ultimately, the slight rise in inflation in November underscores the fact that the economy is still not fully out of the woods, but it also suggests that the broader trend is moving toward stabilization. Investors should prepare for a moderate recovery in the year ahead, with some challenges along the way. For commercial real estate, 2025 will likely bring opportunities, though investors will need to remain mindful of the long-term yield curve and inflationary risks that could influence returns.
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