With the Christmas and New Year’s holidays behind, the pace of events and trading should quickly normalize. Updates over the past 2 weeks extended prior trends for U.S. Manufacturing sector weakness as many labor market measures remain relatively healthy. The Federal Reserve’s Quantitative Tightening continues apace while the impact of higher interest rates and demand changes work through Commercial Real Estate markets.

S&P Global December Manufacturing PMI (January 2) was reported at 49.4 which was down from November but higher from the Flash reading. Report comments noted, “Many firms are generally anticipating that business will pick up in the New Year, with respondents pinning hopes on expectations that the new administration will loosen regulations, reduce tax burdens and boost demand for US-made goods via tariffs. Confidence has consequently risen from a low-point last June, having jumped higher in November on the election result. However, this optimism has been pared back somewhat in December, as firms are now reporting worries over higher input prices, and are concerned that inflation may pick up again, adding to speculation that interest rates will not be cut as much as previously thought likely over the coming year.”

Fed QT lowered the size of the Fed balance sheet to $6.85T at year end. This is more than $2T below the 2022 peak and the lowest since May 2020. Fed Chairman Powell has recently commented that the FOMC is just starting to think about slowing the pace of QT. I am a traditionalist in that I think there is a direct correlation between system bank deposits and the size of the Fed balance sheet. With ongoing U.S. fiscal deficits the tension between QT and longer maturity Treasury rates will, in my opinion, eventually reach an imbalance. Until then I expect the QT policy to restrict aggregate bank balance sheet growth.

A year ago the narrative seemed to be on edge regarding potential credit losses in CRE portfolios that would allegedly soon collapse the banking system. At the time I commented that the challenges appeared to be more of an intermediate term earnings head wind. More recently CRE concerns seem to have been moved out of the forefront of our collective consideration. A recent Trepp report (December 31) on Commercial Mortgage-Backed Securities finds that CMBS delinquency trends have continued to move higher led by the Office sector where delinquencies now top 11% for the first time since Trepp began tracking in 2000. My opinion is that CMBS will generally have higher loss content than bank CRE portfolios but the two should be directionally correlated. The expectation at Trepp is for CMBS delinquency trends to continue to worsen as “survive until 2025” is extended another year.