Economic Insights: Don’t get distracted

Commercial real estate watchers are advised to keep their eyes on the prize and not get distracted by certain wobbly data points such as headline jobs figures.

March 11, 2019

Don’t get distracted

The employment situation last week produced a weak net gain of just 20,000 new jobs. That sent some jitters of a slowdown reverberating through the economy and markets. But there are reasons to take that figure with a grain of salt. Such a low figure looks like an aberration. Nothing in the broader labor market data suggests a slowdown of this magnitude. The low figure likely represents a payback from exaggerated strength due to favorable weather effects in January. Moreover, we always prefer to wait until we see more of a trend confirmed which should emerge over the next few months. One data point in isolation means nothing, especially given the propensity of the numbers to get revised and the fact that the confidence interval (basically a range of error for estimation) for these estimates can be significant.

“…labor…remains scarce and the number of job openings continues to reach record highs.” 

We believe that job growth is slowing, but not at the pace indicated by February’s data. Job growth in 2018 surprised on the upside: the labor force participation rate increased by 40 basis points, but the willingness of employers to accept marginal-quality workers (sometimes out of desperation) helped push job gains higher. For example, some employers accepted applicants that could not pass a drug test. In some cases, the employers extended offers contingent upon the prospective hires entering a drug treatment program which the employers themselves often paid for. But labor, even marginally-qualified labor, remains scarce and the number of job openings continues to reach record highs.

Focus on wages

More tellingly, we focus on the wage data. In line with our expectations, wage growth continues to increase. In February, year-over-year nominal wage growth reached 3.4 percent, the highest rate during the current cycle and just 20 basis points below the previous cycle’s high rate. Because of weaker inflation this cycle, real rent growth (net of inflation) also hovers near the peak from the previous cycle. As we mentioned in our quarterly economic outlook last week, we anticipate that year-over-year wage growth will push into 3.5 percent to 4.0 percent range this year. The headline unemployment rate headed back down to 3.8 percent in February while the U-6 underemployment rate fell to 7.3 percent, its lowest level in 18 years. We anticipate that the headline unemployment rate should head toward 3.5 percent by the end of the year and stay far enough below any reasonable estimate of the natural rate in to trigger continued wage gains. 

We expect productivity growth to slow in 2019 which could pass more pressure through to inflation from wages.

So will wages finally translate into inflation this year? While we do not foresee a significant surge in inflation, two factors warrant watching. The first, the abrupt dovish stance from the Fed, removes a key factor tamping down inflation. Secondly, productivity growth rebounded somewhat in 2018, which makes the direct translation from wage growth to inflation more challenging. We expect productivity growth to slow in 2019 which could pass more pressure through to inflation from wages. None of this suggests rapid inflation, but certainly the potential for more upward pressure on prices than most are anticipating.

What else happened last week

The ISM Nonmanufacturing index significantly exceeded expectations, signaling that economic momentum looks firm and helping to assuage some fears about a slowing economy. The international trade deficit widened in December, helping 2018 set a record for the large trade deficit in history. The housing market showed a bit of upside last week, exceeding expectations for new home sales and inventory for sale in December while housing starts and permits activity for January also fared better than expected. Nonfarm productivity increased during the fourth quarter of 2018, a sign that the underlying (if temporary) recovery in productivity growth remains intact.

What we are watching this week

This week brings a slew of important economic data. Headline and core retail sales for January should exceed expectations. Nonetheless, the pace of growth likely indicates a slow start for the economy in 2019. We also anticipate confirmation of December’s disappointing retail sales figure. The consumer price index (CPI) for February will likely indicate that core inflation held firm on year-over-year basis while headline inflation declined slightly year-over-year. We expect some slight cooling in both headline and core producer price index (PPI) data for February, indicating some loss of momentum recently. We look for import prices to have increased for the first time in four months, largely due to the recent rebound in oil prices. Industrial production for January likely increased modestly. And consumer sentiment for March should hold firm relative to February’s reading which bounced back significantly after a pummeling in January.

What it means for CRE

For commercial real estate (CRE), job gains are the lifeblood of demand. More people working means more demand for virtually all major property types because newly-minted workers need places to work, shop, store goods, live, and vacation. But rising wages feel ambiguous for CRE. More money in the pockets of consumers should provide a boost for CRE demand. But if rising wages narrow corporate margins and/or translate into higher inflation, then the consequences for CRE demand become murkier, even with CRE retaining its role as an imperfect hedge against inflation. For now, we see little reason to worry about either the labor market or the CRE market and our outlook for both for 2019 looks favorable. But we will be paying close attention to the employment situation releases over the next few months for any signs of a slowdown.

Thought of the week

According to a new study, the accumulation of greenhouse gases in the Earth’s atmosphere is costing the U.S. billions of dollars. A one-degree Celsius increase in temperature translates into about 1.2 percent of GDP.

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