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Shutting down the shutdown | Economic insights

January 29, 2019

Grand Reopening?

The longest partial federal government shutdown in history ended on Friday after 35 days. Congress and the president agreed to reopen the government for three weeks and now have until February 15 to reach a more permanent agreement on border security. Otherwise, we risk heading into another shutdown. Due to the length of the shutdown and the fact that shutdowns become damaging at an accelerating rate, we estimate that the shutdown reduced first quarter GDP growth by roughly 20 basis points to roughly 2 percent. But even with the government open again we expect delays in the publishing of data for several months so we remain limited in our ability to read the economy in a timely manner. 

Even with the government (at least temporarily) reopened, one of our biggest concerns may have already begun. We noted multiple times in recent weeks that the shutdown could incentivize government workers to look for employment elsewhere amidst a very tight labor market. Weekly initial unemployment claims (for the week-ending January 19) fell to its lowest level since November 1969. This occurred despite a rise in initial claims from federal employees jumping by roughly 10,000 to their highest level since the government shutdown in 2013. Recently, searches on job sites from federal government employees spiked and some of those searches will result in federal employees leaving for other jobs. The shutdown will also likely lead to more federal employee retirements and has made working for the federal government appear to be relatively less attractive.

"The shutdown revealed that despite almost 10 years of economic growth, many workers (including many federal employees) still live paycheck to paycheck."

Other things equal, an exodus could prompt the federal government to increase pay and working conditions to return to required staffing levels. While that would normally seem a distant prospect with a recalcitrant Congress, the labor market might force the government’s hand. 

Trade risk returns to the front burner

With the risk of the shutdown at least temporarily halted, the trade tensions with China return to the fore. The two sides are meeting this week and recent comments from the U.S. administration and China do not instill a great deal of confidence. While we do not think tensions will seriously escalate, we do not expect a grand détente either. A neutral path – maintaining the current levels of tariffs but no near-term increases – seems the most likely outcome. The current level of tariffs will still drag on economic growth, but only marginally. In the bigger picture, we see increasing tension in the U.S.-China relationship and the trade situation represents just one small part of the overall picture.

A Pause, Patience, and a Prudent Outlook

The Fed also returns to the spotlight this week with its first meeting of 2019. We expect the Fed to pause interest rate hikes until at least May, remain patient as we start to receive information on a timely basis, and examine the data in a prudent fashion in order to determine monetary policy. We expect the Fed will clearly communicate that they are on hold until they can thoroughly examine the data. The shutdown likely buys the Fed some extra time because of the delay in the publication of data. But our view remains that the underlying economy stands on firm footing and that the labor market will maintain strength in 2019.

"While officials will not release any new projections this week (and therefore no signal on the number of rate hikes) we still foresee 1-2 hikes this year because of underlying strength once the current disruptions abate."

We also do not anticipate any new information on balance sheet normalization. We expect that the Fed will continue with its plan to cap the reduction at $50 billion per month. We foresee balance sheet normalization proceeding for another two years until assets near $3 trillion. Of course, much could happen over that period to alter the course, but we still foresee the Fed maintaining a permanently larger balance sheet regardless of the exact amount. Thus far, balance sheet reduction has served as a red herring and not a major disruptive force in the Treasury market because of the relatively small size of the monthly reduction.

What else happened last week?

The housing market continued to exhibit signs of trouble with existing home sales falling roughly 3.5 percent for 2018. Residential mortgage applications and originations have also declined considerably. While higher mortgage rates seem the likely culprit, they only represent part of the problem. Home sales continue to suffer from a lack of available inventory for sale as well as high prices/low affordability even before rates increased. Concerningly, declines in the housing market often presage downturns in the overall economy so we will pay close attention to the health of the housing market in 2019 for more signs of trouble. 

What we are watching this week

The calendar is bursting with economic news and data this week. In addition to the Fed and China trade negotiations, the labor market will show its cards. The employment situation for January should show a bit of pullback after December’s strong showing. Wages continue to head higher – the employment cost index (ECI) should show acceleration in the fourth quarter while average wage growth for January should show a more modest increase than December (though still healthy). Initial jobless claims should show an uptick after the prior week’s strong reading, but the four-week moving average should head lower yet again. The ISM manufacturing index should change little after a larger-than-expected pullback in December. And finally, both consumer confidence and consumer sentiment (two separate measures) should show the both are pulling back considerably after recently hitting cyclically high levels. 

What it means for CRE

For commercial real estate (CRE), the short duration of the shutdown should help it avoid major damage. Some property types such as residential could see marginal impact, but no lasting damage. The industrial sector is hoping for a positive outcome on trade negotiations. The current situation should impart little damage, but an escalating one could cause problems for industrial. And with the Fed likely on hold until May, CRE has about half of a year to digest the changes in interest rates from 2018 before worrying about any impact from rate hikes to come in 2019.

Thought of the week

According to separate surveys from both Fannie Mae and the University of Michigan, the number of consumers in the U.S. who think that it is a good time to buy a home has fallen below the number that think it is a good time to sell a home. That has occurred just twice in the 26 years that those survey questions have been asked. Both of those instances preceded the two most recent U.S. recessions.

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