Variance and variants

Quick takes:

• Labor market tightens further
• Services and manufacturing expanding
• Fed signals more hawkish stance
• Omicron adding some uncertainty
• CRE set for solid fourth quarter

As the economy closes out 2021, it is snapping back from its third quarter lull, much as we anticipated. But two key recent developments are clouding the outlook for 2022. Information on the first, the Omicron variant, should arrive relatively quickly. Information on the second, inflation and monetary policy, will take more time. We remain optimistic about the prospects for economic growth in 2022, but as we mentioned last week, complexity remains at an elevated level.

A robust fourth quarter

Data thus far during the fourth quarter reaffirm our view of a robust end to the year. And the employment situation release for November provides further support for that result. With job growth for the month coming in below expectations at 210,000 net new jobs, the report superficially appeared disappointing. But the details show there is much to celebrate. Revisions to prior months added another 82,000 jobs while average hourly earnings held steady at 4.8%, year-over-year. The labor force participation rate surged during the month, from 61.6% to 61.8%, 1.5% below its level from February 2020. Correspondingly, the employment/population ratio jumped by 40 basis points (bps) to 59.2%, 1.9% below the level from February 2020.

With these changes, the unemployment rate plunged 40 bps to 4.2%, while the broader unemployment-underemployment rate dropped 50 bps to 7.8%. Since peaking at a record of 14.8% last April the unemployment rate has plummeted by 1060 bps. While the unemployment rate often comes in for criticism, empirical research shows that a tighter labor market, as measured by the unemployment rate, drives workers back to the labor market which should help accelerate growth in aggregate supply. November’s data supports that thesis. But how to reconcile surging participation and job growth below expectations? This proves difficult with just one month of data, but for now we note that the surge in self-employment since April 2020 continues, with self-employment 458,000 above its pre-pandemic peak.

Surge in self-employment

This underlying strength continues to drive aggregate demand in the economy, especially consumer spending. Some people criticized the sales figures from Black Friday and Cyber Monday as disappointing. But it appears that many consumers began their holiday shopping early, likely due to dire headlines about supply-chain disruptions and inventory shortages. We still expect solid growth in holiday spending to close out a record-breaking year from U.S. consumers. Additionally, the corporate sector also retains much strength and momentum. The ISM Services index for November hit another record-high level, indicating strong demand that is working through any supply-side disruptions. Meanwhile, the ISM Manufacturing index increased in November, though supply-side issues seem more notable in manufacturing. Individually and together, these indexes all sit above 60 which signals strong expansion in the economy. 

Fed signals shift

Fed Chair Powell’s testimony to the Senate last week seemed to cement the view that the Fed has shifted to a somewhat more hawkish policy, reflecting a change in the Fed’s stance on inflation. Chair Powell even went so far as to (seemingly) retire a word that we have come to loathe – transient. He acknowledged that inflation might present a more durable risk than the Fed previously perceived and signaled that more aggressive policy might be forthcoming next year. That would likely take the form of an acceleration in tapering, as opposed to more and faster rate hikes. But the Fed is working to manage the message and make up for some missteps from earlier in the year. If nothing else, it seemed a clear indication that with the labor market remaining so tight, the Fed’s attention has somewhat shifted away from maximum employment (which increasingly seems within reach) and more toward another key part of its mandate – stable prices. 

Oh no, Omicron

The emergence and spread of the newly discovered Omicron variant add a lot of uncertainty to an already complex environment. While we still know too little about this new variant to understand its precise impact, any downside risk associated with it will not likely impact the economy until 2022. For now, the Delta variant remains the dominant strain in the U.S. with that unlikely to change by the end of the year. With vaccines effective against that strain, most consumers seem willing to stay engaged in the economy. Omicron could change that narrative, but it remains far too early to tell. The risk falls predominantly on the downside, but for 2022 and not the remainder of the year. 

|  What we are watching this week  |

The consumer price index (CPI) for November should show additional slight acceleration in both the headline and core indexes. We expect inflation to remain elevated, likely until we reach higher base prices in the second quarter of 2022. Consumer sentiment for December should show further deterioration, with the new variant piling onto existing concerns about inflation. We continue to watch what consumers do and not what they say and see consumer sentiment likely lifting next year. 

|  What it means for CRE  |

Commercial real estate (CRE) is holding up heading toward the end of the year. Our proprietary models predict another quarter of recovery in space market fundamentals across most property types. On the capital markets side, our models suggest that pricing should remain firm and cap rates should generally continue to drift slightly lower. Despite the myriad challenges it faced, CRE performed relatively well in 2021 and should improve on that performance in 2022. 

|  Thought of the week   |

Roughly 60% of the U.S. population is fully vaccinated as of early December.