Surprise!

Quick takes:

• Labor market’s upside surprise
• Strongest jobs recovery since early 1980s
• Congress moves unexpectedly
• Inflation finally cooling?
• CRE glass, half full or half empty?

After the last two-and-a-half years you might think we’d lost the ability to become surprised by events of economic consequence. But you’d be wrong. The last week or so demonstrated that in our highly complex and sometimes conflicted economic landscape, surprise is a feature, not a bug.

A labor party

The first big surprise came from the employment situation. Contrary to virtually everyone’s view, payroll employment surged during July by 528,000 net new jobs, the largest gain since February. What’s more, revisions during May and June added another 28,000 new jobs. Remarkably, the labor market has now regained all the 22 million jobs lost during the initial stages of the pandemic.
 

It took 29 months for the labor market to return to its previous peak, the fastest recovery since the second Fed recession of the early 1980s. The unemployment rate ticked down to 3.5%, matching the low from prior to the pandemic and the lowest rate since falling to 3.4% in May 1969.  Average hourly earnings posted another solid gain (its strongest since March) and the growth rate held steady versus June on a year-over-year basis. Average hours worked held steady versus June. The participation rate ticked down slightly to 62.1%, its lowest level since December, and well below the pre-pandemic cyclical peak of 63.4%.

Seemingly, the economy has returned to full employment, or even tighter. Yet, mentions of this usually elicit the criticism that simply gaining back lost jobs doesn’t account for the additional jobs that would have been created had the recession not occurred. To do this, we extrapolate from the pre-recession employment trend. By that method, the labor market now sits roughly 5 million jobs below the level suggested by such extrapolation. This tends to happen after every recession to highlight any permanent damage wrought by a downturn. While we see the idea of full employment in terms of supply and demand, some find that lacking given the damage done to labor supply over the last two years. Most clearly, we see this in the low participation rate. Yet it is important to separate longer-term structural issues with those related to the pandemic.

Labor Market Recoveries

As we have been discussing since 2016, the labor market is undergoing serious structural change due to demographics. The baby boomers are aging out of work, one of the key reasons why the participation rate peaked in early 2000 at 67.3%. After the peak it decreases slightly, predominantly due to younger workers foregoing work (temporarily) to obtain an education. But once baby boomer retirements begin en masse, the rate declines considerably and has never fully recovered. Beyond this, a few pandemic-related factors are in play. First, the pandemic accelerated retirements. Even with some workers returning to work, many have not. Second, though estimates vary, millions of Americans likely now have long Covid, which impairs the ability of many from working as they did before the pandemic. Third, the pandemic seriously curtailed immigration. To be fair, so did government policy, but both largely closed off a key source of labor. Meanwhile, demand for labor remains incredibly strong. As quickly as the labor market has recovered, it might have recovered even faster if the labor supply could match it. Nonetheless, with so much labor sidelined, the market remains incredibly tight and likely at or past full employment, even if that currently means millions fewer workers than we might otherwise have.

Party in Congress

Congress also threw a bit of a surprise party in the form of passing the Inflation Reduction Act (IRA). The spending bill focuses on climate, health and tax policy. While somewhat of a watered-down version of the Build Back Better plan, the passage comes as a surprise, nonetheless. As recently as the prior week, many believed passage of such bill would not occur. The bill provides credits for electric vehicles and production of renewable energy. It also opens the door to government negotiation of drug prices, creates a minimum 15% tax on business profits of at least $1 billion per year, and institutes a 1% tax on share buybacks. It also includes additional funding for the IRS to try to reduce tax avoidance. The impact on the overall macroeconomy should prove relatively minor but will likely have a greater impact at a more micro level for certain industries and households. Like almost any spending bill, it will create some winners and some losers.

|  What we are watching this week  |

The consumer price index (CPI) and producer price index (PPI) for July should both show a deceleration in headline inflation on a year-over-year basis while the PPI should also show a deceleration in core inflation. Import prices for July should also show moderation in prices. The early August reading for the consumer sentiment index could show some very modest improvement over July which improved slightly versus June’s reading.

|  What it means for CRE  |

While a hotter labor market usually portends unambiguously good things for commercial real estate (CRE), that will likely not prove true at this juncture. Job gains in categories key to CRE, such as office-using employment, retail and hospitality reflect increased demand on the part of users of those physical spaces. In the case of retail and hospitality, continued spending on the part of consumers is supporting demand, especially as consumers continue to shift from goods consumption to services consumption. For office, however, the translation from job gains to demand seems less rigid than in previous cycles. Uncertainty surrounding concepts like return to office and work from home/anywhere continue to obscure the current environment and cloud the outlook. In some markets, the connection between job gains and net absorption seems disrupted if not severed. 
 

More broadly, such strong job growth could also prompt more aggressive tightening from the Fed. If so, that could continue to weigh on CRE which is already grappling with the disruption brought about by higher rates. That would present even more of a mixed picture of implications. That seems a microcosm of CRE’s overall fortunes. Right now, CRE is getting caught in the crosscurrents of positive and negative developments, but through July the sector is enduring relatively well vis-à-vis other major asset classes.

|  Thought of the week  |

Open jobs declined for the third straight month in a sign that the Fed’s tamping down of excess demand could be working. Yet, openings remain elevated at roughly 10.7 million.