The weekly note
OCTOBER 19, 2023
This Week’s Developments in the US Economy
The Implications of a Potential Fed Pause and a Review of Key Indicators
During the most recent meeting of the Federal Open Market Committee (FOMC) on Tuesday, May 3, Federal Reserve Chair Powell signaled a potential pause in ongoing rate hikes. Mr. Powell acknowledged that the previous ten consecutive interest rate increases, combined with the impact of tightening credit conditions related to the collapse of regional banks in March and April, have brough policy to a sufficiently restrictive position needed to achieve a 2% target, albeit over some time. However, in acknowledging that it will take some time “for the full effects of monetary restraint to be realized, especially on inflation,” it seems clear that understanding whether policy is sufficiently restrictive—or perhaps overly restrictive—cannot be known until policy lags can be measured.
In order to gain a deeper understanding of the changes and momentum of crucial economic indicators that the Fed is likely monitoring for policy effects, we categorized a variety of indicators based on their impact areas (i.e. price, sentiment, and economic momentum) and assessed their annualized pace of change over three-, six- and twelve-month periods. To align with the Fed’s policy targets, for example, we view rates of change below 2% as “positive”, between 2% and the Fed’s year-end projection of 3.5% as “neutral”, and anything above 3.5% as “negative”. The results are illustrative of the potential for a long road ahead given the Fed’s repeated commitments to achieving a 2% target over time.
This Week’s Developments in the US Economy
The Potential for a Goldilocks Economy—Not too Hot, Not too Cold
The labor market is a crucial indicator for both the overall health of economy and, over the course of the Fed’s current tightening cycle, a key gauge informing policymakers’ decisions on the future rate path. With a hotter-than-expected headline jobs print last week, recent market volatility underscores concerns that robust, positive data may lead policymakers to tighten further. In our view, labor market resilience is more likely to support the case for rates remaining higher for longer, while also providing tailwinds to demographic and consumer driven commercial real estate sectors such as housing and logistics. At the same time, we do not see indications of the labor market overheating as employment growth is well below the levels seen in the later part of the previous cycle (see accompanying visual).
Market Reaction to New Data: The JOLTS and Jobs Report
One of the areas that has been a concern for market observers—and potentially misinterpreted—is the perceived jobs surplus in a tight labor market. A striking example of this theme played out recently when the Job Openings and Labor Turnover Survey (“JOLTS”) report indicated over 9.6 million new job postings. However, this narrative shifted when last week’s Jobs Report indicated that most of the new employment is driven by seasonal factors, such as employment growth in Education because of the start of a new academic year.
New Hiring Where It’s Needed Most
Behind the hot headline reading, overall employment growth remains below pre-pandemic levels, and certain sectors, such as Leisure and Hospitality still lag their February 2020 employment figures. However, it's crucial to recognize that some sectors have historically faced labor shortages and the recent job additions are concentrated in sectors that have experienced persistent mismatches between job openings and unemployment, such as Education and Health and Leisure and hospitality.
Since 2020, the labor market has experienced an annualized growth rate of 0.8%. For the same period prior spanning 2016 to 2020, total payroll jobs grew at an annualized rate of 1.5%. This disparity highlights the uneven recovery across sectors. Few sectors have managed to outpace their pre-pandemic growth rates, such as Professional and Business Services, Construction, Information, and Trade, Transportation, and Utilities (“TTU”). But for many sectors, mismatches between demand and labor availability remain (see accompanying visual).
The Case for Sustained Growth: Why Hot Is Not Too Hot
Early in the tightening cycle, there was concern that the pace of hiring in a tight environment would lead to wage growth and, subsequently, price pressure. Despite the consistent rise in employment, wage growth has moderated, clocking in at 4.3% YoY in August 2023, compared to 5.4% a year ago. A couple of key factors influence this dynamic. The labor force participation rate (LFPR) has increased, and participation is increasing by women across all age groups from their pandemic lows, which has helped the prime-age labor force aged 24-54 to increase to some of the highest levels over the last several decades. In addition, wage premiums for job switchers are decreasing, signaling another potential cooling of wage pressures. The net result, in our view, is sustained growth and confidence by US consumers, providing tailwinds to demand-driven sectors.
This Week’s Developments in the Global Economy
Euro Area CRE Poised for a Prolonged Slump
The confluence of sluggish growth and elevated interest rates has had negative implications for the Euro Area commercial real estate market, and conditions do not appear to be improving soon in either area. Commercial and residential property values dropped at the end of last year—according to MSCI, CRE transaction volume in Europe fell by 59% in the first six months of 2023. According to the European Central Bank (“ECB”), 40% of Euro Area CRE is held in REIFs (“Real Estate Investment Fund”), and declining values and lower transaction volumes signal the potential for secular risk. Also, according to the ECB, open-ended funds constitute 80% of the net asset value of those REIFs, which could result in a liquidity mismatch derived from the set redemption terms and illiquid assets held. This week, we assessed the current economic conditions in the Eurozone to gauge the outlook for risk in the Euro Area CRE market.
Current Euro Area Economic Situation
In September, the European Central Bank (“ECB”) raised interest rates for the 10th consecutive time, taking the main refinancing rate from 4.25% to 4.50%. However, in the same month the Eurozone saw softening price pressures as headline and core inflation dropped significantly from 5.2% to 4.3% and 5.3% to 4.5%, respectively. While the ECB pointed to a rate pause, the bank remains cautious and committed to keeping rates high as long as deemed necessary. Among the many potential reasons for conservatism, volatility in energy prices presents a meaningful risk to Euro Area inflation given dependence on a high reliance on foreign energy and intracontinental transportation during a period of regional and geopolitical conflict.
A Challenging Outlook for Euro Area CRE
Against the backdrop of those recent volatility in energy prices (and, in particular, crude oil prices), ECB Staff projections for headline inflation in September saw an upward revision of 0.2% for both 2023 and 2024, taking the projections to 5.6% and 3.2%, respectively. Furthermore, the ECB staff provided a downward revision to the GDP projections. The 2023 and 2024 forecasts dropped from 0.9% to 0.7% and 1.5% to 1.0%, respectively. These are notably much lower than the IMF’s upwardly revised US growth projections released this week, which highlight the bifurcation in the trajectory of major global economies.
As the ECB expressed concern regarding the commercial real estate market earlier in the year, the downward revisions to the economic outlook suggest risks are tilting up for Euro Area CRE. Accordingly, we do not anticipate that conditions will improve in the near term for Euro Area CRE.
Market Rates, Catalytic Indicators, and the Week Ahead
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