Focus on employment

Employment: strong but slowing?

February’s employment situation report showed ongoing strength, but potential signs of slowing. Net job gains totaled 311,000, well ahead of consensus expectations, but a slowdown from January. Revisions subtracted 34,000 jobs from prior months, but that constitutes a small portion of recent job gains. In addition to slowing job gains, some other metrics show the potential for change in the labor market. The unemployment rate ticked up from the 53-year low in January, rising to the highest level since October. This occurred largely because the labor force participation rate increased slightly, rising to its highest level since March 2020. That means more people were actively engaged in the labor market looking for work. The monthly average hourly earnings growth rate eased to its slowest pace since February 2022. The year-over-year growth pace increased slightly but came in below expectations.

By industry, leisure and hospitality continued strong gains, accelerating relative to recent months. Retail and healthcare also posted healthy gains. Generally, those gains reflect the ongoing shift back to in-person activity by consumers, especially services. Most of the gain in jobs came from private services-producing industries. Of note on the downside, weakness occurred in information and financial activities, which makes sense given the interest-rate sensitivity of those industries.

Open jobs remain elevated

Open jobs also showed continued labor market strength, with tentative signs of slowing. Job openings for January declined slightly versus December but remained highly elevated near 11 million. While the BLS’ and private market providers’ data show that open jobs seem to have peaked, the labor market remains incredibly tight. But in some tentative signs of loosening the number of quits fell to its lowest level since May 2021 while the number of layoffs increased by 16% during the month. Is this reflected in weekly unemployment claims? The most recent week’s data saw the biggest jump since September but remain low. And one data point does not make a trend. But we expect to see further weakening in the labor market ahead as ongoing rate increases further drags on aggregate demand.

What does the Fed have to show for its efforts?

Chair Powell testified to Congress last week and caused a tailspin in markets and economic models. His hawkish comments threw cold water on the hopes that Fed tightening would end soon. In particular, he emphasized that the Fed is not afraid to increase the pace or magnitude of rate hikes if the data suggests such a move. While the Fed has not yet updated its forecast for the fed funds rate, we expect that will come at this month’s meeting with the terminal rate expected to top out somewhere around 5.5%.

But what does the Fed have to show for its efforts? Thus far most of the impact has occurred in public and private markets. Both the stock market and bond market endured notable losses last year, something that occurs very infrequently. Technology investments, including private equity and crypto, suffered significant downturns. And real estate markets, particularly for-sale residential, also pulled back under the weight of higher interest rates. But activity in the real economy remained resilient, reflecting the lag between higher rates and the impact on real economic activity. Consumers continued to spend, companies invested in equipment and IP, and of course the labor market powered ahead.

Inflation seemingly peaked around mid-2022, but much of the slowdown observed last year occurred because of easing supply pressures. We expect inflation to continue to slow over time, especially as higher rates exert a greater drag on demand and shelter costs filter through to indexes like the consumer price index (CPI). But we expect a bumpy road on the way down with more meaningful disinflation in the latter half of the year. And we remain worried that the ongoing resilience in the economy could ultimately backfire if it causes the Fed to raise rates more aggressively, as seems probable.

For now, that remains a more distant prospect, but it could present problems for anyone who banked on a slowdown in the economy in early 2023 followed by a reacceleration in the latter half of the year.

What it means for CRE

While the CRE market would normally cheer a healthy labor market, it still likely represents a net negative because it keeps pressure on the Fed to raise rates. A higher rate environment will keep restraining the CRE market because unlike a typical tightening cycle, property market fundamentals are already slowing. Broadly speaking, our proprietary modeling suggests slower rent growth and higher vacancy rates in the coming years. Property types in a strong position, like industrial, should experience less disruption. Property types in a weaker position, like office, face a more pronounced disruption. But no property type should come through this downturn unscathed.

Thought of the week

The market still expects the Fed to hike 25 basis points (bps) at its next meeting, but the odds are almost even between 25 bps and 50 bps.