Spring 2017 has brought the U.S. economy an even stronger employment picture but also the first signs that the optimism brought on by the election of a pro-business president may not yet be translated into actions.
The Bureau of Labor Statistics’ (BLS) April report on hiring showed 98,000 new jobs added in March, a steep drop-off from the recent pace of 200,000-plus new jobs. There were several mitigating factors that need to be considered, not the least of which is that a one-month snapshot provides little usable information.
Robert Bach, director of research for Newmark Grubb Knight Frank, noted in his April 7 weekly email that the jobs report was both mixed and explainable. Harsher weather in March greatly reduced the hiring in construction. Congress’ attempts to overhaul the Affordable Care Act led to uncertainty that halved the amount of hiring in the healthcare sector. Continued expansion of online shopping gutted the retail sector hiring, creating a 35,600-job difference between March’s decline and the three-month average gain.
The upside in the April report was the continued better-than-inflation wage increase of 2.7 percent year-over-year; an increase of 11,000 jobs in the sector that covers oil and gas exploration; and the 263,000 jobs created in the private sector, as reported by ADP. The latter reflects the continued strength of the private sector. The overall lower number is a result of the Trump administration’s leaving thousands of federal positions unfilled and presents the potential for a significant bump in jobs in the future.
The portion of the BLS report based on household surveys was more definitively upbeat. The unemployment rate dropped two-tenths of a point to 4.5 percent, as the number of people employed grew by 472,000 and the number of unemployed dropped by 326,000, indicating that new entrants to the labor force are finding jobs. The U-6 rate, which includes marginally-attached workers and those working part-time for economic reasons, fell to 8.9 percent, its lowest rate since the recession began in December 2007.
One interesting trend worth noting in the April report was the widening gap between the “soft” and “hard” economic data being gathered. The gap even received mention in the Federal Reserve’s March meetings and in the recent Beige Book on current economic conditions.
Soft data is the more frequently-updated economic information that is the result of behavior surveys, like consumer and business confidence or business hiring plans. The surveys of this kind – like the University of Michigan’s Consumer Confidence Index – have soared since the election on the expectation that a Trump Administration would lower taxes and regulatory burdens. Thus far, the administration has struggled to impact policy but consumers and business owners have reflected little of this in their responses.
At the same time, hard data – like government employment, retail sales or gross domestic product (GDP) estimates – is showing that the economy is performing pretty much like it has for the past few years. That data has tended to be much less volatile over the course of time and more reflective of the actual economy.
Respondents to soft data surveys remain more upbeat even as hard reports on spending and investment have more muted results. In the March Beige Book, which surveys business owners in all Federal Reserve Bank districts, there were glimpses of the way that the gap is playing out. The Fed’s report noted that action was running behind optimism in several of its districts.
“Participants generally agreed that the recent momentum in the business sector has been sustained over the inter-meeting period. Many reported that manufacturing activity in their Districts had strengthened further, and reports from the service sector were positive. Business optimism remained elevated in a number of Districts. A few participants reported increased capital expenditures by businesses in their Districts, but business contacts in several other Districts said they were waiting for more clarity about government policy initiatives before implementing capital expansion plans.”
Economists have begun to see the trend in consumer and business investing continuing in the same way as in 2016. Employment gains, increasing compensation and record high household per capita net worth should support similar – or higher – consumer spending during 2017. Likewise, firmer oil prices and improved capital equipment spending are signs of a better business investment environment overall, in spite of the lack of government policy action.
Few observers have moderated their low expectations for first quarter GDP growth beyond one percent but expectations for the second quarter are much higher. There are probably limits to the growth beyond that level, however. A 4.5 percent unemployment rate may make robust job creation more difficult going forward. Promised infrastructure spending will now happen too late to impact 2017. Should spending and investment remain stuck in the current pattern, it is harder to see a path towards GDP gains of three percent or more.
As all types of data are suggesting a possible economic fork in the road in the U.S., the Federal Reserve seems satisfied that its employment and inflation goals have been met and that the process of reversing the intervention taken during the Great Recession can begin in earnest.
At its March 14-15 Federal Open Market Committee meetings, the Federal Reserve Board of Governors held substantive discussions about the reduction of its balance sheet. Federal Reserve assets have swollen to $4.5 trillion, in part because of its extended period of buying mortgage-backed securities (MBS) in the years following the crisis to provide liquidity to the mortgage market.
Those MBS holdings now reach about $1.8 trillion. But the Fed has been adding fewer and fewer MBS purchases each month and, with the pace of maturing securities growing rapidly over the coming few years, the share of the Fed’s balance sheet that will be MBS compared to Treasury notes will normalize. It’s quite feasible to envision a path to eliminating the trove of MBS bonds, which were once feared to become a permanent toxic asset base, without any disruption to the normal flows of the mortgage bond market. A steep decline in refinancing has also dampened the number of maturing bonds for the Fed to reinvest. Happily, one holdover fear of the last economic crisis may prove to be unfounded and should not impede the residential market going forward.
The most recent data on new home construction saw the long-term trend continue. March’s housing starts hit 1.22 million units, a decrease of 6.2 percent from the upwardly-revised February volume. The data came in under analysts’ expectations but the difference was attributed to the impact of bad March weather following an unusually warm February. The April 18 report by the Census Bureau showed construction of single-family homes at 821,000 units. Construction of multi-family projects (structures of five or more units) fell to 394,000 units in March, although permits for multi-family surged 13.8 percent during the month.
The Census Bureau reported on April 5 that total construction spending totaled $1.193 trillion in February, an increase of three percent from February 2016. That total was only $12 billion below the February 2006 record high, not adjusting for inflation. Private residential spending rose 6.4 percent year-over-year, with multi-family construction spending still growing at double-digit rates. Private non-residential spending grew by 7.5 percent compared to February 2016. Public construction declined by eight percent during the same time. Commercial construction continued to be the leading subcategory but a closer examination of the commercial sector offers an interesting indicator for 2017-2018.
Commercial real estate was hard hit during the 2008-2009 downturn, with property values falling more than 50 percent nationally. Unlike residential properties, however, commercial real estate began recovering as the overall economy did, with absorption following job creation and consumer spending. That recovery allowed many of the troubled assets in loan portfolios and commercial mortgage-backed securities bonds to regain value without being a drag of the financing markets when the loans matured. There have been some structural changes that have limited the post-recovery construction of commercial real estate.
The highest-profile change has been the shift in shopping from stores to online fulfillment. This behavioral change has limited the demand for new retail bricks and mortar dramatically. Compared to the 2007 business cycle peak, multi-tenant retail construction peaked again in 2016 at a level that was 40 percent lower. In 2007, retail construction was 73 percent of the spending on all commercial construction. Last year, the share fell to 57.2 percent. As might be expected, the rise in online shopping has boosted warehouse investment, but the 2016 construction spending was only $3 billion – or 16 percent – above the 2007 level.
Gains in employment over the past five years have helped push office construction higher but changes in workplace design and habits have reduced the amount of space needed per worker by 50-to-100 square feet. If the pace of job creation slows, as is expected, construction of offices will slow commensurately. Estimates for 2017 are lower than the growth in 2016 but it’s anticipated that U.S. markets will see another five-to-eight percent bump in office building.
What may prove to be the biggest drag on commercial real estate for the next 18 to 24 months will be a more adverse financing environment. The first quarter Federal Reserve Bank Senior Loan Officer Survey found that one-fourth of those surveyed were tightening credit standards for nonresidential property and more than 42 percent said the same for multi-family. Demand for commercial loans was mostly unchanged, with nearly three percent seeing more demand for non-residential real estate.
On the investment side of the financing equation, there seems to be little evidence through the first quarter of declining interest in commercial real estate. The relative paucity of other income-producing investments is keeping interest in commercial real estate high, although year-end 2016 results are showing returns on commercial real estate that are dipping as prices rise and interest rates begin to push cap rates up. Major real estate investment portfolios reported yields that were below ten percent in 2016, with most falling several hundred basis points in return as the year advanced. Should this trend continue and rates creep higher, the risk-adjusted spread between real estate and bonds will begin to chase investors from commercial real estate. Barring some black swan event, however, investor appetite for real estate should enhance the equity side of financing in 2017.
Taken as a whole, the economy after the first quarter of 2017 appears to be one that is near the end of a cycle. Compared to the peak of the previous cycle in 2007, however, the U.S. consumer, business and investor are in decidedly better shape. The lessons learned from the financial crisis are showing in stronger household balance sheets, lower commercial real estate leverage and more conservative business plans. Should the economy begin to slow later in 2017, the U.S. will be buffered against the consequences in ways that it was not in 2007. With the global economy finally showing signs of growth, any domestic drag should be a bump instead of a fall.
A decade after the previous business cycle highs, commercial construction has peaked lower in virtually all property types.