U.S. Wage Growth Points to Likely Interest Rate Increase in December, Say Real Estate Economists

by John Nelson

The Bureau of Labor Statistics (BLS) released its monthly jobs report on Friday, Nov. 2, revealing that the U.S. added 250,000 jobs in October, above forecasts of 188,000 by The Wall Street Journal. The unemployment rate also stayed at 3.7 percent, its lowest rate since 1969.

In addition to the strong employment findings, the BLS reports that wages are up 3.14 percent over the past 12 months, the first time since April 2009 that the metric rose more than 3 percent from a year earlier.

The Federal Open Markets Committee (FOMC) decided in its November meetings last week to not raise the short-term federal funds rate, but real estate economists are confident that the Fed will raise rates at its year-end meetings on Dec. 10-11 due to higher wages paid to U.S. workers.

“The Fed will likely interpret [strong wage growth] as a warning sign for higher inflation,” says Ryan Severino, chief economist at JLL.

“The Fed is raising rates from more than a wage inflation risk perspective. Labor shortages lead to wage inflation,” adds Kiernan “KC” Conway, chief economist of the CCIM Institute. “I expect three more rate hikes in 2019, and one of those to be a 50-basis-point hike — probably early in 2019 as the Fed [reacts to] even lower unemployment rates and more inflation from housing, materials and energy.”

The BLS reports that the U.S. added 250,000 jobs in October. Job totals for September were revised down to 118,000 and revised up to 286,000 in August. (Source: BLS)

In addition to how the Fed will interpret higher wages, REBusinessOnline asked Severino and Conway for their opinion on what else the October jobs report means for those in commercial real estate. What follows are their edited responses.

REBusinessOnline: Was the 250,000 jobs added in line with your expectations or a surprise?

Severino: The strength in the report was a bit surprising, but I expected a strong month. I thought we would see a rebound after some weather-related weakness in October’s data and that appears to be the case. That isn’t the only factor behind the data, but it helped boost payrolls for the month.

Conway: It was above expectation; however, it should be taken with a grain of salt. There was a most curious comment in the BLS report that I believe will result in a downward revision in the November report. That comment was: “Hurricane Michael had no discernable effect on the national employment and unemployment estimates for October.” (The BLS closed the October survey period prior to full knowledge of Hurricane Michael’s impact. The full impact of the hurricane will be fully realized in the November report.)

Historically, Category 3 or 4 storms have a material impact on everything from retail, schools, government, shipping, commerce, etc.

REBO: Employment in leisure and hospitality rose by 42,000 in October, which is double the average monthly growth in the industry for the 12-month period prior to September. What’s fueling that?

Severino: We continued to see broad improvement in the economy and that often translates into demand for leisure-and-hospitality-related services, especially with robust corporate earnings driving business travel and faster wage growth helping to boost leisure travel.

Ryan Severino, JLL

Conway: The strength in the U.S. economy resulting in more business travel and consumers being confident in their employment situation and engaging in more leisure travel are what are fundamentally driving growth in the hospitality and leisure industry.

REBO: If you’re an owner, investor or developer in commercial real estate, beyond leisure and hospitality what employment sectors in the October report were particularly noteworthy?

Severino: The gain of roughly 35,000 net new jobs in business and professional services was impressive given the difficulty organizations (especially small businesses) face in finding qualified labor. Much of the surge in employment has come from lower-skilled workers with lower levels of education. A gain of that magnitude of higher skill workers is a heartening sign this far into an economic expansion.

Conway: Job growth is being driven by small- and medium-sized business. In ADP’s latest October report, more than half of the 227,000 private-sector jobs added were produced by businesses with less than 500 employees. This growth is the direct result of both regulatory and tax relief being provided by the Trump Administration and the Tax Cut and Jobs Act.

KC Conway, CCIM Institute

One thing to watch here that the Federal Reserve is missing is productivity gains in services. Artificial intelligence (AI) is invading many service sector jobs from self-service kiosks at fast-food restaurants and grocery checkout to banking and medicine. The bank branch will be something in the Smithsonian in 10 years as banks use AI to provide more financial services and credit decision-making. Technology will keep wage inflation in check the next few years.

REBO: Manufacturing added 32,000 jobs in October and 296,000 year-to-date. From a historical standpoint, how does this year-to-date increase stack up?

Severino: Manufacturing employment is rebounding and in some respects is performing better than it has since the early 1990s, particularly when viewed vis-à-vis the overall labor market. Though to be fair, this has been quietly occurring for much of the last eight years.

Conway: The manufacturing jobs we are producing today are fewer and much different than prior cycles. A factory or warehouse today is much more automated with everything from robotic assembly lines to automated forklifts in warehouses. So while we are producing manufacturing jobs, the level is much less than in the 1950s to 1990s, and that’s not a bad thing. It means goods can be priced at levels the average household can afford. However, it means we have to rethink what we do with the displaced middle-class labor that used to provide manufacturing. The proof of this observation lies in the more than 63 percent labor participation rate.

REBO: Employment in the construction industry increased by 32,000 jobs in October and 330,000 year-to-date. Do you believe the narrative of construction’s labor shortage is changing?

Severino: No I do not. The market for labor in construction, particularly skilled labor, remains incredibly tight. We are squeezing as much as we can out of the labor force.

Conway: The five hurricanes in the past year are a huge factor. We are seeing construction and labor prices rising by as much as 10 percent annually due to the rebuilding efforts. We have seen four of the most populated areas of the country severely impacted by Category 3 or 4 storms that resulted in record flooding in Texas and North Carolina. Everything from sheetrock and roof shingles are in short supply. And construction labor is in short supply from Texas to North Carolina and south through Florida.

Construction lenders need to be doing sensitivity analyses on commercial real estate construction loans to see if rents can increase enough over the next two years of that construction loan to offset 20 percent cost increases. If not, that 75 to 80 percent loan-to-cost construction loan will be a 90 to 100 percent loan-to-cost loan at completion. That coupled with higher interest rates over the next two years is a recipe for another bank commercial real estate loan crisis.

REBO: Many economists are predicting that this current expansion will be the longest in U.S. history. Is there anything in the October jobs report that you think helps support or refute those forecasts?

Severino: Extrapolating from one data point is difficult, but robust job growth this far into an expansion is heartening. However, robust job gains can relatively quickly turn into job losses just a few months later so we should not get complacent because of the recent run of good labor market data.

Conway: Since 1857, the U.S. has experienced a recession every decade. If we make it past first-quarter 2019, the U.S. will have defied history. I am in the camp we will defy history now that the November mid-term elections are past us, USMCA/NAFTA 2.0 is agreed to and the NFIB Business and Consumer Confidence remains at or near record levels. This momentum will carry us into the second half of 2019 or maybe early 2020.

However, every recession/commercial real estate disruption that has occurred since the 1950s has been caused by an item like inflation, regulation, currency/debt crisis, change in tax code and disruptive technology. All of those disruptive elements are elevated here at the end of 2018.

We are late in this recovery, the Fed is on an interest rate hike trek, currency crises are bubbling up in Europe and emerging markets again, and technology (like AI, blockchain and Amazon) are disrupting this economy. I don’t believe we have another 2007-type recession, but the risk for a normal cycle recession is more likely in 2020 than not.

— John Nelson and Matt Valley

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