Mark Schniepp
November 8, 2024

Long Term Rates Have Moved Higher

The 30 year fixed rate mortgage yield plunged 100 basis point between May and September 2024. The Fed cut short term rates in September, and again on Thursday November 6.

Paradoxically, longer-term interest rates have moved upward since, driving up mortgage rates and other consumer and business borrowing costs.

The 10-year U.S. Treasury yield reached a recent low of 3.64 percent on September 17, the day before the Fed announced its first rate cut. As of November 8, that rate was up to 4.32 percent, an increase of 70 basis points.

So we’re seeing a reversal in longer term rates. Why?

Growth

A vibrant economy that is generally firing on all cylinders will generate inflation. The investor belief is that there is significant confidence in the economy, soon to be impacted by Trump policies which were friendly the last time around. This is pushing the 10 and 30 year treasury bond yields higher as substitution from bonds to stocks continues.

Stock prices like a vibrant economy, and so the markets spiked the day after the election believing a conservative administration will ease government regulations which kneecap the private business sector.

I have long maintained that the ebullience in financial markets over the last couple of months manifesting the day after the election, signals to the Fed that it doesn’t need to cut rates that much more.  The quarter point easing on Thursday, November 7 was not likely necessary. We risk igniting inflation with easing monetary policy.

Record stock prices reflect high expectations for the economy which already has increased household wealth and now makes the corporate borrowing environment more favorable. Hence our outlook for 2025 is one of steady growth and low unemployment.

Government Debt a Factor

I’ve shown you over the last year how Federal debt has risen sharply, due to the inability of Congress to restrain itself from massive spending. The level of federal spending has never returned to the pre-pandemic trajectory. Here it is again, now at $35.9 trillion.

Government debt is financed through issuance of U.S. Treasury bills, notes and bonds. The U.S. Department of the Treasury has been required to issue increasing amounts of debt to fund government operations. The last 2 years of high interest rates means the cost of financing government debt is more expensive.  The average interest rate paid today is more than double what it was in 2020.

One factor that is affecting Treasury bond yields (and therefore higher rates to you) going forward is the expectation of more government bonds coming to market, entirely due to the high federal government debt, the annual government deficit and the higher interest costs associated with today’s elevated interest rates. The supply of debt is therefore increasing, rapidly.

Consequences

Government Debt

The demand for debt is weakening. The demand for 10 year treasury bonds remains low due to the expectation that more bond auctions will be coming. This increases the yield on all treasury term rates to entice buyers.

Higher interest costs, in turn, contribute to the growth of federal spending — continuing a vicious cycle of borrowing, interest, and higher debt. Currently, 22 percent of annual federal expenditures are debt payments. The 2024 payment will be $1.1 trillion. The federal government is on a path to spend more on interest costs than its combined spending on education, research, and infrastructure.

Housing

Higher long term treasury bond rates move mortgage rates in lockstep.  Higher mortgage rates will not rescue the housing market from the recession it’s been in for the last 2 years.  We don’t see a meaningful contribution by housing to overall economic growth in 2025, but it’s not likely to become a drag on growth either.  Higher rates mean less inventory as would be sellers avoid having to finance their next home at current rates. Less inventory means no relief on the rise in selling values, because existing home supply will remain limited.

Delinquency rates

The average personal loan interest rate is 12.4 percent. American consumers owe $249 billion in personal loan debt, through quarter 3 of 2024.  This is up $4 billion from quarter 1. 24 million Americans have a personal loan. The 60-day delinquency rate for personal loans is 3.4 percent, the highest rate since 2012.

Added to personal loan debt, Americans owe $1.14 trillion in credit card debt. The delinquency rate has moved to 3.3 percent, the highest rate since
2011.

While consumer debt is still not that high relative to consumer personal income, it is a rising concern because of (1) its current direction, and (2) the current trajectory of interest rates.

Mark Schniepp
October 2024

The Immigration Surge

The immigration issue has now jumped to the most important problem cited by Americans, surpassing inflation and the general economy.[1]  If you’ve watched any TV in the last 2 years, you’ve seen hordes of people from all over the world massed at southern border ports of entry.

The volume of immigrants coming through these ports of entry was originally dismissed simply as pent-up immigration from pandemic closed borders. The official Census record did not report much change in the flow of immigration over the last 3 years. However, in January of this year, the Congressional Budget Office reported revised numbers of immigrants for calendar years 2021, 2022, and 2023. The total is 7.1 million. The current estimate for 2024 will be lower than 2023 at 2.8 million “encounters” that will bring total 2021 to 2024 immigration to 10 million.[2] The revised numbers which represent an immigration surge is the largest volume of immigrants per year in the history of the U.S.

And this does not include the 530,000 immigrants that have flown into the U.S. since January 2023 as part of the Cuban-Haitian-Nicaraguan Parole Process, a program where DHS receives immigrants on charter flights from these three countries into 50 different international airport destinations in the U.S.[3] The House Committee on Homeland Security has deemed this an unlawful process of alien admission to the U.S.[4]

Moreover, the Department of Homeland Security unofficially estimated “got-aways” at 600,000 in FY 2022, with likelihood that the number is higher in FY2023.  Anyway you slice up the data, it appears that a total volume approaching twelve million migrants have entered the U.S. since 2021.

The changes in U.S. immigration policy under the Biden administration have meaningfully modified procedures on how migrants are encountered and either admitted or denied at border crossings.

Who are the Recent Migrants ?

More information about these migrants has surfaced this year in scholarly papers.[5]  While immigrants wait for their asylum court dates, they enter the labor force and work because most of them are working age between 18 and 64. Their median age is 28. Compared to the native born population, 78 percent of migrants are in the labor force whereas only 60 percent of the native born population are of working age or want to work. The median age of the native born population is 37.

The surge in potential workers from immigration would naturally push the unemployment rate higher as they entered
the labor force more rapidly than they became employed. Sure enough, Immigrants who have arrived since early 2020 face higher jobless rates than the broader population. Unemployment for recent immigrants averaged 8.2 percent over the May-June-July 2024 period, versus 4.2 percent for American-born workers and 3.5 percent for earlier immigrant cohorts. Overall unemployment has crept up over the last 18 months, from 3.6 percent in March 2023, to 4.2 percent in August of this year, largely due to the swelling numbers of immigrants looking for jobs.

It is true that these workers have alleviated the severe staffing shortages in particular industries in the post pandemic period. They have contributed significantly to the decline in job openings, which have fallen sharply in California. However, the rate of unemployment in California has gradually moved higher since 2022, and among all 50 states, is
the highest with the exception of Nevada.  The rising unemployment rate is not necessarily due to a softening of the labor market. It is due to a surge in the labor force that can be linked directly to the recent influx of immigrants.

An outsize share of post-2020 immigrants are working in low-paying jobs. The most-common occupations, according to the census data: construction laborers, maids and housecleaners, and cooks.

Furthermore, the influx of immigrant workers that has helped fill job openings also dampened wage growth across the affected industries in the state.  Because of the tight labor markets in 2022, wage growth averaged 6-7 percent. Now it has moderated to between 3 and 4 percent, falling sharply in migrant-intensive industries which include construction and leisure & hospitality.

A meaningful data revision is likely coming

Population growth in California which has been reported as negative by Census, has more than likely been positive since 2021, as more net migrants from the southern border have and are being diverted into California. Census has simply not caught up with the migrant surge at the border. The wage and salary data appear to confirm this.  The Wall Street Journal reported that new migrants are living in counties that rely on farm workers, construction services, food and hospitality, and helpers in healthcare (home health aids). This includes Los Angeles County, the Inland Empire, and the Central Valley counties, along with San Diego, Orange, and Ventura Counties.

Unemployment rates are likely higher in these areas with increased population and labor forces than is being reported because the most recent immigrants from 2021 to present cannot be contacted by survey which is the principal mechanism for recording economic data on the resident labor force, workforce, and the number of unemployed.

Is the migration surge a cost or a benefit ?

Many government analysts laud the immigration numbers warning that if rates of entry into the U.S. return to the pre-2021 normal, future economic growth in the U.S. will be insufficient to sustain our current standard of livings. The retirement of the baby boomers and overall aging of the workforce, as well as low and falling birth rates mean population growth will become entirely dependent on immigration by 2040, as deaths of U.S.-born residents will outpace births.

However, what is missing here is a thorough analysis of the costs existing U.S. residents bear as a result of massive immigration and the type of immigration that is being enabled today. While immigrants fill jobs, mostly lower-paying, they also use social services that are often more costly than the payroll and sales taxes that they generate, by working and spending. This includes K-14 education, Medi-Cal, and assistance payments including Calfresh for low income individuals and families.  Furthermore, migrants that ultimately find private housing are and will continue to exacerbate the housing crisis in California.

A recent paper by the Center for Immigration Studies prepared for the House Judiciary Committee concluded that:

Illegal immigrants are a net fiscal drain, meaning they receive more in government services
than they pay in taxes. This result is not due to laziness or fraud. Illegal immigrants actually
have high rates of work, and they do pay some taxes, including income and payroll taxes. The
fundamental reason that illegal immigrants are a net drain is that they have a low average
education level, which results in low average earnings and tax payments. It also means
a large share qualify for welfare programs, often receiving benefits on behalf of their U.S.-
born children. Like their less-educated and low-income U.S.-born counterparts, the tax
payments of illegal immigrants do not come close to covering the cost they create.[6]

The issue regarding the alleged need for more immigration to sustain U.S. GDP growth may be entirely refuted by the coming era of AI that is just ahead of us. With more automation in both the workplace and in the thinkspace, will we actually need more workers?  Robots are already replacing maids at hotels. iPads have replaced waiters at restaurants. It is likely that the size of the workforce will ultimately shrink as more mundane and repetitive jobs are mechanized, and more AI tools can substitute for jobs in education, professional services, customer services, manufacturing, warehousing, transportation, and retail trade.

A bigger fear may be how we actually find jobs for lower skilled workers. Immigration has been the backbone of the U.S. labor force for more than 100 years. However, we need to consider a more discerning immigration policy that will admit newcomers who will pay their way and fill jobs that will be necessary in the evolving economy of today.

¹Gallup, Most Important Problem, monthly survey of Americans, https://news.gallup.com/poll/1675/most-important-problem.aspx
²An “encounter,” previously known as an apprehension, includes all people who are either stopped by the Border Patrol or who turn themselves in. Most migrants simply approach the Border and indicate they intend to seek asylum.
³U.S. Customs and Border Protection, “CBP releases August 2024 Monthly Update,” September 16, 2024, https://www.cbp.gov/newsroom/national-media-release/cbp-releases-june-2024-monthly-update
⁴https://homeland.house.gov/2024/04/30/new-documents-reveal-airports-used-by-secretary-mayorkas-to-fly-hundreds-of-thousands-of-inadmissible-aliens-into-u-s-via-chnv-mass-parole-scheme/
⁵Brookings, Who are the New Immigrants?” Tara Watson and Simon Hodson, September 11, 2024, https://www.pewresearch.org/short-reads/2024/09/27/key-findings-about-us-immigrants/
Pew Research Center, “What the data say about Immigrants to the U.S., by Mohamad Moslimani and Jeffrey Passel, September 27, 2024, https://www.pewresearch.org/short-reads/2024/09/27/key-findings-about-us-immigrants/
Wall Street Journal, “How Immigration Remade the U.S. Labor Force,” by Paul Kieman, September 4, 2024.
⁶Center for Immigration Studies, “The Cost of Illegal Immigration to Taxpayers,” by Steven Camarota, Director of Research, January 2024, page 1

Mark Schniepp
September 2, 2024

The U.S. Economic Expansion Remains Modest                                 

The economy remains in an expansion through growth has moderated this year. It has been 52 months since the last recession and there is low probability that another one is in the forecast anytime soon.  Some lingering issues still remain from the last recession amidst new issues that have emerged.

Most of the serious imbalances in the economy caused by the trauma of either totally or partially shutting down businesses from March 2020 to May 2021 have been resolved.  However, we are not entirely back to normal yet. Impacts directly the result of the pandemic still haunt the economy today and remain unsettling.  This includes inflation, the labor market and the office market.

Inflation

The supply chain interruptions followed by the massive government spending bills were the causes of the highest surge of inflation in 40 years, peaking in the summer of 2022. Progress on inflation has been steady since, though with hiccups. This has led to a pessimistic American consumer kneecapped by general prices for goods and services that are 21 percent higher today then in early 2021.

Tight labor markets

Closed schools and coronavirus infections generated a meaningful defection from the labor force by men but mostly women to care for children and the sick. This included accelerated retirements by the eldest baby boomer members of the work force. The net effect was a meaningful decline in the labor force. It took 2 full years for it to be restored to pre-pandemic levels. Growth of the labor force today is less than one percent—well below the trajectory of growth indicative of 2018 and 2019.  In California the labor force has still not returned to pre-pandemic levels.

Consequently, with general economic growth largely normalized in 2022, 2023 and 2024, tight labor markets have persisted. This has driven up wages and caused perceived “shortages” of workers in many industries, including construction, healthcare, and leisure & hospitality.  Inflation has been harder to extinguish due to soaring wages in these sectors.

Though labor markets are now softening with unemployment rising, unfilled job openings are still higher than they were than before the pandemic.  And labor markets were tight at that time.

A normalizing labor market will result in lower wage inflation, fewer job openings, and the return of workers to the office. We don’t expect this normalization until well into 2025, or later.

The Office Market

The social risks during the heat of the pandemic surge generated widespread adoption of work from home arrangements, particularly from office using companies who could virtually connect remote employees together for meetings and collaboration as a surrogate for in-office work.

When pandemic restrictions were entirely lifted in the spring of 2021, workers were hesitant to return to the office insisting on remote or at least hybrid arrangements. The prevailing tight labor market enabled employees to make demands they otherwise could not for fear of being replaced. Those replacements were now absent.  Employers consented. Thirty to forty percent of office workers were remote in 2022 and 2023. Though work from home arrangements are now moving back toward in-office requirements, hybrid arrangements are still pervasive. Furthermore, companies found they could operate with less space with remote and/or hybrid workers. When leases required renewal, companies chose to downsize their space. More office space became available. Vacancy rates soared. This scenario persists today.

With high rates of vacancy, the value of office buildings has plunged 20 to 40 percent. Leveraged office building owners faced with renewing mature loans, now face higher financing costs, reduced loan values, and a less cash flow from fewer tenants. If lenders stop modifying loans and push towards remaking them, a potentially seismic foreclosure issue could ensue.

The office market will ultimately return to pre-pandemic status, but the timing is uncertain, and at least some carnage is inevitable.

New Issues  

Spending behavior largely rests on the how consumers perceive economic conditions; how these conditions will impact their job opportunities, their incomes, housing, and prices of goods and services. General perceptions of the economy that are pessimistic or uncertain usually weigh down spending. Sentiment indices of the American consumer have been weak, due to consumer uncertainty.

General consumer sentiment reflects the unsettled post pandemic economy and newer issues including massive immigration at the southern border, low housing affordability and political uncertainties. Consumers’ assessments of the current labor situation, while still positive, have weakened, and assessments of the labor market going forward are more pessimistic. This has occurred in tandem with the rising rate of unemployment.

Consumers are also concerned about federal debt. Fifty-three percent of Americans view the debt as a very big problem.[1]  They are right because its growth is a root cause—runaway government spending—of current inflation.

GDP

The growth of GDP has been positive all year, and for this quarter (July to September), the rate of growth is running at 2.5 percent. This follows on the heels of 3.0 percent growth in quarter 2.

The Federal Reserve now has the difficult task of driving inflation lower, while preventing the labor market from weakening further.  Up to now, rate hikes have been largely successful. But in recent months, the rising unemployment rate has persuaded the Fed to begin cutting rates in September and very likely in November. In fact, these cuts are now presumed and embedded in stock and bond valuations today. The federal funds rate cuts should improve sentiment among home builders, financial market investors, and consumers seeking home and car loans.  But it could stall recent progress made on inflation.

For the rest of the year, we see inflation remaining stubborn to tame, and GDP growth running at below trend.

Downside and Upside Risks                                    

Though recession is the largest risk, the likelihood of a contraction in growth is low. The next biggest risk is rising unemployment because that will certainly lower growth but also inflation. The Fed’s forecast for inflation in June was 2.6 percent for 2024, and 2.3 percent in 2025.  This forecast is possible providing spending by consumers subsides.

The odds of recession are less likely than they were a year ago, but not completely off the table, especially with unemployment rising, along with stock market volatility.

We are now less worried about escalating war in Ukraine, but other geo-political tensions, such as between Israel and Iran, or China and Taiwan or even the U.S. and China are or could become bigger threats, and any stress in these tensions could lead to an economic tipping point.

The upside risk is that (1) inflation is snuffed out this year, (2) unemployment rises but modestly enough to keep spending as an engine of positive economic growth, and (3) world economic growth resumes- –in Europe especially—which would maintain U.S. productive capacity and export growth.

[1] Pew Research Center, Top Problems facing the U.S. May 23, 2024

Mark Schniepp
August 10, 2024

In the August 2023 newsletter, I wrote about the tight labor market. Unemployment at that time was below 4 percent, Unfilled job openings exceeded ten million and workers quitting their jobs (for a better job elsewhere) was still quite high.

A year has passed and the data show a clear change in the labor market.

The unemployment rate has jumped to 4.3 percent.  Job openings have declined 20 percent. New hires are now less than they were before the pandemic.  How quickly the winds have changed.

The weaker July labor market data arrived just after the Federal Reserve voted to hold interest rates steady, the same level that was in place a year ago. There is some fear among investors that the Fed is waiting too long to make the long anticipated rate cuts in view of the stock market correction in recent weeks. The worry with the rising unemployment rate is that once it starts upward, it tends to keep rising.

However, GDPNOW, the Atlanta Fed’s real time estimate of economic growth has third quarter 3 GDP now running at a 2.9 percent clip. Furthermore, a 4.3 percent unemployment rate is still quite low, and it was caused in large part by rising labor force growth rather than a decline in employment.

Rising labor force growth is likely due to the massive immigration surge that we’ve observed through the southern boarder over the last 3 years. Migrants have added significantly to the U.S. labor force and are taking jobs in the construction, healthcare, and leisure/food services industries.  It is these sectors along with the public sector in California that is creating the lion’s share of all jobs now.

The growth of foreign born workers is now dominating total workforce growth. Foreign born workers which include undocumented immigrants have recently jumped to an all time record high in numbers. Over the last three years or since July of 2021, native born employment has increased 2.9 percent while employees of foreign born status have soared 18.3 percent.   Foreign born employment has risen by 5.1 million workers during this time frame, and 1.2 million over the last year. Meanwhile, native born employment has declined by 1.2 million workers since July 2023.

The surge in potential workers from immigration would naturally push the unemployment rate higher as they entered the labor force more rapidly than they became employed. These workers have alleviated the severe staffing shortages in particular industries in the post pandemic period. They have contributed significantly to the decline in job openings, which have fallen sharply in California.

However, the same influx of immigrant workers that helped fill job openings also dampened wage growth across the affected industries in the state.  Because of the tight labor markets in 2022,  wage growth averaged 6-7 percent. Now it has moderated to between 3 and 4 percent.

In  summary, the labor market then is simply not as weak as the a rising unemployment rate might imply.  However, some concern has been heightened this year regarding the lack of broad based job creation in the California job market.  Healthcare, the state and local public sector, and leisure and hospitality are responsible for creating most of the net jobs in the state during 2024, with little contribution from other sectors. And the technology sector which peaked in 2022 has not yet rebounded from the spat of layoffs that occurred from late 2022 to mid 2023.

A rate of unemployment in the state is 5.2 percent, having increased by the same amount over the last year as the national rate. This would normally be of concern had the increase not been attributed to a rising labor force due largely to immigration.

Mark Schniepp
July 2, 2024

It’s mid 2024 and it appears the biggest news in the current cycle is the presidential campaign in which the first (and perhaps only) presidential candidate debate just concluded.

I’ve referred to the monthly Gallup polls in this newsletter over the years. Gallup is the longest running poll on the satisfaction of Americans with the direction of the country.

The June survey shows that 21 percent of Americans responded “Satisfied,” and 77 percent responded “Dissatisfied.” The most important issue facing the country today was the economy, with 36 percent of respondents in June citing either the economy in general including wage issues and unemployment, and inflation. This high of a response about the economy has been relatively persistent for the last 2 years.

Though inflation has subsided, it has hit a stubborn floor that remains above the threshold needed by the Federal Reserve to begin normalizing interest rates. Furthermore, previously in their lifetimes, many Americans have not experienced inflation of the scale that has pushed general prices of goods and services up 19 percent since the start of Biden’s presidency.

Consequently, inflation continues to loom large over Americans’ evaluations of the country and the economy.

According to another survey, 23 percent of U.S. adults say the economy is in excellent or good shape today, down from 28 percent in January but slightly higher than the 20 percent who rated the economy positively a year ago.

Americans see inflation as one of the top problems facing the nation, with 62 percent responding that inflation is a very big problem for the country in the latest Pew Research Center survey conducted in late May.[1] The increased borrowing costs and the resumption of rising housing costs, are still on the minds of Americans even as the headline inflation rate recedes.

Only 23 percent of Americans rate the country’s economic conditions as either good or excellent, while 36 percent say “poor” and 41 percent say “only fair.”  This is consistent with the Gallup Poll.

The share of Americans who rate their personal finances as excellent or good declined from 52 percent in 2021 to about 42 percent in 2022, and sinking to 41 percent today.  There is very little divide between Americans identifying by political party. What is more relevant however is that Americans believe their personal finances are in the weakest of conditions since the survey began in 2019.  And it’s not that they are earning less money, it’s that inflation and high interest rates have eroded the ability of those finances to acquire needed goods and services today.

The most recent ABC News/Ipsos poll found that the economy and inflation remain the most important issues for Americans when determining who they may support for president in November.[2] The economy and inflation received 88 and 85 percent responses respectively as the most important issues affecting presidential support. Nearly half of Americans said that these are the single most important issues for them.

Clearly, this poll, and the Pew Research Survey are both consistent with other surveys such as the University of Michigan Consumer sentiment study that routinely monitors how U.S. consumers rate the economy.  Sentiment in that survey has gradually ticked up since 2022 but the level of optimism is still well below expectations based on current economic data.

In summary, Americans are not happy with the current state of the U.S. economy and this typically affects elections, especially presidential elections every four years.

Consequently, other issues of concern, number 2 and number 3 by Gallup being immigration and poor government leadership may not really matter in the grand scheme of things. It’s still the economy stupid as James Carville said during the Clinton-Bush campaign back in 1992. And because he turned out to be correct, we’ve been repeating that mantra during all presidential elections since. Why would this year be any different?

[1] https://www.pewresearch.org/politics/2024/05/23/publics-positive-economic-ratings-slip-inflation-still-widely-viewed-as-major-problem/pp_2024-5-23_economy_00-01/

[2] ABC News/Ipsos Poll, May 5, 2024, https://www.ipsos.com/en-us/most-americans-say-economy-and-inflation-are-most-important-issues-determining-who-they-will-support-for-president-in-november

Mark Schniepp
June 11, 2024

A Looming Issue that Needs Resolution                                      

The 2024 economy remains in an expansion. Recession is now off the table and it appears that modest growth is the likely scenario through the end of the year. Many of the economic indicators are positive, as is the direction of most of the capital markets.

A market where conditions remain weak and are growing weaker is Commercial Real Estate, and in particular, the office market, especially in California. San Francisco has the highest rate of underutilization of office space for any metro area in the country. Not far behind is Downtown Los Angeles, San Jose, Palo Alto, and downtown San Diego.The issue for rising vacancy in the office market is typically that office using employment has contracted as part of a broader based employment decline. Consequently, companies cut back on space to cut costs and “weather the downturn”.  That’s not the case this time. We have near record levels of employment in office using sectors. The problem is that many of these workers are not using the office, and are instead working from home.

The work from home arrangement, made ubiquitous during the pandemic has materially impacted the office market today and this could lead to more serious problems later this year or next.

Vacant offices reduce cash flow for building owners. Reduced cash flow makes it difficult for owners to address their debt service, mainly the mortgage payment. Office loans that mature are at greater risk of distress and delinquency because of the difficulty of generating enough cash flow to cover debt obligations in the current environment. A substantial volume of office loans matured in 2023. Extensions on existing mortgage obligations granted by lenders in 2023 have pushed the looming problem into 2024 and/or into 2025.

This puts the bank at risk of having to foreclose on the office building owner-borrower and reduce the value of the asset on its books, possibly raising a flag for regulators. It’s a vicious circle, largely the result of pervasive work-from-home arrangements that became extended after the pandemic ended and remain in place today.

Where is the Office Market Distress?                               

The wave of office distress that has been anticipated has yet to occur. But the exposure to distress continues to broaden.

Delinquency rates are not rising that much or that fast yet because banks have chosen to extend maturing loans. Now, lenders in the office market space have adopted the mantras of “extend and pretend” and “survive until ‘25,” hoping for circumstances to improve in 2025. Those circumstances include lower interest rates and rising vacancy which would expand cash flow.

REIT commercial real estate values have not collapsed. There has been no major correction in valuations though a number of REITs are not rising in value, weighed down by the share of poorly performing office product in their portfolios.

Consequently, the indicators that would confirm a major problem is here are not signaling the true extent of the distress.

Return to the office (RTO)           

If workers willingly returned to the office, or employers mandated their workers to RTO, utilization would increase, cash flow would be restored to building owners, and the risk of delinquency would abate. Problem solved?  Well yes, but it’s not working like that.

Source: Resume Builder, August 2023. “Do you believe RTO has improved or worsened the following conditions in the office?”

More workers are fact coming back to the office, cutting their work-from-home days from 5 to 3 or even less. Mandates by many employers have brought many workers back, but this is not the first choice for managers, nor always effective since a portion of workers will not comply. Companies including Google, JP Mortgage Chase, Zoom and Amazon, that have instituted stricter in-office policies have experienced tensions. In May 2024, Amazon began requiring that staffers work out of physical offices at least three days a week. This led to a walkout of employees at its Seattle headquarters. The company has found that having most of its employees in the office more frequently has led to greater energy, connection and collaboration. Other surveys of companies that have mandated a return to the office have found that productivity, employee relationships, and company culture have improved. Meta also is sticking to its RTO policy, announced in June 2024, where people assigned to an office are expected to be there three days a week.

Generally, because we are still in a tight labor market, employers are afraid of losing their best workers, or want to provide their employers the opportunity of choosing work from home at least in a partial or “hybrid” fashion. Many jobs can be performed remotely from the workplace, and these workers will likely never return to the office. Companies that take a hard stance on returning to the office understand that it may not work for everyone, and it’s a chance they are willing to take because of the strategic value being placed on in-office collaboration.

The decision to require workers to RTO only part of the time, shows us today that there will be limits on how many workdays employees will be on-site in the office. Rather than return to a traditional work-in-the-office schedule, many white-collar employers have settled into a mix of both in-office and remote work.

It appears that even if fully remote working employees are converted to hybrid experiences, there will still be 10 percent of the office workforce that will participate in hybrid arrangements of 1 to 2 days at home, and 3 days in the office. Even this arrangement where more employees have returned to the office will enable employers to reduce their workplace space, and/or modify it so that it will more efficiently accommodate a hybrid arrangement.

The Office is Not Dead                         

Over time, we believe that even hybrid working arrangements will be reduced for the majority of workers, though not all, especially senior workers that do not manage employees day to day or other occupations or functions where there is less interaction with employees.

That said, office vacancy is expected to increase as many workers return and employment grows over time. A gradual resolution of the office dilemma is expected with vacancies beginning to turn around probably by next year.

Mark Schniepp
May 6, 2024

“Businesses remain especially upbeat regarding their payrolls. Almost no businesses say they are laying off workers. Businesses understand that they will have a perennial problem filling open job positions as baby boomers age out of the workforce and foreign immigration is diminished. It is also encouraging that businesses’ equipment and software investment intentions are holding up well.”

— April 29, 2024 Economic Roundup by Moody’s Analytics

The labor markets remain in a full employment condition. But the rate of new hiring has now fallen below the pre-coronavirus levels of 2018 and 2019. Hasn’t Moody’s been watching the surge of migrants at the southern borders of the United States on TV?  The inflow of migrants will eventually lead to a softening labor market, rather than a perennial problem filling job positions. In the most recent JOLTs report (job openings and labor turnover survey), the number of openings is shrinking and the rate of hiring as slowed.

Investment in equipment and software has been stellar the last two quarters. And consumer spending has not slowed down. But even stronger growth in spending has occurred by the federal government. And this spending spree has continued to drive up the federal debt, and is hindering progress on extinguishing inflation.

Moody’s continued to report the following day that

“… businesses remain cautious about their sales and pricing. Financing conditions are also tight. They have much to worry about, including the Russian war in Ukraine, high global inflation and aggressive monetary tightening by global central banks, the U.S. banking crisis earlier last year, and the ongoing political drama in Washington DC. The recent geopolitical events in the Middle East and the volatility in long-term interest rates around the world aren’t helping either.”

I don’t know how many businesses other than the industrial war complex that are worrying about the Ukraine war, other than hoping it won’t end. The two schools of thought on this are (1) the war is largely a border dispute which Russia is determined to settle by acquisition of eastern provinces, and (2) Russia considers Ukraine as the first conquest in an inevitable strike on other counties within their sphere of influence.

If you side with the latter, you are more likely to support the Congressional appropriations to Ukraine. I’m not aligned with this opinion, and more aid to Ukraine is simply expanding federal debt, increasing expectations of higher rates of inflation, and losing the support and confidence of Americans. In the most recent April 2024 poll, Gallup reported:

“The majority of Americans, 65%, continue to think the war in Ukraine is at a stalemate, and are more likely now (23%) than they were in October of 2023 (14%) to say Russia is winning.”[1]

In a February 2024 survey by The Harris Poll, more than two-thirds of Americans support urgent U.S. diplomacy to end the Ukraine war.[2]

Inflation is a worry for not only businesses but consumers. And the largest concerns are in the banking system, especially regional banks holding commercial real estate debt.  The ongoing political drama in Washington DC is not merely drama. It is a fight by the Freedom Caucus to limit runaway government spending and stabilize the dollar principally to reverse its vulnerable displacement as the world’s reserve currency.

What the mainstream economic news does not mention enough is the rapidly increasing federal debt, how it is interfering with the Fed’s fight against inflation, and how this is jeopardizing confidence in the U.S. dollar. This is why we have the BRICs  alliance today along with the threat of transacting oil in other currencies, and generally undermining the global status of the dollar.

“In April, the Conference Board’s consumer confidence index fell to its lowest level since July 2022, dipping below the long-run average of 100. Deterioration in consumers’ expectations for future economic conditions led the decline in sentiment as the component retreated further below 80 . . .”

— Moody’s Economic Roundup, April 30, 2024

Written comments in the Conference Board’s survey also indicated that consumers are worrying more about politics and geopolitics, and this includes the prolonging of the Ukraine War and the Middle East conflict between Israel and Gaza, and now Iran.

However, Americans are more concerned with the southern border, with inflation, with the general economy, and mostly with U.S. government leadership, according to the monthly Gallup polls, including the most recent edition conducted in March.[3]

The slide in consumer confidence has not manifested into any noticeable pullback by consumers yet, but clearly they are growing pessimistic again due to the lack of new progress regarding immigration, inflation, and poor government leadership. Congress needs to start becoming more serious about the federal deficit by messaging they are resolute in shrinking it. To date, they are not.

[1] https://news.gallup.com/poll/643601/americans-say-not-helping-ukraine- enough.aspx#:~:text=As%20has%20been%20the%20case,quick%20end%20to%20the%20war.

Both Republicans (62%) and independents (44%) increasingly see the U.S. as doing too much to support Ukraine compared with when Gallup began asking this question in August 2022. Democrats are at 14 percent.

[2] https://quincyinst.org/2024/02/16/new-poll-more-than-two-thirds-of-americans-support-urgent-u-s-diplomacy-to-end-ukraine-war/

[3] https://news.gallup.com/poll/1675/most-important-problem.aspx

Mark Schniepp
April 2024

The U.S. Economy             

Inflation has receded meaningfully in the U.S. without the corresponding increase in joblessness historically observed when restrictive policy is needed to extinguish inflation. The progress on inflation over the last year has led policymakers within the Federal Reserve to become more upbeat that their interest rate tightening has worked, and the target of 2.0 percent will be met this year.

Furthermore however, the urgency to cut interest rates this year—up to 3 cuts proclaimed by the Fed last December—is unlikely in view of recent reports of higher-than-expected inflation.

The fully anticipated recession of 2023 never manifested, and the Fed and economists in general are now more upbeat about a soft landing than they were last fall.  The “soft landing” refers to the continuous growth of the economy—with no recession—despite sharp interest rate hikes over the last 24 months.

Incoming data for the nation have generally been positive. The key reports indicate that consumers are feeling more optimistic about this year’s economy, homebuilding jumped higher in February, and homebuilders are becoming more optimistic about sales this year. Stock market prices are at record highs, industrial production ticked higher in February, and the index of leading indicators also moved higher in February for the first time since February 2022.

The labor market remains surprisingly strong evidenced by a low 3.8 percent unemployment rate, low numbers of unemployment insurance claim filings, historically high levels of job openings, and general wage increases. The latter threatens to stall progress on inflation this year if the rate of unemployment continues to remain under 4.0 percent, which it has for the last 26 consecutive months.

We believe that the election year combined with not-so-consistent progress on lowering overall headline inflation will not necessarily induce further rate hikes, but will postpone any rate cuts during much of 2024.

A meaningful part of the inflation problem rests with the housing component of the local CPI.  The improvement in housing inflation has been only marginal, and the increase in housing prices and rents generally eclipsed headline inflation through much of 2023.

The Housing Market                              

There remains a strong disincentive for homeowners to sell because they have locked in low mortgage rates on the homes they live in now.

With little supply in the market or waiting on the sidelines, home prices are rising again, and moved nearly 6 percent higher in February 2024 than a year ago. In California, because the paltry inventory of for-sale homes is so much more severe, prices are rising in all major metro markets of the state.

The forecast for inflation is for slower improvement in 2024, with more progress occurring in 2025.

The UCLA Anderson GDP forecast for 2024 was revised upward from 2.1 percent to 2.5 percent. Subsequently, UCLA predicts 2.5 percent growth for 2025 and 2026, and lower rates of unemployment than previously forecast back in December.

The California Economy              

Labor markets have been strong since the economic recovery began after the pandemic. Total jobs increased by 5.6 percent in 2022, 0.7 percent in 2023, and 1.5 percent growth is expected in 2024. The fact that 2023 is lower is more a function of running out of workers than an absence of jobs.

The slowdown in job creation suggests that out-migration and a reliance on hard-hit industries including technology and information are responsible factors.  Population in California has been in decline now since 2019, and this has negatively impacted the growth of the labor force, defined as people wanting to work in California.

Recent revisions in the employment data by the State show that California struggled with job creation from late 2022 through May of 2023, the period when layoffs within the tech and retail sectors were the most prolific. Job creation now appears to have stabilized, averaging 28,000 new jobs filled per month.

In the Southern California region, the growth of employment over the last 18 months has been similar across counties.  Riverside, Ventura, and Orange Counties have all now converged at 1.5 percent year over year growth in February 2024.

Construction employment in California reached a record high in 2023 due to the volume of new construction projects—both residential and non-residential—continues to expand.

Except for last year—2022—the total of new housing starts in 2023 was the highest volume since 2006. Expansions in Southern California, Sacramento Valley and the Central Valley led the state in homebuilding.

California’s seaports are now returning to normal again. International exports are no longer in decline. Cargo volumes are recovering at the principal ports in the state—Los Angeles, Long Beach, and Oakland—where the dockworker’s strike interrupted significant container activity for approximate 14 months. The labor dispute ended in August 2023.

But the slowdown in China, Germany, and elsewhere in the Pacific suggests that a complete rebound to 2021 or even 2020 levels of cargo is still a year or more away.

Nevertheless, with higher volumes of goods now arriving into California’s west coast ports, the growing need for warehouse and distribution space, along with conveyance systems will increase moderately in 2024, accelerating in 2025.

The 2024 Outlook for California                           

The expectation of California economic growth exceeding the U.S. remains probable this year, because of

• The positive outlook for technology, especially AI development in the Bay Area
• More venture capital investment coming into San Francisco and Los Angeles
• The potential for expanded trade flows due to East Coast Port labor disputes and bottlenecks at the Panama Canal
• Positive homebuilder sentiment and continued homebuilding exceeding normal levels over the last 10 years
• The return of production in the TV, Movie and Sound Recording industries.

Real incomes are expected to rise in 2024, due to the containment of inflation. Consumer spending is forecast to slow but still contribute positively to the growth of gross state product over the year.

The unemployment rate will rise as open job positions fill and more workers are expected to enter the labor force, especially from the record college senior graduating class this June.

Mark Schniepp
March 2024

The Fed Controls the Federal Funds Rate

The federal funds rate has been at the 5.25% to 5.50% range since July 2023, the highest level since 2007. This is the interest rate that banks can charge each other and it’s the principal monetary policy instrument that the Fed controls.

After raising the funds rate 11 times in 15 months, the Fed forecasted as recent as December 2023 that it would make quarter point cuts—up to 3—by the end of this year, lowering the benchmark rate to 4.6 percent, or in a direction that has a more neutral impact on the economy.

Lowering the federal funds rate will also push down shorter term treasury bill and bond rates but not necessarily longer term bond yields like the 10 year which directly influences mortgage rates and vehicle loan rates.  However the actual act of cutting rates will likely rally the stock and bond markets, the latter which will push long bond rates lower.

Can We Expect Cuts Soon ?

The Fed indicated it needs to see more ”positive data” before pulling the interest rate lever. There are seven “Open Market Committee” opportunities for the Fed to cut rates this year, with the first one coming up this month on March 20.

What I believe this year is that the data won’t demonstrate compelling enough news for the  Fed to cut rates anytime soon, and (1) at least not until mid-year and (2) probably not until the end of the year. But whatever I think, it’s not going to be a factor.

A justification for the lowering of rates now is the progress made on the personal consumption and the headline inflation front. Even the core rate has improved considerably and it receives no help from lower prices for energy which have been in a general decline over the last year. Moreover, the Fed preferred personal consumption expenditure price deflator has now declined to 2.0 percent which is line with the Fed’s target.

And don’t forget it’s an election year so despite data that don’t comply, there will be pressure put on the Fed to lower rates to help the economy and stock market look good under the current administration.

In January, the Fed indicated a rate cut or more this year was still possible but said that cuts were not imminent.  This is because incoming data on the economy directly influences their decisions about monetary policy: quantitative easing and interest rate moves.

Incoming Data

GDP growth is still pretty expansive, running at 3.2 percent last quarter and currently estimated by GDPNOW at 2.2 percent for the current quarter of 2024.

That kind of growth really doesn’t need a boost from a drop in rates. If GDP growth slows in March and through the Spring, then the likelihood of a rate cut rises.  But with better economic conditions than expected being reported daily, growth is not slowing down.

Headline inflation has fallen to 3.2 percent. This is a big improvement over a year ago but progress in lowering consumer price inflation has stalled. Headline inflation has moved little since July 2023.  Food prices rose sharply between December and January, the highest monthly rate of increase in a year. Core inflation is still too high at 3.9 percent. We seem to be stuck in an inflation rut.

Unless progress on inflation resumes, and core inflation falls faster, the Fed might be reluctant to touch rates.  However, since their goal is a 2.0 percent inflation rate, which has now been met by their preferred Personal Consumption Expenditure Price Deflator, they are now becoming satisfied that enough progress on the inflation front has been made.  I’m not convinced of that yet. We need to see what happens in February and March.

There is wage inflation that is now exceeding general price inflation, a condition that adds upward pressure on the 2 percent inflation target.  But with rising productivity of workers, higher wages are in line with higher levels of output and add that results in less pressure on the price level. Furthermore, the share of labor in the economy has declined to levels lower than at any time over the last 20 years. This means that firms have higher profits than normal and as the labor share climbs back, the profit rate will return to normal as wages climb. Under this condition. Inflation pressures subside.

There is also the federal deficit which has soared to $34.5 trillion of which $1 trillion per year represents interest payments. This type of spending by Congress—now with sharply rising debt financing adding to the burden—is an automatic spending boost on the economy. How the Fed weighs this factor is unknown, and they will likely ignore it in an election year.

The evidence is mixed on what the Fed will do and when. I believe data needs to be more convincing; otherwise, we face a rapid increase in private spending to go along with Federal spending. That combination leads to growing pressures on the inflation rate.

Mark Schniepp
February 2024

Yes, we’ve started 2024 being happier than at any time during 2023.

The sentiment and confidence indexes that measure how consumers feel about the economy both today and in 6 months hence have improved in recent months.

The latest measure shows consumer feelings about the economy at a 2 year high.

The economy in the survey is defined by inflation, job prospects, and interest rates. The improvement in January was the third straight month of upward movement and the highest since December 2021 when the pandemic was generally abating.

January’s increase in consumer confidence likely reflected slower inflation, anticipation of lower interest rates ahead, and generally favorable employment conditions. The gain in sentiment was largest for people age 55 and over, but improved for all age groups.

Meanwhile expectations for inflation fell to a three year low and expectations of a recession this year also declined. Inflation expectations dropped to under 3.0 percent in January, which is down sharply from 4.5 percent in November.

The personal consumption expenditures price index, the preferred measure of inflation by the Federal Reserve, rose 2 percent for the month of December, following a 0.3 percent increase in October and a 0.8 decline in November. A year ago, this inflation measure was at 6.7 percent.

Conditions on the inflation front are clearly improving. These conditions, together with an all time high in the stock market, a tight labor market, and falling interest rates, are all responsible for the rising moods of consumers in early 2024.

The January jobs report was strong: employers hired about twice the number of people than economists had expected. The unemployment rate is also now at 3.7 percent —- still extremely low by anyone’s measure.

The strong economic reports in November, December and now January, have led to rising estimates of growth for the end of 2023 and the beginning of 2024.

The Con to Strong Growth

It was looking like the Fed was growing eager to initiate interest rate cuts this year in view of the progress on inflation. But wage inflation is still running at a 4.5 percent clip and that is too high the target rate—2.0 percent—-to be reached, probably not until the 2^nd half of 2024.

Postpone therefore, the housing market rally in 2024 because it’s unlikely that mortgage rates are going to retreat much anytime soon.

Rigged Improvement through 2024?

The sentiment and confidence indices had been at levels consistent with recession through much of 2023, but with nothing but improvement in recent months, those signals are now retreating.

The vulnerability of the economy that pervaded much of last year is no longer evident now. And if the inflation reports continue to improve, the Fed just may be persuaded to begin cutting rates by mid-year.

Remember, 2024 is an election year so policymakers may make decisions that try to influence voters and this may be more likely as the year progresses into November. The Biden Administration would benefit from the semblance of a strengthening economy.