Why Rates Will Fall

The Real Estate Espresso Podcast

Why Rates Will Fall

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Welcome to The Real Estate Espresso Podcast, your morning shot of what’s new in the world of real estate investing. I’m your host, Victor Menasce.

On today’s show, we’re talking about the weakness in the labor market, but first, I’d like to introduce our new sponsor. These are the folks at the Cost Segregation Guys. Cost segregation is one of the powerful tools that you can use to take advantage of bonus depreciation. This is where you depreciate a capital asset, not over 27 or 39 years or some other really long time period, but you get to expense a capital investment entirely in the year in which it’s made. The tax implications of that are massive.

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On today’s show, we’re talking about weakness in the labor market and why the headline unemployment rate is telling a much more optimistic story than what many people are feeling on the ground. Moreover, the surge in energy prices is causing some people to sound the inflation alarm bell, which has led to a surge in yields on U.S. treasuries. But this is not telling the whole story, and frankly, I believe we will see a reversal in interest rates soon.

Yes, the Fed has signaled they intend to keep rates unchanged at the next meeting, but the Fed does not set the market rates. One of the market experts I follow is Danielle DiMartino Booth. She was at the Federal Reserve Bank of Dallas for 10 years reporting to Bank President Fisher. In a recent interview with David Lin, Danielle made the case that the labor market is weaker than the official numbers suggest, and the Fed is missing the employment side of its mandate.

I think that deserves a closer look, because whether you’re investing in real estate, running a business, or simply trying to understand the economy, labor is one of the most important signals to watch.

So let’s start with the headline number. In March, the official unemployment rate came in at 4.3%, with 7.2 million people unemployed. At first glance, that sounds pretty healthy. Historically, 4.3% is not a high number. But the problem is that unemployment, by definition, only counts people who are actively looking for work. If someone wants a job but has stopped searching, they are no longer counted as unemployed. This is one of the biggest reasons the headline rate can stay low even if the labor market is getting weaker.

The same March report showed the labor force participation rate at 61.9%. That’s been trending downward for a while. The employment-population ratio is at 59.2%. It also showed 6 million people not in the labor force who currently want a job. On top of that, the number of people marginally attached to the labor force rose to 1.9 million, including 1 million discouraged workers who believe no jobs are available for them. Those people are very real, but they’re largely invisible in the headline unemployment rate.

So when people ask, why is unemployment so low, the answer is not that the market is strong. In fact, part of the answer should be that the labor supply has been shrinking. Some people are retiring. Some have become discouraged. Some are staying out of the labor force for family or health reasons. And some of the recent decline of participation is also tied to slower labor force growth and lower immigration. A smaller labor force means fewer people are counted as unemployed, even if job creation is weak.

This is where the labor market starts to look a lot softer beneath the surface. The March report showed 170,000 jobs added, which sounds decent. But in the month of March, there were also 110,000 job cuts announced, which will not appear in the unemployment numbers for several months until their severance.

We’ve had a record 13 months of consecutive downward revisions to the employment numbers. The previous record of 11 months of downward revisions was set during the great financial crisis in the wake of 2008. February’s numbers were revised down to a loss of 133,000 jobs, and the prior year payroll growth was effectively flat on net.

More importantly, the February JOLTS report showed that job openings fell, and hiring is falling to the lowest level since March of 2020, which was the start of the pandemic. Layoffs remain low, but hiring also is very weak. This is not a booming labor market. It’s a frozen labor market.

Jerome Powell, at a recent talk that he gave at Harvard, described it as a zero employment growth equilibrium, and he acknowledged that it has downside risk.

So now we need to deal with the second question. Why are so few people collecting unemployment benefits? The Department of Labor’s latest weekly data showed about 2 million people collecting insured unemployment in state programs, while the Bureau of Labor Statistics counted 7.2 million people unemployed in March. Whichever metric you use, it still works out to about 28 to 29% of all unemployed people receiving benefits.

Now, that gap is not new. The Labor Department’s own chart book notes that recipient rates were around 50% back in the 1950s, 40% in the 60s and 70s, and then they fell sharply in the 1980s as the states tightened their requirements. There’s quite a few reasons for that.

First, unemployment insurance only covers eligible workers. In general, you need to have lost your job through no fault of your own and meet your state’s local work and wage requirements. That automatically excludes a lot of people. Self-employment income is generally not covered by regular unemployment insurance, so a freelancer, an independent contractor, a gig worker could be out of work and still not qualify for benefits.

Second, many people exhaust their benefits before they find any job, especially in a weak market. The March jobs report showed 1.8 million people unemployed for 27 weeks or more. That represents about a quarter of all unemployed. Once someone’s exhausted their benefits, they do remain unemployed, but they disappear from the continued claims.

Back in the 70s and 80s, unemployment benefits covered about 70% of people’s salary. Today, it’s less than a third. So a lot of people just never even apply, or some are denied, or they experience delays. There’s not a lot of benefit for them to applying for these benefits because they don’t come close to providing enough income for people to sustain their families. They’d sooner go work in the gig economy, driving for Uber or Lyft, because at least there they’ll make more money. It’s still not enough, but they’ll make more money.

And even Jerome Powell, at the most recent talk that he gave at Harvard University, acknowledged that their tools don’t deal well with the supply side of the equation. Their economic forecasting tools tend to be focused primarily on the demand side. So when asked about the oil shock on the economy, he turned the question around and asked the people in the audience what they thought the answer was.

Last week, we did talk about the deflationary impact of the oil price shock. The weakness in the labor market is going to be only amplified by that supply-side constraint. And as a result, we’re going to see tremendous weakness in the labor market. As that becomes visible, we are going to start to see the market bidding down interest rates. And eventually, the Federal Reserve will follow.

As you think about that, have an awesome rest of your day. Go make some great things happen. We’ll talk again tomorrow.

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