Inflation, Unemployment, & Construction: An Overview
As it stands currently, the American economy sits squarely in a myriad of contradictions. Inflation is rampant (but cooling in some sectors), unemployment remains near fifty-year lows, and construction is remarkably holding fast, relative to the current economic climate. It remains incredibly difficult to forecast the future as we contend with geopolitical and financial uncertainty, while simultaneously navigating the challenges that remain from the COVID-19 pandemic. Dr. Cammarosano, an economist, author, and professor who served on JFK’s budget committee had a mantra he constantly repeated: if the construction industry is doing well, America is doing well. Admittedly, his advice predated the development and subsequent dominance of the tech sector in the US economy, but his barometer of America’s growth and stability has stood the test of time even as other industries have come to dominate their portion of the GDP.
In the most recent Fed meeting on December 14, Jerome Powell used the phrase “structural labor shortage” and indicated the American labor force is nearly 4 million bodies short – which he stated was a conservative estimate. Indeed, the global economy as a whole is currently experiencing a labor shortage. To paraphrase Zoltan Pozsar, Credit Suisse’s leading authority on short term interest rates and market structure: “no central bank can materialize human beings.” This duality presents a significant challenge – low unemployment does increase the possibility for a “soft landing.” However, the high demand for workers who do not exist can force companies to increase wages, which usually results in passing those costs down to their customers in the form of higher prices, which results in workers demanding pay raises, which results in… more inflation. Lee Kennedy, President and CEO of Lee Kennedy Company - a full service construction firm providing feasibility analysis, pre-construction and construction management, provided valuable insight into their labor and employment conditions. He indicated that while they are seeing an increase in worker availability – they are still facing difficulty in finding both management and professional staff, as well as skilled tradespeople who left the industry during COVID and did not return.
The most simplistic response to this dilemma: continue to raise the rates, with hopes that companies will have to cut back on expansionist policies and hiring expenditures. Unfortunately, these are cold and imprecise tools. It is essentially sacrificing the stability and future of thousands of hard-working Americans for the “greater good,” in this case, the health of the U.S., and by extension, the global economy. Their latest projections indicate a target unemployment of 4.6% - an increase of 1.1% from where it currently stands at 3.5%. With the benefit of hindsight, we know that throughout American history, a trend has emerged: when the unemployment rate rises by .5%, it ultimately rises by more than 2%. This potential increase disrupts the chance for a soft landing.
The good news: inflation is showing signs of moderation. As of the past 5 months, MoM inflation prints are: July 0.0%, August 0.1%, September .4%, October .4%, November .1%. That translates to 1% inflation over that period, and extrapolated over the course of a year, brings us to 2.5% - just a shade over the Fed’s target inflation rate of 2%. Shipping container costs – a key factor in determining prices as they relate to the global supply chain – have dropped precipitously. The Asia to US West Coast supply line has fallen nearly 90% to $1,426/FEU, down from highs of almost $20,000 at this same time last year, and prices for shipping containers for other trade routes have dropped just as significantly. Lee Kennedy offered additional commentary into pricing and lead time dynamics – most notably, steel mill products are starting to decrease and level off. As the supply chain normalizes, many raw material deliveries are flowing smoothly, with some exceptions. Their firm estimates any further price increases in 2023 will be a function of inflation, as opposed to market conditions.
The construction industry may bring us hope if Dr. Cammarosano’s thesis holds true. Headlines are dominated by development projects being put on hold, increased lending costs, and more restrictive conditions – all of which portend a negative future. However, to revisit the theme of contradictions that this economy finds itself in, the DMI (Dodge Momentum Index) has increased 3.8% in November MoM, continuing its steady ascent. The DMI is a monthly measure of the initial report for nonresidential building projects in planning in the U.S., shown to lead construction spending for nonresidential buildings by a full year. “A total of 21 projects with a value of $100 million or more entered planning in November. Commercial planning experienced a healthy increase in hotel and data center projects and modest growth in stores and office projects. The institutional component remained net-positive alongside a robust increase in planning projects for government administrative buildings and religious facilities. On a year-over-year basis, the DMI was 25% higher than in November 2021, the commercial component was up 28%, and institutional planning was 21% higher.” More good news: the commercial construction backlog in the U.S. reached its highest level in three years. Construction of hospitals and healthcare facilities lead the way in the backlog, as well as large industrial projects taking advantage of new federal incentives, namely chip plants and projects tied to the EV and lithium-ion battery industries. Monthly construction spending during October 2022 totaled $1.8 billion, slightly below estimates, but is almost 10% above the October 2021 estimate. Locally, Lee Kennedy is seeing similar trends as well – they currently have a strong backlog in the Boston area market with growth in the number of starts in late 2023 and 2024. “Preconstruction currently is extremely busy, with a combination of commercial and academic projects. We are getting back to our pre-COVID volume.”
There are no clear solutions to the current predicament the world finds itself in. Ask ten different economists for their predictions, and you are likely to receive twelve different responses. In a world of uncertainties, contradictions, and “never-before-seen” events happening monthly, to offer a definite forecast would be foolhardy. If the thesis on construction proves to be true, and the industry can maintain its growth and stability, it could provide us with the critical support required to navigate through these turbulent seas and into a future of smooth sailing. There exists a famous quote, often attributed as a Chinese curse: “May you live in interesting times.” There has been nothing dull about these past few years, and we can expect that to continue for the foreseeable future.
Author: Mark Fallon, Director of Research & Strategy
[1] https://www.federalreserve.gov/mediacenter/files/FOMCpresconf20221214.pdf
[2] Grant, James. “‘Volcker Was Lucky.’” Grant's Interest Rate Observer, 28 Oct. 2022, https://www.grantspub.com/index.cfm
[3] https://www.cnbc.com/2022/12/07/freight-rates-from-china-to-west-coast-down-90percent-as-trade-falls-rapidly.html
[4] https://www.construction.com/news/November-2022-Starts
[5] https://www.costar.com/article/1282704680/commercial-construction-backlog-hits-longest-wait-period-in-more-than-three-years
