Market Monitor: The U.S. Labor Market’s Impact on Fed Policy

As we step into 2024, what do the latest U.S. labor market numbers mean for the Federal Reserve’s monetary policy? The Bureau of Labor Statistics (BLS) is our go-to source for understanding the job market’s dynamics, and its reports inform the Fed’s strategy to control inflation.

There is a bit of a puzzle in recent employment data. The BLS’ December Establishment Survey showed an encouraging increase of 216,000 new jobs, surpassing forecasted figures. However, its Household Survey, which encompasses a broader range of job categories and is more responsive to immediate economic shifts, reported a significant decline in employment, the largest since April 2020.

Turning our attention to wages, average hourly earnings increased 0.4% in December, culminating in a solid 4.1% annual increase. While this wage growth bodes well for employees, with paychecks outpacing inflation, it may pose a concern for the Federal Reserve. Higher wages mean consumers have more money to spend, which could keep inflationary fires burning. The Fed has previously commented that a 3% annual increase in average hourly earnings is consistent with its 2% inflation target.

As of November, the Atlanta Fed Wage Growth Tracker registered 5.2%, which means, on average, the hourly wage has grown by about 5.2% compared with the previous year. Although wages are still growing, the rate of growth slowed in late summer 2023 and then plateaued from September to November.

December saw declines in both the labor force participation rate and the employment-to-population ratio. While the unemployment rate may appear stable at 3.7% (expectations were for a tick up to 3.8%) and there have been positive changes in real wages, that’s only a partial picture: Unemployment remained steady because declines in the labor force almost matched the decline in household employment, with decreases of 676,000 and 683,000, respectively. A decline in labor force participation could bolster inflation, as fewer people in the workforce usually pushes up wages.

The Establishment Survey notes that 216,000 jobs were created in December, exceeding economists’ predictions of a 170,000 gain and the best report since September 2023. However, it’s important to note that downward revisions to previous months’ estimates, prevalent throughout 2023, mirrors trends observed prior to the Great Financial Crisis. That’s a potential red flag that we will be keeping an eye on.

The Job Openings and Labor Turnover Survey, or JOLTS report, lags a month behind the jobs report but provides additional details about the labor market, such as the number of resignations, or “quit rate.” The quit rate is typically a sign of a strong labor market, as people usually quit their jobs when they are confident in finding new employment or have another job lined up. That rate trended downward in 2023 (see chart); November’s was the lowest rate since September 2020.

Total Non-Farm Quit Rate, 2018-23

Source: U.S. Bureau of Labor Statistics

The Small Business Optimism Index, a key economic indicator monitored by the NFIB Research Foundation, dipped by 0.1 point in November, settling at 90.6—the 23rd consecutive month that the index has fallen below its 50-year average of 98. According to the report, 23% of owners surveyed reported that inflation was their single most important problem in operating their businesses, unchanged from October but 10 points lower than this time last year. The index is considered a leading indicator of economic health, as small businesses represent a sizable portion of the economy.

After its December meeting, Fed officials hinted at three rate cuts in 2024. But these mixed signals from the job report might cause the Fed to rethink its game plan. Prior to the release of that report, the futures market was betting heavily that the Fed would lower rates at its March 20 meeting, followed by another four or five cuts throughout the year. While that forecast has tempered a bit, the market is still expressing optimism for further rate relief.

For those of us in real estate, particularly multifamily properties, these economic indicators and how they might influence Fed decision making are consequential. The 10-year benchmark risk-free rate, a key factor in cap rates and borrowing costs, has recently dipped from 5.00% to just over 4%, easing concerns about valuation impairments. As we embark on the new year, it is important to understand these economic indicators’ significance in forecasting future market trends. Wage growth, employment data, and the Fed’s decisions on interest rates will significantly shape the multifamily real estate market in 2024.

Balancing the risks of a recession and an inflationary environment in the multifamily real estate market requires understanding economic indicators like employment data, wage growth and the quit rate. Inflation can benefit multifamily property cash flows through increased rents but also raise operational costs and interest rates. During a recession, demand for rental housing may decrease, requiring competitive pricing or enhanced amenities to maintain occupancy rates. Investors should adopt a diversified investment approach, prepare for interest rate fluctuations, monitor policy decisions and maintain a long-term perspective while moderately leveraging and keeping adequate cash reserves.