A “New Era” of Unemployment is Coming

Dave:
Hey everyone. Welcome to On The Market. I’m your host, Dave Meyer. And today, I’m going to be joined by an incredible guest, Joe Brusuelas, who is the principal and chief economist for RSM US. And he is going to be talking about a topic that isn’t immediately obviously relevant to real estate investors, but it’s super important and that is the labor market.
And if you’ve been following the news, you’ve probably seen that despite tech layoffs that have really made a lot of splashy headlines in January, which is the last data we have for the job market, as of this recording, there was an unexpectedly large number of jobs added over 500,000. And this obviously impacts every one of us because we, most of us want jobs and have jobs and whether or not there are layoffs and how the economy is growing is super important.
But the labor market is also really fundamental to what the Federal Reserve is doing right now. And obviously as real estate investors, we care a lot about what is going on with the Fed and what they’re doing with interest rates.
And just before we have Joe on, I just want to re-explain something we’ve talked about a few times on the show, but I just want to make clear, is that in the Federal Reserve, their mandate from Congress is twofold. They have two jobs. The first on one hand is to, is they call it price stability, which is basically fight inflation, right? Don’t let inflation get out of control. You want stable prices. Their target right now is 2% growth per year. That’s what the Federal Reserve targets.
On the other hand, they also want to ensure maximum employment. They want as many people working as possible. And these are their two jobs, and sometimes they work really well together. For most since the Great Recession until the pandemic, they were doing really good. We had relatively low unemployment, we had low inflation. That was great for the Federal Reserve. It made their job relatively easy.
Now, over the last couple of years, it’s gotten a lot harder because we have two things going on. We have inflation going up so rapidly, that many economists, and we’ll hear Joe’s opinion about this in just a minute. Many economists feel that we need less employment to control inflation. And I’m not saying that’s what I want. I don’t want anyone to lose their job, but a lot of economists believe that the key to fighting inflation is to increase the unemployment rate.
The thought here is that, if you increase the unemployment rate, fewer people have less spending power, they spend less money. That puts less, that puts downward pressure on demand and prices basically. So a lot of people think that, and a lot of the Fed’s intention with raising interest rates is to create what they call, quote, unquote, they call it, they have this word for it like, “slack in the labor market” quote, unquote, basically means more people losing their jobs.
So the Fed is basically hoping, it’s not what they want, but they’re basically saying that they are so worried that about inflation being bad, that they’re willing to sacrifice their other mandate. They’re willing to increase unemployment in that effort.
The problem is that nearly a year after their first interest rate hike, it’s not working. The unemployment rate is extremely low. And frankly, I don’t fully understand why. Which is why we invited Joe onto the show.
Joe has been an economist for 20 years. He’s got a lot of really interesting opinions about what’s going on in the labor market, and obviously Joe doesn’t know for sure, but he’s an expert on this topic and studies it a lot. And what he talks about will have a really big implication on what happens with interest rates and the housing market, obviously follow those interest rates decisions.
So I found this super interesting and gave me a lot to think about. I hope you enjoy it. So we’re going to take a quick break, but then bring on Joe Brusuelas, the chief economist and principal for RSM US.
Joe Brusuelas, welcome to On The Market. Thanks for being here.

Joe:
No problem. Thanks for having me.

Dave:
So we’re excited to have you on because we can’t make sense of the labor market. So we’re hoping you can help us understand what is going on. So can you give us a high level summary of how you see the labor market right now?

Joe:
Sure. A couple of things. The first is between 1945 and 2015, the labor market grew about 1% per annum. Given the shocks we went through in the great financial crisis, all of the things that followed, plus the shocks in the pandemic, the labor force is now barely growing.
We’re talking one to two tenths of a percent per year. We’re simply not producing enough native born replacement workers. And so we’ve reached a situation where the labor market is going to remain historically tight for the foreseeable future. Let me put that in a context for you.
So we only need to produce about 65,000 new jobs a month to meet demand. That’s very, very low. Right now, I think even notwithstanding the, “517,000 jobs” quote, unquote, that were created in January, the underlying rate of job creation is about 200,000 a month. So we just really have a very tight labor market.
Now, for many of your listeners, they’re probably thinking, “What’s this guy talking about? All I read are how all these people are getting laid off. How intentions of hiring or slowing.” Well, when you take a look at the underlying condition of the labor market, the median duration of unemployment’s eight weeks.
So if I see 250,000 or so, people have been laid off in tech, why aren’t they showing up? Well, not only are we not producing enough people, the people we are producing don’t have the requisite skill sets that are necessary to meet where the demand is.
So those people who’ve lost their jobs in tech, they have two choices. They can trade down, take a little less money and stay in tech, or they can go work in the other portions of the real economy where those skillsets are incredibly in demand and they’re going to find very good employment at very good wages, triple to quadruple what the average American probably makes. So that’s how you sort of square the circle. That labor market is tight. It’s going to remain tight.
Here’s the important thing. Wages are not going to increase at one and a half to 2% per year. We grew accustomed to between 2000 and 2020, they’re probably going to be in that three to 4% range. And that’s good for workers, but that’ll be a challenge for businesses who are now adjusting to this historically tight labor market.

Dave:
And so it seems like this problem has become more acute recently, when if the source of the issues you say is sort of a lack of native born Americans. Why is it sort of all coming to a head right now?

Joe:
Well, in 2017, we really began to tighten immigration policy on top of the tightening that occurred really since 9/11. And so the typical solution in my lifetime, when labor’s gotten tight is we go ahead and we begin importing workers, through either the H-1B visa or we increase legal immigration, or we just basically de facto legalize the illegal workers.
So when you tighten up on all those things you get in the situation that we’re in. That’s why over the last several years, labor market has become somewhat tight.

Dave:
So when we look at the unemployment rate in the US, I often get a lot of questions about this. I’m hoping you can clear it up for us.
How is it calculated and does it factor for people leaving the labor market and people having two jobs or how, can you just explain to us how it works?

Joe:
So the monthly employment report is two separate surveys. The establishment and the household. The unemployment rate is derived from the household survey. It does account for people who exit the market, who exit the market permanently. And it attempts to see who is out of the market but looking for work. And then it does population adjust the number. So we get a pretty good sense of who’s working and who’s not. Now, is it perfect? It is not. But it’s the best we have for now.
I think the important thing to understand is as wages have increased over the past three years following the shocks of the pandemic, we’ve drawn people back in to the point where we’ve got more people working than we ever have just on a nominal basis, even if the employment population ratio remains basically 60%.
So we are at a situation where the people who are now coming back to the labor market, their skillsets of atrophy, their professional networks are almost nonexistent, and they often need vast and deep retraining to make sense. And so this is adding costs onto the firms who now are really having a difficult time finding qualified workers. You can find workers, but can you find qualified workers that you don’t have to train or retrain at an increased cost to your operation?

Dave:
Got it. Thank you. So most people assume, I’m one of these people, that as interest rates have risen, that we would see larger percentage of firms laying off workers and that we would start to see the unemployment rate tick up, but we’re seeing it move in the other direction. Can you help us make sense of that?

Joe:
Okay. Well, one is again, we just, it’s what I outlined earlier. The population or the increase in the population of the labor force just isn’t growing the way it did before, and that’s created an imbalance. Okay?
Second, economists like myself do a terrible job at explaining the long invariable lags on the real economy from interest rate hikes. Now, historically it would take one to two years. Now, it’s starting to show up in dribs and drabs, we can see it.

Dave:
And is that a year, sorry to cut you off, but is that a year to 24 months from the first hike? Because we’re not even at a year for the first hike.

Joe:
Yeah. From the first hike in each successive hikes.

Dave:
So this could be years in the future.

Joe:
Yeah. We had six supersize hikes in the middle of last year. They’re just barely beginning to show up. And second, we’ve had some labor hoarding, especially in tech and especially in real estate construction. And it makes sense in tech, it’s because we don’t have people with those scientific math and engineering skills, right?
In labor or in the construction industry, it’s because we cut off the immigration valve. So it’s very difficult to find anybody to work. I built a home in Austin, Texas last year, early over the past two years. It took a long time to do that-

Dave:
That must have been a challenge.

Joe:
It was very difficult to find people to do the work, much less the supply chain issues where I had to put all kinds of things that I wouldn’t normally put in the house because that’s what was available.
And that added a secondary layer of cost once things begun to get available, but those are first world problems. That’s not really something we got to concern ourselves with in the economy. So the combination of labor hoarding and immigration policy has created a situation of constraints in the overall economy.

Dave:
Could you just explain to everyone what labor hoarding means?

Joe:
Sure. What it means is that detect economy and the life sciences economy runs on a separate and distinct logic compared to the one that you live in. They are so flush with cash that when they find employees, they’d rather keep them in order to meet expectations, expected increases in demand, even if that means they don’t have enough to do with them.

Dave:
Wow.

Joe:
So that’s why in 2022, you saw tech in the really last six to eight months of the year, released some of their workers back into the workforce. It was about a quarter of a million, a little bit less, but those people aren’t showing up on the unemployment roles because hey, if you can hire them, you probably should because they can do some incredible things that your workforce probably can’t.

Dave:
That’s super interesting. So the cost of eventually replacing these people is higher than holding onto them through a recession.

Joe:
You just nailed it. The cost of letting them go is so expensive. You’re better off keeping them, and we’re beginning to hear that more and more inside the real economy, outside the supercharged areas of life sciences tech, obviously we see what’s going on in artificial intelligence. And so right now it’s very difficult to let somebody go. You don’t want to because it’s going to cost more to replace them.

Dave:
That’s fascinating. But it sort of makes sense given this sort of challenge that people have had hiring over the last few years. There’s definitely some, I’m sure, some reticence to let people go because they’ve seen just how difficult it can be to rehire.

Joe:
The last time we saw this was at the end of the 1990s during the dot-com era. I remember going to the grocery store and the unemployment rate was in the mid-threes, and it was difficult to hire people.
And I remember the person who back then who would’ve bagged your groceries, was basically been out of workforce for a good 10 to 15 years and looked at me like, “Am I supposed to be doing this?” And I’m like, “Well, yeah, this is I think what you’d be doing.” And they didn’t know how, right?
They were mixing up things, they were putting the eggs on top, that sort of thing. It’s been a long time since we’ve been in a situation where labor’s just this tight. And it’s natural that A, you’re asking these questions and B, the public is going a little bit restless because the explanations we’re providing don’t match up with their historical experience, and we just haven’t seen this in over a generation.

Dave:
So given that you’re saying there’s this lag of 12 to 24 months from each successive rate hike, do you expect unemployment to go up over the course of the year?

Joe:
Well, historically it was. I think it’s a bit sooner for these reasons. One is transparency out of the central bank. We know what they’re doing in almost real time. B, large scale asset purchases are what journalists call quantitative easing. The use of the balance sheet really impacts the real economy in very different ways because the Fed didn’t do that part of the great financial crisis.
And then three, the structural changes in the market, mean financial markets are much more important, vis-a-vis the banks. So we get a much shorter time span. So it is going to start to show up. Okay, where will it show up? Here we go. Here’s the thing you can take with you, Dave, and hang your hat on.
In the housing market, there are currently through the end of January, 1.7 million homes under construction, and that’s just about what we need to, because we got a big shortage in overall, the overall stock of housing. We need a lot more housing and we need it quickly.
But housing starts and housing permits, imply a run rate of 1.3 million at an average annualized base pace. So as those homes get completed and we decelerate down to that 1.3 million, you are going to see a lot of men, 25 to 54 discharged and looking for work in the open market that will make the unemployment rate go up.
Now, I want to say this, and this is really important. The economy will slow, but it’s not yet certain that we’re going to go into recession. If we do go into recession, it’s going to be modest and it will not have unemployment rates, that you would normally associate with the recession.
Now you’re a younger guy, Dave. You remember two recessions, the pandemic where it went to 14% and the great financial crisis where it went to 10%. We’re not going to get anywhere near that. We’re talking 5%, that would’ve been considered full employment 20 or 40 years ago.

Dave:
Interesting.

Joe:
So again, to circle back, those demographic changes I have now come home, it’s altering our own understanding of how the economy works and what constitutes full employment.
We have a 3.4% unemployment rate. My estimation of full employment is 4.4%. When I was in college, it would’ve been 6%. Indeed, times passed and things have changed and they require new policies.

Dave:
You hit on something, I want to get back to the labor market, but you hit on something about a recession and that it might be a mild one.
I think one of the common questions we have from our audience is how do you define a recession? Let’s ask an economist.

Joe:
Okay. I could tell you it’s easier to talk about what it’s not. It is not two consecutive quarters of negative growth. We define recession in the United States economy very differently. It’s a broad and synchronized decline across a number of discreet economic variables such as reemployment, retail sales, hotel, wholesale sales, industrial production. We could go into it deeper, but that essentially nails what a recession is.
And here’s what the difficulty is. If one were to look at, say, housing, I think it’s pretty honest. We’re in recession right now, even if the unemployment’s not there because residential investment declined by 26.7%, in the fourth quarter. Manufacturing is very close. It either is or soon will be. But you look at tech, you look at life sciences, you look at the broader service sector, not so much. Right?
I travel a lot as an economist, the best part of my job is I get to go around the North American and global economies. I’m not stuck in the glass skyscraper as I was for many decades. It’s made me a better person and a better economist. I get a good idea of what’s going on out there. Try going to an airport right now. Just try. It’s a difficult proposition. I mean, there’s no recession at the airport, right?

Dave:
No way.

Joe:
It’s happened.

Dave:
Oh my God. It’s crazy, yeah.

Joe:
So if we do have a recession, we’re going to have a non synchronized recession or what some might call, a rolling one.

Dave:
Okay, a rolling one. Because that makes me wonder what purpose or what use does the word or term definition of recession mean then, if it isn’t ubiquitous across the economy, should the average American really care if we’re in a, quote, unquote, “recession” or not? Or should we really just be thinking about the individual sectors of the economy that impact our individual lives?

Joe:
Okay. There’s two things here. There’s the public and then there’s investors. The public should care because we need to get that downturn, you will get an increase in unemployment and remember one person’s recession is another person’s depression. Right?
Now, if we’re talking about investors, that’s a different thing. We definitely need to be looking at the different ecosystems out there because they’re going to have different realities and the deeper you dive down to the zip code level, the different outcomes you’re going to have.
I live in Austin, Texas. My job is in New York, basically I’m all over the place. I live in the tech utopia, but this Austin’s the boom town. We don’t have enough people to fill the jobs. We don’t, I mean, the unemployment rates and the low twos, we don’t have enough homes to meet the needs of the people who live here. We don’t have enough people. So that’s going to be very different than Huntsville, Alabama.

Dave:
Right.

Joe:
Right? Or Kansas City, Missouri or Kansas City, Kansas for that matter. So it really does matter whether we’re in a recession or not. Now, before the time you and I inhabited this, the third stone from the sun, federal government said is the fiscal and monetary authorities did not respond the way they do now.
It was thought that, well, markets automatically clear, markets are perfect, and what the best thing we should do is nothing. Just let the market clear, liquidate stock, liquidate labor, liquidate everything, because that’ll get us back on the virtuous cycle.
Well, we had some problems along the way, and markets are not perfect. They don’t perfectly adjust. I know for some people those are fighting words, but that’s just the way that is these days.
And we need to be able to identify when the economy slowed down in order to use the balance sheet of both the fiscal authority and if necessary, not always the case, but if necessary, the monetary authority, the central bank, in order to stimulate the economy to get the animal spirits moving again and create the conditions for resumption and expansion of overall economic activity.

Dave:
That’s a great segue to my last question about monetary policy. Given what you said at the top of the show that a lot of this is demographic driven and that we have basically too many jobs right now for the working population.
How difficult is the Fed’s job going to be? They seem particularly concerned about wage growth, which you said would be three to 4%, and a lot of people are saying they need to, quote, unquote, “break” the labor market before they stop raising rates. So how do you see this all playing out?

Joe:
There’s a couple of things here, and this discussion works on our travels on a couple of different levels. The first thing is the Fed does need to generate additional labor slack in order to cool the economy. We were looking at the employment costs index through the end of the fourth quarter. It’s up 6.3% on a year ago basis, that’s clearly too strong, and that’s on the edge of wage-price spiral terrain. So policy needs to move in further into restrictive terrain.
That means the policy rate’s going to increase. We think three consecutive 25 basis point increases in March, in May, and in June. That’ll bring us to a potential peak of 5.5% with risk of moving higher. It’s going to depend on the evolution of the data.
Now, the problem here is that the inflation that we’re seeing is a bit different than that, which we’re going to see going forward. Most inflation we’ve seen has to do with the supply of shocks and unleashed by the pandemic, and then the policy response put in place to mitigate those shocks.
April 2020, unemployment rates at 14%. You know what these inflation problems are well worth an unemployment rate at three point a half percent as opposed to 14%. So I do the same thing over again essentially, perhaps with some small differences on the margin.
Now, as the goods inflation is turned to deflation, we’re now shifting to demand for services, hence why it’s a problem at the airport or at the mall or the grocery store, right? Because demand’s still strong. That’s where we have to deal with what’s going to be higher on employment through the middle. That’ll start in the middle of the year and increase probably through the end of next year.
Now, there are things going on with respect to the supply side of the economy that don’t have to do with monetary policy or fiscal policy that have to do with some of the broader economic and strategic tensions out there in the world. It’s very clear that at the very least we’re going to be engaging and selected to coupling from China. The G7 are clearly moving in that direction. That means, goods specifically higher priced, sophisticated goods are going to get that much more expensive and those are going to be passed along here in the United States.
That means that 2% inflation target is likely to give way to a three or perhaps three and a half or 4% inflation target, because we just don’t have enough people, and we’re engaging in this decoupling from hyper-globalization to a globalization that’s defined by regionalization. Well, that means rates are going to meet higher than what they’ve been for the past 20 years.
Most of your lifetime, what you know is inflation at around one to 1 and a half percent per year and very low interest rates that in real terms are negative. That’s not going to define the next 20 years for you. You’re going to be moving and living in a very different time, a very different era. Essentially the era of 1990 to 2020, the era of hyper-globalization has effectively come to an end.
We’re moving into a different era that requires different policies and quite frankly, different people with different analytical frameworks and economic models. So we’re going to have a pretty big turnover here, and that’s why your question about why the public should care? Is spot on. But the public is different from investors, and so the two right now are traveling on parallel lines.

Dave:
All right. Well, Joe, thank you so much for being here. We really appreciate you joining us. Hopefully we can have you back someday to expand on this topic a bit more.

Joe:
Sure. Thank you very much.

Dave:
All right. Big thanks to Joe for being here. Obviously, the labor market is not my area of expertise, but I’ve been trying to learn a bit more about it given its importance in what the Fed is doing in monetary policy in the US, and because that has huge impacts on the real estate market.
I really want to understand more, and I think the main takeaway for me is that the interest rate hikes that have been going on for nearly about a year right now are really just starting to be felt in terms of the labor market.
And although we’re seeing these sort of surges in jobs recently, it’s probably, according to Joe, Joe thinks that we’re going to start to see the unemployment rate tick up over the next couple of months, starting probably mid-year is what he said. And as a result, that should help inflation. That is Joe’s opinion, and I think that’s an interesting good take. We’re obviously don’t know what’s going to happen, but I think he’s very informed and offered some really interesting opinions there.
So thank you all. Hopefully you like this episode. If you have any questions about it, you can always hit me up on Instagram where I’m @thedatadeli. We appreciate you listening and we’ll see you next time for On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Pooja Jindal, and a big thanks to the entire BiggerPockets team.
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