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How low, how long?

Ahead of the Curve, June 29, 2017

In my last Ahead of the Curve, I began to consider the possibility of a longer cycle. Others are thinking along the same lines, prompted no doubt by inflation rate levels, which have been surprisingly low.

What Is the Lowest Sustainable Rate of Unemployment?

The Fed recently reduced its estimate of the long-run sustainable rate of unemployment to 4.5%—the rate at which unemployment is consistent with stable inflation at around 2%. Since the rate of unemployment has in fact fallen to 4.3% without eliciting a notable uptick in wage growth, there is every chance that the sustainable rate of unemployment is a bit lower still.

In any case, I like to look at these things a bit more crudely. What is the likely cyclical low point in U3 unemployment1, when will we get there, and how long before we reach the end of the cycle?

How low, how long? - Ahead of the Curve - Fig 2

The average cyclical low, over the last five cycles, is 4.7%. It also appears that the cyclical low is trending down a little over time, probably due to the way in which globalization has reduced the ability of workers to push for inflation-busting wage raises.

The Next Cyclical Low?

To calculate the end-of-cycle date, I assume that the sustainable rate of unemployment is lower than the Fed estimate—say, 4.3%. In addition, as already seems to be happening, I assume the actual rate of unemployment will overshoot this by 50 basis points. This makes the next cyclical low in unemployment 3.8%, somewhat in line with the end of the long boom of the 1990s. Notably, the 1990s was characterized by substantive supply-side advances linked to information and communications technology. The development of U.S. oil production may be this cycle’s main supply-side shift.

The rate of decline of unemployment, once a recovery gets underway, is very constant. So, if I extrapolate the current rate of decline forward, U3 hits 3.8% in May 2018. This is not the end of the cycle: There is one further phase to consider, the “bouncing along the bottom” phase.

In two of the last five cycles, this phase has been non-existent, so we cannot count on it, but at the end of the expansion in the 1980s, unemployment bounced along the bottom for about 12 months. As we have noted, it is much harder nowadays for American workers to get wage rises because it is easier to offshore jobs. So, we assume unemployment will stay at the cyclical low point for 9 months. This dates the end of this cycle to May 2019. The chart shows the forecast along with what happens next.

How low, how long? - Ahead of the Curve - Fig 1

What Does This Mean for Real Estate?

First and foremost, it means that demand-side fundamentals will remain reasonably strong for another 24 months. Although job growth will begin to slacken from the middle of 2018, vacancy rates should continue to fall. This said, investors should increasingly focus on the supply side. This is subdued compared to previous cycles, but it is ticking up appreciably in all sectors.

Second, there is no reason why well-leased, well-managed real estate cannot survive a downturn, particularly if refinancing is not required. Where possible, loans should be structured to run through to 2022. From now on, leasing plans to maintain occupancy rates should be developed. Occupiers should look to take on core space only.

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1U3 unemployment is the International Labor Organization’s official unemployment rate, based on people without jobs who have actively looked for work within the past four weeks.

For more information about this report, please contact:

Richard Barkham, Ph.D.
Global Chief Economist, Head of Global Research & Head of Americas Research
+1 617 912 5215