California

Economy to Slow Significantly as Cyclical Housing and Employment Hurdles Arise

California’s robust economic growth will slow down significantly in 2019 and 2020 as the state’s technology boom, housing market, and employment activity run into cyclical and other hurdles. However, a recession is most likely not imminent—even as risks abound.

That’s according to a collection of three different economic forecasts recently published by some of California’s brightest academia and industry experts. These individual opinions range in perspective, but they spotlight intriguing viewpoints, trends and projections so your credit union can plan appropriately.

Click here for the entire archived forecast report, or view the synopsis below:

UCLA Anderson Forecast (UCLA)

  • The total number of jobs in California (all types) is expected to rise 1.5 percent and 0.9 percent, respectively, in 2019 and 2020 as employment growth continues its long slowdown. The state’s average unemployment rate (hovering around 4 percent today) could continue falling in 2019 before rising back to 4.5 percent by sometime in 2020 (a higher number of individuals increasingly entering the “labor force” as existing job postings are filled and new jobs are created). By late 2020, total nonfarm jobs will flatline at around 17.5 million after rising from a low of 14.2 million in 2010.

  • As California’s job expansion continues slowing, the growth still taking place is dominated by the health care and leisure/hospitality sectors, which reflects the demand of aging and retiring baby-boomers. Total employment—including company payroll employees, sole proprietors, independent contractors, and farm workers—has dropped from a 2 percent annual growth rate (October 2016 – October 2017) to 0.6 percent (October 2017 – October 2018). Over the long-term, nonfarm company payroll employment increased to 17.2 million in October 2018, about 11 percent higher than the payroll jobs peak before the Great Recession from 2007 – 2009. It’s risen 22 percent from 2009.

  • California’s various job sectors will grow (or retract) differently over the next couple of years depending on the industry. Some of the most notable sectors are those experiencing slow growth before flatlining in 2020 (construction, education, health care, professional/business services, and federal government); or those experiencing steady growth for another two years (financial activities and state/local government); or those poised to continue rising strongly (information); and lastly, those most likely to decline (manufacturing and trade).

  • Personal income growth in California (adjusted for inflation) will be 3.7 percent and 4 percent, respectively, in 2019 and 2020. The continued growth in personal income in 2020 is reflective of the changing mix of employment in California and tight labor markets in high-wage occupations.

  • How long can the “tech boom” continue its year-over-year stellar growth in California before overheating or running out of steam? The spurt of tech payroll jobs during the past three months of 2018 was driven by professional, technical and scientific services—the fastest growing in the state for that period (on a percentage basis). However, funding for technology innovation and start-ups is starting to dry up. Additionally, there is somewhat of a correlation between the market-capitalization of the NASDAQ stock index (which has experienced recent volatility) and local technology employment, as well as a relationship between declining private venture capital funding and local tech jobs. Time will tell what the impact will be from the recent volatile nature of capital and equity that funds tech incubations, start-ups, hiring, innovation, and research/development at new and existing companies. “If we entered a long-term bear stock market in 2019, this would be cause for concern and clearly represents a negative risk to the (California) forecast,” the report states. “At present we do not expect that—however, we have built into our forecast a slowing of (economic) growth consistent with current NASDAQ indicators.”

  • Population growth in California will continue its multi-year trend of slowing down. Growth will average about 0.7 percent annually in 2019 and 2020. Due to foreign immigration and natural births (but not domestic migration), the state’s population will hit 40.6 million by late 2020 (from about 40 million today). The major year-over-year influx of new residents that the state experienced from the late 1970s to early 1990s (and then again from the late 1990s to mid-2000s) is dwindling as natural births and domestic in-migration continues to decline.

  • Homebuilding in California will accelerate to about 140,000 units per year by the end of 2020. This is in spite of higher mortgage interest rates. It will materialize through the easing of zoning and regulatory requirements for developers and a continued strong demand for housing. From 2009 – present, annual new units have slowly risen from a low of 30,000 to 130,000 in 2018. Regarding existing homes, the median price of a single-family unit in California reclaimed its 2007 peak of $600,000 last year (2018).

  • U.S. economic growth will slow down quarter by quarter from late 2019 – late 2020 unless the labor force expands or worker productivity increases (neither of which are expected). Growth Domestic Product (GDP) will slow from it’s recent 3-percent trend to annual rates of 2.1 percent in 2019 and 1 percent in 2020. Also, the benefits from a huge government fiscal stimulus via recent congressional tax cuts will eventually wane, and the lagging effects from interest rate increases by the Federal Reserve will start to impact consumers and businesses. The 220,000 per-month job average in 2018 will decelerate to 160,000 per month in 2019 and a much weaker 40,000 per month in 2020. Similar to California, the national unemployment rate will continue declining (to 3.5 percent nationally in 2019) before gradually increasing (back up to 4 percent nationally by late 2020). August of 2018 saw the most workers voluntarily quitting their jobs to move to other opportunities in more than 18 years, which is a sign of the national labor market at or near “full employment.” There are now 0.9 unemployed persons (less than 1 human) per job opening, compared with 6.6 during the depths of the Great Recession in 2009.

  • The current short-term “federal funds rate” (2.25 – 2.5 percent) set by the Federal Reserve will probably be hiked three or four times in 2019—hitting the 3 - 3.5 percent range. But why? “We perceive that the ‘normalized funds rate’ will be equivalent to a ‘real rate’ of 1 percent. With inflation running somewhat above 2 percent, this implies a normalized funds rate somewhat above 3 percent,” the forecast report states. Additionally, underpinning the Fed’s move to higher interest rates are growing inflationary pressures in the economy, including U.S. worker wages—which are on track to increasing 3.3 percent in 2019 and 4 percent in 2020. Similarly, U.S. inflation (as measured by consumer price indices) will approach 3 percent in both 2019 and 2020, largely driven by higher service-sector prices.

  • The yield on a 10-year U.S. Treasury bond will exceed 4 percent by late 2019 (from its current approximate 2.7 percent in mid-January). Along with the Federal Reserve engaging in its “quantitative tightening” program (selling mortgage and treasury bonds back into the financial markets to bring down its once-peaked $4.5 trillion balance sheet and “normalize” long-term consumer/business interest rates), the growing U.S. debt will experience continuing annual trillion-dollar deficits with global bondholders demanding a higher return.

  • The U.S. financial markets face serious risks going into 2019—namely over-leveraged corporations. While the zero and low interest rate policy of the Federal Reserve helped pull the economy out of the Great Recession and later stimulated growth, it also induced corporations to “leverage up.” As a result, Moody’s now rates about half of all investment-grade corporate bonds “Baa”—its lowest tier. “That means the slightest of economic downturns can force many of these credits into ‘junk’ territory,” the forecast report states. “And this data does not take into account the huge issuance of less-than-investment-grade paper over the past decade that now accounts for about half of the $9 trillion bond market.” Also, further exacerbating the corporate credit situation has been the huge deterioration in the $1.3 trillion “leveraged loan” market. Although not as overextended as the mortgage market was in the mid-2000s, the corporate debt market has the potential to trigger the next recession.

  • Other risks to the U.S. economy include “trade tension” between the United States and China, and ongoing congressional gridlock in Washington, D.C. Also, “don’t forget that the energy, social media, banking and pharmaceutical industries will soon find themselves in the crosshairs of the newly elected Democratic House of Representatives,” the report states.

A. Gary Anderson Center for Economic Research (Chapman University)

  • The future performance of the California economy will hinge on several major trends. One of those is the well-being of the state’s construction industry. Given the “weakness” in residential construction at the national level, it shouldn’t be surprising that California’s construction sector will also be subject to downward pressure. Rising mortgage rates, lower housing affordability, and rising levels of unsold housing are all rearing their heads.

  • New residential permits for single and multi-family housing units will drop from 122,000 in 2018 to 110,000 in 2019. This decline in residential construction will be offset, in part, by a 4 percent increase in nonresidential construction (commercial buildings, schools and hospitals). Residential home price appreciation will continue in 2019 but at a slower rate (3 percent annually versus 7 percent in 2018 and 2017).

  • Low rates of unemployment in 2019 will stifle California’s overall job growth. In nearly all job sectors, nearly all workers who want a job have a job. Also, growth in technology industries is slowing down as most employment expansion within this high value-added sector is occurring in newly emerging tech hubs around the nation. Annual employment growth in the state will register 1.5 percent in 2019 versus 2 percent in 2018; 2 percent in 2017; and 2.6 percent in 2016.

Beacon Economics

  • California’s economy in 2019 and 2020 should resemble 2018—mostly. California’s economic performance has been remarkably steady, fueled by expansion in the state’s industries, increases in incomes and wages, and strength tied to the recent congressional federal tax cuts. “In the second quarter of 2018, the average weekly wage for private sector workers was $1,265, up 4.6 percent over the prior year. Over the same period, prices in California increased 2.6 percent, implying a 2 percent inflation-adjusted gain in the average wage,” the report states. “This continues a recent trend of wage increases generally outpacing inflation, giving workers more purchasing power to drive spending and economic activity.”

  • However, California’s economic growth is constrained by an extremely tight labor market. “To ensure its future economic vitality, California will need sustained labor force growth, which means providing the education and training residents needed for the 21st Century economy—and ensuring workers can afford to live here by addressing the state’s housing problems,” the forecast report states. “The scant increase in the state’s workforce is cause for concern in 2019, although… rapidly growing regions continue to attract workers, most notably in San Francisco, the Bay Area, and the Inland Empire.”

  • In what industries will California experience the most economic growth in 2019? The answer depends on the type of growth. Over the past three years, half of the state’s job gains have occurred in population-serving sectors (health care, leisure/hospitality, and government)—a trend most likely continuing in 2019. Smaller but noteworthy contributions also came from professional/scientific/technical services and transportation services.

  • But the picture is considerably different when looking at California’s economic output. More than 40 percent of the output generated during the past three years emanated from just one industry—information (with gains mainly attributed to technology-related segments). Combine this with the contribution from professional/scientific/technical services, and about half of all output generated in California came from tech-related activities over the past three years. Other external industries that weighed-in with sizable contributions to economic output included manufacturing and transportation.

  • These findings provide insight into the future direction of California’s economy. The state can count on increases in employment among its population-serving industries in the coming quarters (health care, leisure/hospitality, etc.)—but if the state wants to increase the size of its economic pie, it must look to its external industries to fuel that growth.

  • The fact that the United States is on the edge of the longest economic expansion in the nation’s history hasn’t dampened the forecast. “Despite handwringing over everything ranging from battles with major U.S. trading partners to a feared onset of inflation, the California and U.S. economies will continue expanding through 2020,” the forecast report states. “There is simply nothing out there at the moment, whether it’s the sell-off in the stock market or rising interest rates, that has the power or speed to knock the expansion off its track. The U.S. economy has solid fundamentals, including private sector debt levels, consumer savings rates, rising wages, the overall pace of homebuilding, and business investment. Unemployment is low—but job growth remains steady. Apart from a rapidly growing federal budget deficit, the U.S. economy looks fairly well-balanced.”

  • Even a major trade war with a foreign country wouldn’t end the current U.S. economic expansion. “The United States exports fairly little to China—only 8 percent of all exports,” the forecast report states. “And what does get shipped out typically doesn’t have a long supply chain. The greater threat comes from the fact that the United States sources 20 percent of its manufactured imports from China. But the tariff-increased costs to U.S. importers have been largely offset by a 13 percent depreciation in the Yuan currency relative to the U.S. dollar.”

  • The U.S. housing market has slowed as a result in the bump in mortgage rates, which has created considerable consternation. However, there is a big difference between a housing pause and a housing bust. “The U.S. housing market is not overpriced, nor has there been much risky lending—or lending in general—occurring,” the report states. “The pace of building has been reasonable, so there is no excess supply to worry about. That the market is responding to changes in interest rates is a good thing. Prices need to adjust to a higher carrying cost; once that happens, the market should get back on track. The slowing pace of sales is part of that process.”

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