Houston Updates

Soft Landing Confirmed for Houston in 2024: But How Soft Will It Be?

September 14, 2024

Over the past year, our economic outlook for Houston has focused on the long employment slowdown that began with the post-COVID peak in job growth in April 2022 and the final return of 362,400 pandemic job losses. The US economy has also been slowing, after adding back its pandemic losses only two months after Houston. Now, both Houston and the US are reaching the end of these long cooling periods and returning job growth to near-trend levels.

When the Federal Reserve began raising interest rates in 2022-23 it was widely expected that a US recession would be only 12-18 months behind with the economy taking the express elevator down. Instead, the picture of US economic growth in Figure 1 is that of a long slow escalator ride. Month-to-month swings in employment during the slowing were often large, but a simple three-month moving average makes the downward slide clear. If the trend slows soon enough, we will achieve the much-sought soft landing, and if it continues down it becomes a question of how soft it might be. Or whether we might trip getting off this escalator.

Houston has led the US descent throughout, taking a separate and faster escalator. (Figure 2) The local economy appears to be softening more quickly than the US with data revisions that cut 20,000 jobs out of growth from late last year, and Houston’s monthly jobs reports have seen cuts in three of the last five. So far in 2024, we have added about 20,000 new jobs or at a 35,000 annual rate. A 60,000 pace would be closer to trend.

City Sales Tax Revenues

Our escalator is a nice analogy for the long-lived consumer support from the pandemic stimulus. The trillions in direct pandemic fiscal spending was mostly gone by late 2021 or early 2022. However, for sales tax revenue linked directly to consumer spending, fiscal support would continue from the extraordinary levels of “excess saving” that simply stacked up in consumer bank accounts. Look back, for example at Figure 9 our December 2022 Economic Outlook, we saw an estimated $2.5 trillion on consumer balance sheets in late 2021 with only $1 trillion spent by the end of 2022. This was not saving for the future in any traditional sense, but temporary funds that allowed many households to continue spending at levels beyond their means until the last few months.

For sales tax collectors, the flip side of the coin for “excess saving” turned to “excess spending.” This created a one-time event where taxes surged strongly, stayed high for a long while, fell back to normal levels, and then struggled forward at typical, long-run rates of growth. This is exactly what we are watching play out today, with Houston’s inflation-adjusted sales taxes now down 7.7 percent from their peak in 2023Q1. If we take the Survey of Professional Forecasters at their word, and the US sees a soft-landing with sub-par job growth through 2025, the City should find the bottom on its sales taxes collections in the next quarter along with a return to revenue growth. But it will be subpar revenue growth in the soft economy that follows through 2025, a return to trend in 2026, and we will match the one-time spending spike of 2023Q1 only in early 2029.

We are looking at the end of post-pandemic economy in the US and Houston and a return to economic fundamentals. If the household consumer is the primary driver of the economy, then for the US we care most about employment and income. For Houston, we have a comparable payroll employment series, but for Houston we do not have a timely monthly or quarterly data series on income or spending. We have a close proxy, however, in local sales tax collections. Both the City of Houston and METRO MTA collect a one-cent tax on a large base of spending on goods and services, including retail and eating and drinking places. It is reported regularly by the Comptroller with only a two-month lag. The METRO tax base is larger because it stretches further into the suburbs.

Figure 3 illustrates the history and shows the very strong long-run ties between sales taxes and the local employment. There are many factors that can drive spending and sales taxes off the jobs trend – several recessions, oil with the fracking boom and bust, and COVID stimulus – with the current COVID differences standing at the end chart and on the right. The size of these differences suggest why such a period of post-COVID adjustment is still working itself out.

The Consumer

The key to the US economy has been the consumer since the pandemic began. With the post-COVID excess savings exhausted, a more useful way to now track consumer behavior is through a return to fundamentals -- income and spending – and, in particular, by tracking their position relative to trend. Figure 4 shows recent developments in the most basic support for consumer spending – inflation-adjusted personal income after taxes. We see this measure trending upward at pre-COVID rates, sharply interrupted three times by COVID stimulus, and then recovering to income levels that run below trend. Income fell back with the end of COVID spending, tried to recover to trend in 2022 and early 2023, but since then income growth has remained flat to very slow.

Meanwhile, inflation-adjusted US spending in Figure 5 staged the same sharp one-time jump in spending due to stimulus we have seen repeatedly in other data. This spending remained high, supported by excess savings and economic recovery, and it didn’t fall below trend until this summer. This is spending on retail sales and food and drink. Unlike income, we see spending from 202021 stimulus simply holding on at high levels and waiting for trend growth to catch up.

A good sign all around would be to see both series reach their proper level of trend growth and then settle in at these rates. Spending is headed in the right direction, but real income still struggles. These two charts taken at face value suggest that weak income growth could easily turn the US soft landing into a period of relatively weak growth. Such a soft patch (though no recession) is exactly what we will see in the US forecast.

In Figure 6, we get a closer look at real and nominal US retail sales since December 2019, including food and drink. Food and drink are added to retail to better match the performance of local sales taxes. The second and third round of stimulus arrived in late 2020 and early 2021, and real retail sales surged 11.4 percent between December 2020 and the following April. Since the 2021 peak they have given back virtually no ground over time despite weak real income. It is yet another way to indicate sustained high retail sales supported by stimulus in place of fundamentals.

The inflation-adjusted sales figures have appeared to briefly peak several times in this data, only to be revised up again. That said, it is time to see some weakness here and modest decline with the stimulus gone and weak underlying incomes.

The US Outlook: Is the US Already in Recession?

In both the US and Houston another sign of the softening economy is a rising unemployment rate. A long-reliable cyclical measure called Sahm’s Rule, based on the unemployment rate, recently surged to the fore when it triggered news that the US has fallen into recession.

Figure 7 shows the US unemployment rate, with its rise to pandemic highs over 14 percent, a long decline to 3.4 percent before turning up in 2023, and it’s current position at 4.1 percent. The right side of the figure shows the monthly unemployment rate on the left, and the calculation of Sahm’s Rule on the right.

Sahm’s Rule simply says that you should look over the last 12 months and if a three-month moving average of the unemployment rate has risen by a half a percentage point or more from the low-point, then the US is already in recession. This simple calculation has not failed to be right since 1970.

So do we believe it now? Claudia Sahm invented the rule and even she is quite skeptical. Given the impact of pandemic stimulus -- and the end of stimulus -- we should first have seen an unemployment rate artificially pushed to low levels. Now, as stimulus wanes we are seeing a return of unemployment to 4.0 percent, and many economists would set a healthy, full-employment rate closer to five percent. Bottom line: We are likely just confusing pandemic/stimulus distortions and their undoing with deteriorating labor market fundamentals.

Our US forecast contains no recession but includes some soft growth extending through next year. In drawing up the forecast, we rely heavily on the short-run US forecast from the Survey of Professional Forecasters. The SPF is the oldest quarterly survey among US economic outlooks. It was compiled and published by the NBER from 1960 to 1990, when the Federal Reserve Bank of Philadelphia was asked to take it over. Its results are published quarterly on the Philadelphia Fed website.

The survey response comes from at least 35-40 professional macroeconomic forecasting groups that acknowledge their regular participation, plus an unknown number of others that remain anonymous. Respondents are from academics, consulting, banking, and industry. Compare this to the general survey of National Association of Business Economics membership who may or may not be forecasters or to the heavy financial-sector participation of the Wall Street Journal’s outlook survey.

In past cycles, the result of the Fed raising interest rates enough to halt inflation typically has been recession. Figure 5 shows the results of the Survey for gross domestic product (GDP), the broadest measure of the economy. Despite sharp increases in interest rates through 2022-23, the SPF forecast in Figure 5 saw no recession in 2023 but only a long slowdown. Then, even these slow projections turned around and shifted back to normal growth for GDP at 1.7-1.9% and have remained within the range this year. This latest forecast looks like a soft landing is in the works.

The US jobs data in Figure 9 is of special interest because of Houston. Regional economic data are limited compared to the wide-ranging and detailed data available for the US. In Houston, GDP and personal income figures are published annually, for example. Payroll employment, in contrast, is available for Houston monthly and provides substantial industry detail that allows a broad comparison of Houston to US performance.

Like the GDP data, the 2023 payroll employment forecast for the US was expected to fall back in response to high interest rates in 2022-23, but jobs also peaked along with GDP and general growth. But it has brought relatively soft payrolls that are projected to remain well below 150,000 jobs per month through 2025. Results now point firmly to a soft landing followed by a year or more of relatively soft job growth. As we will see, this US jobs slowdown set Houston up for similar results.

Monetary Policy Begins the Rate Cuts

On August 17, Federal Reserve Chair Jerome Powell announced that it is time for interest rates to be cut, and that the first cut would likely come in September. The policy rate had risen to a range of 5.0-5.5% in July of 2023 in response to a serious outbreak of inflation and still remains there. The CME’s Fed Watch tool now expects a September cut of 25 b.p. with a probability of 63% and 50 b.p. cut with a 37% chance. By September of next year, there is a 54% chance the rate will lie between 3.0-3.5%, with other possible rates scattered across alternatives ranging as high as 4.5% or as low as 2.0%. Another measure, The Atlanta Fed’s Market Probability Tracker is little different, with a policy range centered near 5.0% next month and 3.25% in September 2025.

Chair Powell had promised substantial progress on inflation before rate cuts could begin. Figure 10 shows the progress made so far in taming inflation using the Fed’s preferred measure of price change, the Core Personal Consumption Expenditure (PCE) Deflator. The PCE deflator is accepted as a superior measure of price change compared, for example, to the Consumer Price Index. Removing the core of the PCE deflator means dropping food and energy prices because these large commodities are not responsive to Fed control. If the consumer wants to know how inflation affects daily life in their household keeping food and energy is certainly appropriate, but the core measure is uniquely useful as a guide to monetary policy.

The latest outbreak of inflation came immediately on the heels of the second and third rounds of stimulus payments in early 2021, and it has been blamed alternatively on chronic supply shortages and too much money chasing too few goods. (Figure 10) Both explanations may, in fact, boil down to a chicken and egg problem. Based on 12-month changes, CPI inflation peaked at 8.6% in early 2022, after core PCE inflation peaked two months earlier at 5.4%. The Fed prefers acting on the 12-month price changes to be sure short-term transitory factors are fully worked out.

Based on 12-month changes, real progress has been made with the latest reading at 2.5 percent, but decline has come more and more slowly in recent months. The three-month changes on the right side of Figure 10 confirm the need to be careful with short-term price changes, but looking through the noise progress similar to the 12-month changes is again visible.

The second part of the Fed’s inflation fight is its commitment to firmly anchor expected price increases at near two percent. High or rising expectations can trigger more inflation if consumers demand future wage increases to protect their incomes. Figure 11 shows that evidence on price expectations is mixed. Consumers – always the pessimists in these surveys – still see inflation on a steady three-percent path for several years to come. More encouraging is the latest issue of the Survey of Professional Forecasters that sees 2.4 percent core PCE inflation in the fourth quarter of this year, 2.2 percent next year, and a stable 2.0 percent in 2026. Financial markets, as judged by the behavior of inflation-protected bonds, now seems fully convinced that 2.0 percent is close at hand.

Looser monetary policy bodes well for lower market rates and interest-sensitive sectors like housing and autos. One large bank that shares the financial market views on coming Fed rate policy outlined above expects to see a ten-year treasury rate near 4.0 percent by the end of this year and 3.6 percent at the end of next year. Conventional mortgage rates should be 6.6 and 6.0 percent.

Oil Markets and Oil Prices

Post-COVID oil prices increased to $70/b by late 2021, drawing strength through the early post-pandemic era from a rapidly improving global economy, stronger travel demand, and increased power generation. OPEC would intervene in oil markets in 2022 and cut oil production to maintain $70 oil prices in the face of a weakening global economy. There are still active cuts today of 5.9 million barrels of oil per day, with 3.7 million in the official OPEC+ framework and 2.2 million of “voluntary” cuts from several countries led by Saudi Arabia.

The effect has been to keep the price of oil steady near $80 per barrel through the first half of this year, even as these cuts were at least partially offset by increased production in Brazil, Guyana, and the US. (Figure 12) However, just in the last few weeks we have seen oil prices slip below $70 per barrel and remain there. This is due to a weakening global economy, particularly in China, but also increasingly visible in both the US and Europe. OPEC+ has responded by discounting prices on oil shipments into Asia and delaying a planned production increase until at least December. We will discuss the possible impact on the Houston economy later, but this clearly puts pressure on the US fracking industry to maintain current production levels.

US oil production returned to new peak levels last June and has essentially moved sideways since that time. (Figure 13) This latest recovery to a prior peak level was a third slower than the fracking bust recovery in production from 2016 to 2019, as US public companies kept a close eye on OPEC. It was OPEC that taught the fracking companies that they are a high-cost source of oil after the cartel slashed prices three times from 2014 to 2020 and forced US producers through three rounds of bankruptcy. Some $295 billion in fracking assets went through the US bankruptcy courts.

As a high-cost source of oil, fracking can no longer depend on rising equity as a source of financing. They now are value stocks that divert 30-40 percent of operational cash flows to paying dividends. Many companies tell their investors that they will not increase production as long as OPEC holds spare capacity. As a result of this new financial model, fracking is a smaller, slower-growing, and more stable industry.

For producers, this combination of a new financial model and strict attention to OPEC spare capacity explains why there has been no rush back to the oil fields since 2020. (Figure 14) The rig count fell to near 760 before COVID arrived, and then rigs fell hard to an all-time low of 253 in the Saudi/Russia oil war. Recovery saw a brief return to 780 working rigs before falling yet again, and they are now down 20.9 percent. Frac spreads are the more modern measure of activity in the oil fields, but they tell much the same story – well down from pre-COVID levels and 4.4 percent below levels of last fall.

Increasingly mixed in with this story of fewer rigs and wells is rapid gains in fracking technology and productivity, best symbolized by the now-routine extension of lateral wells in the Permian Basin by two miles or more. Longer laterals require fewer rigs and fewer wells, but they produce more oil at a lower cost per barrel.

The challenge for the best of these producers is how to spend the money from large productivity gains with OPEC currently voluntarily withholding a million barrels per day of their capacity -- and carefully looking over the producers’ shoulder. The answer so far has been that the most successful of the producers – mostly the largest public companies – are buying the weaker companies. Merger strengthens the economic position of the company, enriches management and stockholders, and does not force large new supplies of oil onto the market. The last 18 months have seen over $100 billion in such mergers, mostly concentrated in the Permian Basin. In 2025, DOE forecasts US oil production of 13.7 million barrels per day, a small increase from 13.2 million in May of this year.

Oil-related employment in Houston has behaved much the same way as the rig count – slower and lower despite healthy oil prices. (Figure 15) After losing 43,000 upstream oil jobs to the 2018 credit crunch, COVID pandemic, and Saudi/Russia oil war, the return of these jobs continues at a slow pace. Only 21,100 oil jobs are back so far or 49.1 percent. If we begin counting from the end of the fracking boom in 2014, Houston has lost about 80,000 jobs in oil production, services, fabricated metal, and machinery. Again, this slow recovery in jobs is just one more sign of a cautious domestic industry – smaller and slower-growing even after several years of $70-$80 oil.

We assume that near-term upstream job growth continues in Houston. How many jobs still depends on what oil price we see: $40 for the low, $65 for the medium, or $80 for the high. See Figure 16. Again, oil-related employment is spread over local oil producers, oil services, machinery, and fabricated metals.

Our estimated employment growth from 2024Q1 to 2028Q4 averages 0.7 percent in the low forecast, 1.7 percent in the medium, and 2.6 percent in the high. This compares to 7.5 percent annually for the 2010-2014 period at the peak of the fracking boom, to 5.3 percent for the decade leading up to 2014, or to 3.1 percent for the two decades leading to 2014. The 1994-2004 decade that followed the oil bust of the 1980’s was a period of industry consolidation that saw oil jobs grow at only 1.1 percent per year.

How Is Houston Doing?

We got considerable insight into the Houston economy in Figure 2 showing the long two-plus years of economic slowdown following the pandemic stimulus and excess savings. The slowdown has reached a point where the most recent reports on local job growth have moved well below trend. We are on-track in 2024 to add only 35,000 new jobs or 60 percent of normal. We also saw that the local unemployment rate continue to rise and stand well above US levels, but unlike the US it has yet to trigger a recession warning. (Figure 7)

And while the US consumer seems to be barely holding on to positive inflation-adjusted spending, the Houston consumer is falling behind judged by recent sales tax reports. We saw this earlier in the quarterly real retail sales allocation data in Figure 3, but Figure 17 restates tax inflation-adjusted sales tax collections on a monthly basis since the pandemic and shows performance for both the City of Houston and METRO MTA. Both levy a one percent tax, but METRO collects over a broader area reaching further into the suburbs. The bottom line is in the real sales tax chart on the right shows both the City and METRO slowly giving back inflation-adjusted revenue. Current dollars aside, less is being spent and fewer goods are being purchased.

All of these indicators taken together do not necessarily point to recession, but more likely to a soft patch for both the US and Houston, a distinct slowing to subpar growth that will last through 2025. After two-plus years of extraordinary growth, this weakness is real, but it may feel worse than it really is.

Locally, both housing and autos will benefit from lower interest rates this year. Both were hurt in different ways by the pandemic and responded differently. Autos for example struggled in 2021 and 2022 to deliver product due to chip and other material shortages that choked supply chains and made price the major outlet for surging auto demand. (Figure 18) The big supply kinks now have been worked out, local auto sales rose through late 2022 and early 2023, but then fell steadily since the middle of last year. The relatively weak overall economic growth should keep any auto recovery moderate at best.

Auto and truck prices remain high – still about 25 percent above pre-COVID levels – but prices peaked in early to mid-2023 and have been falling slowly even if we ignore inflation. Once we recognize that CPI inflation is up by more than 20 percent since 2020, real prices for autos have been falling steadily and are now only a few percent higher than pre-COVID levels.

Existing home sales were a local pandemic bubble that burst as mortgage rates began to rise in 2022. (Figure 25) Existing home sales in Houston fell hard during lockdown months but recovered quickly with a check from the federal government and zero interest rates. Housing became a major element of the 2021 financial boom, as sales in Houston rose as much as 42.9 percent above pre-pandemic levels, only to fall hard after the Fed rate hikes began. Sales briefly fell 39.8 percent below pre-COVID levels in 2023, but they have now recovered to 4.4 percent above pre-COVID levels and improvement is only waiting for mortgage rates to fall.

Existing home prices surged from $250,600 for the typical unit to $343,500 during the boom period, or by 37.1 percent. So far, sharply falling sales have pulled prices down by only 7%. Like autos, inflation counts for a big part of the surge in home prices, and local history says prices could hang on to a large part of the nominal gains in years to come. However, such an outcome would likely mean a decade or more of limited home price appreciation.

Houston’s Economic Outlook

The chief drivers of Houston’s job growth outlook are the US economy and oil markets. Fed monetary policy plays a key role in the outlook, and the Federal Reserve has already laid out a path leading to rate cuts ahead. We assume the Fed recognizes that there is still work to do, and carefully sticks to its two-percent inflation target. Further, we assume election-year politics do not result in meaningful short-run success in pumping up the economy. We follow the Survey of Professional Forecasters assumptions that the US GDP remains on the low end of trend growth for both GDP and employment. A soft period of growth is ahead but no recession is indicated.

For oil, the new financial model for large public oil companies is widely implemented, assuming 30-40 percent of producer cash flows are diverted to stockholders to finance drilling. The result is a smaller and more stable upstream oil industry in Houston. High oil prices of $70-$80 continue through this year, providing a modest boost to local oil-related employment.

To pull the forecast together, we use a high, medium, and low outlook for planning purposes. (Figure 20) We use the price of oil as the vehicle to spread the outlook from low to high employment levels. For current planning, the low oil price is set near $40 per barrel and the high at $80. The medium price is $65 per barrel or the long-run marginal cost of oil. In all cases, we use the new financial model with 30 percent of operational cash flow diverted to investors or else used to strengthen the firm’s finances.

With a weaker global economy, oil prices have slipped below $70 per barrel in per barrel in just the last few week. Traders and oil forecasters have quickly shifted their oil price outlook downward through the rest of 2024 and into 2025. Any projection of oil prices beyond then is highly speculative, and the long-run cost of $65 per barrel remains the best guess for prices by mid-2025 and after. This recent decline in prices should slow short-term growth in Houston’s oil industry.

Figure 21 is an overview of how economic fundamentals play out over the longer run for low, medium, and high cases. This is our forecast of Houston’s economic future through calendar year 2029. We see the COVID lockdowns end, a long recovery to pre-pandemic employment levels and beyond, a meaningful slowdown in the second half of this year and in 2025. Houston then returns to the basics in 2026 and beyond, settling into trend growth near 55-60,000 jobs each year.

Figure 22 is the 2024-2029 forecast of Houston’s payroll employment stated in annual changes and measured Q4 over Q4 each year. Under the medium $65 forecast the Houston outlook for 2024 is only 48,500 jobs or down from 76,200 expected in our spring forecast. The slowdown is partly a slowing of US employment growth. But more than that, it was the result of a downward revision and loss of 20,000 jobs in late 2023. Houston simply brought far less economic momentum into 2024 than previously estimated by the Workforce Commission.

If oil prices had continued to average near $80 per barrel, as they did for the first half of this year, then then our outlook would still be for the $80 or high forecast column in Figure 22. It would imply 2024 job growth near 51,000 jobs, and it might have brought 58,200 jobs in 2025. The recent decline in oil prices to $65 per barrel, however, means only 48,500 jobs this year and 46,300 in 2025. Even the projected 50,200 jobs in 2026 means growth is still running below Houston’s trend.

Written by:

Robert W. “Bill” Gilmer, Ph.D.

September 14, 2024

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