California Economic Outlook Report- April 2023

Scott Anderson
Chief Economist
Bank of the West
  • California's job growth has already slowed, dropping to 2.2% annualized in February and 2.8% from a year ago. This just as employment in California exceeded pre-pandemic levels. The state's total nonfarm employment is now 1.7% above February 2020 levels. California's jobs recovery has been broad-based and strong in this expansion so far, increasing at an average 6.3% year-on-year over 23 consecutive months.
  • We forecast that California job growth will slow to 1.0% year/year – down significantly from a solid 5.1% growth rate in 2022 – and then drop to just 0.1% in 2024. The slowdown is predominantly due to the Fed's aggressive rate hiking campaign which will continue to cool consumer and business demand, and the California labor market. We expect a mild recession in the U.S. this year that will be somewhat more severe here in the state of California. The sharper- -than-average contraction in California's technology sector and housing market, and weak overseas economies are the main drivers of a more severe recession across much of the state as the Fed tightens monetary policy further this year.
  • A downturn in the California economy will likely add to California's growing state government budgetary woes. The Legislative Analyst's Office (LAO) recently concluded that California is likely to suffer a $24 billion budget deficit for the next fiscal year which begins on July 1, 2023. The projected shortfall stems from the state's reliance on high-earning taxpayers whose incomes tend to fluctuate with the business cycle. The most likely course of action at this point is to delay some program expansions as the state dips into its large budgetary reserves.
  • California's unemployment rate fell to a record-low of 3.8% in August 2022 but has already risen to 4.3% in February. Even so, the California jobless rate today is still basically in-line with the pre-pandemic rate of 4.4% in February 2020. The state's unemployment rate is forecast to average 4.7% this year and then climb to an average of 5.2% in 2024 on sharply slower job growth.
  • California's housing recession deepened in November with existing home sales plunging a staggering 47.7% from a year ago. This is the biggest year-on-year drop in California home sales in at least the past four decades. The outlook for the California housing market over the next two years is sobering. California housing starts are projected to plunge 20.1% in 2023 as builders pull back significantly on home construction in the face of dissipating demand.
  • The housing market downturn in California that began in mid-2021 continued into February with existing home sales plunging 33.2% from a year ago. That marks the twentieth consecutive month of declining existing home sales. The extended sales weakness is likely to prompt homebuilders to curtail construction with housing starts expected to drop 20.1% this year and then rebound 2.4% in 2024 as the Fed cuts interest rates.
  • Weakening sales and poor housing affordability are putting considerable downward pressure on California home prices. California's home prices have declined year-on-year for the past four months and the decrease accelerated to -4.8% year–on-year in February – the biggest drop since December 2011 according to the California Association of Realtors. California's home prices are projected to slump 7.5% this year – the sharpest decline since 2009 – and drop another 2.4% in 2024 as inventories rise, and housing demand weakens on high mortgage rates and low affordability.


Employment Outlook

Job growth in California moderated to 0.2% in February from a month ago, half of the gain registered in January. The weak monthly growth was primarily driven, as it has been in recent months, by above average gains in construction (+0.8%), leisure & hospitality (+0.6%) and education & healthcare (+0.4%). Employment was essentially unchanged in five sectors and the only major sector to shed jobs was information (-0.5%). Information employment has declined month-on-month in five of the past six months.

Construction Employment Grew The Fastest

The slowdown in job growth in February pushed California's job growth from a year ago down to 2.8%, marking the weakest showing since March 2021. California's job creation has underperformed the U.S. average for two of the last three months after exceeding the national average for 20 consecutive months. Over the past year, leisure & hospitality (+8.1%), education & health services (+5.4%) and other services (+4.5%) have been the strongest performers.

Pent-up demand for travel and entertainment supported by strong nominal wage gains and excess savings have been underpinning job creation in the state. The only California sectors with job growth below 1.0% over the past year were financial services (+0.1%), trade, transportation & utilities (+0.1%) and information (-1.2%).

The state's job growth is forecast to slow to 1.0% this year – the slowest annual pace since 2010 excluding the Covid recession – following robust growth of 5.1% in 2022. California job growth is expected to drop to just 0.1% in 2024 as still-elevated inflation, fading pent-up demand, depleted savings, and higher interest rates dent consumer demand.

California's unemployment rate reached an all-time low of 3.8% in August but has steadily increased to 4.3% in February as the number of unemployed grew 16.2% over the last five months. Even so, California's unemployment rate remains significantly below its long-run average of 7.2% since January 1976.

CA's Jobless Rate Climbed Again in February

The state unemployment rate is projected to average 4.7% this year and move up to 5.2% in 2024. Moreover, the state unemployment rate will remain above the nation's over the next two years with the U.S. jobless rate forecast to average a comparatively low 4.1% in 2023 and 4.8% next year.

Housing Outlook

The lowest mortgage rates since September of last year helped to elevate California home sales above an annualized 250k units for the first time in four months. California's existing home sales were 284k units in February, up 17.6% from January, but still 33.2% lower than a year ago. California home sales have declined year-on-year for 20 months in a row now.

California Home Sales Remain Challenged

The surge in mortgage rates from a year ago is stifling housing demand as it continues to put downward pressure on home affordability. To wit, the California Association of Realtors Housing Affordability Index fell to 17% in the fourth quarter of 2022, down from 25% a year ago and about half the long-term average of 32% from 2006 through 2022. This means that only 17% of California households could afford to purchase the median-priced California home of $790,020 in the fourth quarter of 2022.

California Housing Increasingly Unaffordable

California's home inventory for sale was also rather discouraging for homebuyers. The Unsold Inventory Index sank to 3.2 months in February from 3.6 months in January and is at its lowest level in four months, pointing to shrinking inventory for sale. The index signals the number of months it would take to sell the supply of existing homes on the market at the current sales pace.

The sharp slowdown in existing home sales continues to filter through to home prices. The statewide median home price was $735,480 in February, down 2.1% from January and 4.8% lower than a year ago. A shift toward more home sales in the lower-price segments was partially responsible for the weakness in home prices. Nonetheless, the statewide median home price has decreased 18.3% from the peak of $900,170 in May 2022.

Home Prices Dropped Again in February

The outlook for California homebuilders this year is rather bleak amid high interest rates, eroding home affordability and cooling demand. Accordingly, housing starts are projected to plunge by 20.1% this year following a more modest 3.5% decline in 2022. Starts are expected to rebound by 2.4% next year as falling mortgage rates begin to stoke pent-up housing demand.

California home price growth slowed sharply to 7.9% last year from an unsustainable 19.2% pace in 2021. California home prices are expected to fall 7.5% in 2023 and drop another 2.4% next year on slower job and income growth and softer demand for homes.

California's Revenues Are Weakening

The Legislative Analyst's Office (LAO) recently revealed in its annual forecast that California is looking at a $24 billion projected budget deficit for the next fiscal year which begins on July 1, 2023. The projected shortfall can be attributed to the state's heavy reliance on upper income taxpayers whose incomes often fluctuate with the price of equities, real estate and other investments. Almost 50% of the personal income tax paid in California in 2020 came from just 1% of tax filers, according to the state's finance department.

Over the past decade, taxes collected from capital gains — the most unstable form of income — have doubled, representing a larger share of the state's revenue and tying the state's budgetary prospects to particularly wobbly economic cycles.

Large Deficit Projected For Next Fiscal Year

The state's fiscal outlook is darkening rapidly. California's fiscal deficit could approach $30 billion to $50 billion in a recession, according to the LAO. However, the state's budget is in a much stronger position than it was prior to the last fiscal crisis in 2008/09. Indeed, the state has $37 billion in specific reserve funds that includes about $23 billion in a rainy day fund that voters agreed to strengthen in 2014.

Solid reserves should enable the state to avoid the kind of extreme program reductions enacted during the Great Recession that took years to restore. Therefore, the most likely course of action is to delay some program expansions if there isn't enough revenue to fund them.


Employment Outlook

The Bay Area economy has finally recovered all the jobs that were lost in the early days of the pandemic. Total nonfarm employment edged up 0.1% month-on-month in February – down sharply from a 0.5% gain in January – pushing the level of jobs 0.3% above the March 2020 peak. The weak February job growth was led by above average gains in construction, financial activities, manufacturing, trade, and government.

Recent Performance and Outlook

Bay Area job growth of 3.2% from a year ago is still firmly above the statewide average of 2.8% and slightly above second place Central Coast with growth of 3.0%.

The Bay Area unemployment rate increased 0.2 percentage points to 3.0% in January – the highest level since May 2022 – as the number of unemployed rose 7.2% from December while the labor force was basically unchanged. Despite the modest rise, the Bay Area still has the lowest unemployment rate of all four main regions of California, with Southern California a distant second with a jobless rate of 4.1%.

Bay Area job growth is forecast to moderate to just 0.8% this year – the slowest pace since 2020 – and then decelerate to 0.3% in 2024. Bay Area job growth will be limited by weakness in technology and construction jobs and the movement of jobs to lower cost metro areas.

Housing Outlook

The prolonged weakness in the housing market in the Bay Area extended into February with existing home sales plunging 32.0% from a year ago. Home sales have now fallen year-on-year for 18 straight months amid widespread tech layoffs, higher mortgage rates and generally low housing affordability.

Home sales fell year-on-year in all nine Bay Area counties in February with the largest drops in Napa (-43.3%), Santa Clara (-37.9%) and Solano (-34.4%) counties. The smallest declines were in San Mateo (-17.2%) and Marin (-27.6%).

Home Sales Slumped in All Bay Area Counties

Existing home inventory in the Bay Area is finally on the rise, helping to put downward pressure on home prices. The Unsold Inventory Index was 2.7 months in February – up sharply from 1.8 months a year ago – and the median number of number of days it took to sell a home nearly doubled to 17.0 from 9.0 over the same period. As a result, the median Bay Area home price plummeted 19.2% year-on-year. This is a sharp deterioration from the 14.6% decrease in January and marks the third consecutive month of double-digit declines.

Bay Area home prices are projected to decline 12.0% this year – the first decrease since 2019 – as demand slows amid higher mortgage rates, sharply slower employment growth and rising unemployment. Home prices are projected to rebound a moderate 1.4% in 2024 as mortgage rates begin to ease and demand stabilizes.

Homebuilders will respond to the slowdown in home sales with housing starts forecast to plunge 20.5% this year – the largest decline since 2009. Housing starts are expected to rise 3.6% in 2024 as home demand rebounds on falling mortgage rates and pent-up demand.

Bay Area Tech Layoffs Accelerating

Massive layoffs have become rampant within the technology sector over the last several months as the technology labor market now faces a major contraction after persistent over-hiring during the pandemic. According to data on Layoffs.FYI, over 220,000 technology workers have been laid off globally since October. The Bay Area, in particular, has been hit hard as Meta, Google, Twitter, LinkedIn, Yahoo and other regionally-based tech companies have eliminated an estimated 100,000 positions.

More major layoffs are forecast to continue in the months ahead amid high interest rates and elevated inflation, making the economic downturn in the Bay Area somewhat more severe than that seen in the rest of the country and in other parts of California. That begs the question of whether Silicon Valley is heading toward another big bust like 2001's dot-com meltdown.

The most likely answer is probably not. In 2001, the growth of the Internet created a buzz among investors, who were willing to invest money in startup companies without a business plan, product, or track record of profits. In contrast, the sharp run-up in tech hiring during the pandemic was due to a surge in demand for tech products when most people were confined to their homes. Therefore, the recent layoffs are largely a rebalancing of supply and demand for technology products as more workers return to the office and resume more normal lives.


Employment Outlook

Southern California's job growth fell to 0.2% month-on-month in February from 0.3% in January. The moderate monthly gain was driven by large increases in construction (+1.5%), other services (+1.0%) and leisure & hospitality (+1.0%) jobs. Employment in four major sectors decreased, including information (-2.5%), manufacturing (-0.5%) and government (-0.5%).

Construction Employment Grew the Fastest

Southern California has underperformed on job creation compared to other regions of the state with growth of 2.5% in February, down sharply from 3.1% in January. The largest job growth over the past year was in leisure & hospitality (+7.8%), but above average gains also occurred in education & healthcare, other services and professional & business services. Information services, which includes movies and sound recording and broadcasting, plunged 7.5% after dropping 4.2% in January.

Trade, transportation & utilities employment – which had slowed for 10 consecutive months – decelerated to 0.2% year-on-year in February. Activity at the region's two largest ports of Los Angeles and Long Beach slumped 37.6% from a year ago, the seventh consecutive month of year-on-year declines.

Southern California's job growth is projected to slow markedly to 1.2% this year from 5.3% in 2022 and drop to just 0.2% in 2023. A relatively high exposure to jobs in international trade, recreation, entertainment, television and film production and leisure & hospitality will limit the region's job growth over the next two years as the U.S and global economies experience an economic downturn.

Southern California's unemployment rate continues a recent pattern of outperforming most other regions of the state. Indeed, the region's unemployment rate in January was 4.1%, just a tick below the statewide average of 4.2%.

The Southern California unemployment rate is forecast to average 4.7% this year – up marginally from 4.5% in 2022 – and then climb to 5.1% next year. Southern California's relatively higher exposure to industries that have historically been more sensitive to the business cycle will push unemployment higher.

Housing Outlook

There is still no significant indication that the protracted weakness in the Southern California housing market is nearing an end. Existing home sales declined 34.1% year-on-year in February, while home sales have fallen year-on-year for 20 consecutive months amid higher mortgage rates, a scarcity of inventory, and poor affordability.

The extended weakness in home sales is finally beginning to pressure home prices. The median home price fell 2.1% from a year ago in February. This is the second decrease in the last three months and the biggest drop since January 2012.

Home prices fell in most metro areas ranging from -1.7% in Riverside to -9.3% in Ventura. The one outlier was the San Bernardino MSA where prices rebounded a modest 3.7% after declining 0.7% in January.

Southern California's home prices are forecast to drop 8.0% this year – nearly wiping out the 9.0% gain last year – and then fall 2.5% next year on still-weak demand.

Home Prices Fell In Most So. California Metros

Declining Ports Traffic A Risk

Two-way container traffic at the region's busiest ports of Los Angeles and Long Beach mostly expanded for the first half of last year but has been dropping year-on-year for the last seven months. Moreover, the trade declines have accelerated to 37.6% year-on-year over the past two months – a larger drop than any decline during the early months of the pandemic.

Container Traffic Has Declined Recently

The extended drop in two-way container traffic is likely the result of the slowing U.S. and overseas economies, and a shift by U.S. consumers to spending on services and away from durable goods. Rapidly slowing international trade is an important downside risk to our Southern California economic outlook.


Employment Outlook

Job growth in the Central Coast was 0.3% month-on-month in February, less than half of the 0.8% gain in January but slightly above the average monthly growth of 0.2% last year. Job gains were above average in six of 11 major sectors with the largest advances in mining & logging (+1.0%), government (+0.7%), education & healthcare (+0.6%) and leisure & hospitality (+0.6%).

Recent Performance and Outlook

Financial services, other services, and information sectors saw notable net job losses, totaling 0.5%, 1.3% and 1.7% respectively.

Nonfarm employment growth in the Central Coast is projected to decelerate sharply to 1.0% this year from a solid 4.3% in 2022 and then slow to 0.6% next year. Demand for travel is expected to weaken as the U.S. and global economies enter a synchronized downturn, holding back the region's critical tourism industry.

The Central Coast's unemployment rate jumped to 4.3% in January – a sizable increase from 3.9% in December – amid a 12.6% surge in the number of unemployed in January.

Jobless Rate Climbed in the Central Coast

The Central Coast jobless rate is projected to average 4.7% in 2023 – up from 4.4% in 2022 – and then increase to 5.2% in 2024 as service sector employment growth slows.

Housing Outlook

Central Coast existing home sales plunged 38.3% year-on-year in February, a slight deterioration from January's decline. Home sales dropped from a year ago across the region from -35.9% in Monterey to -40.2% in Santa Barbara.

Existing home inventories are rising in the Central Coast of California. The Unsold Inventory Index surged to 3.5 months in February from 2.0 months a year ago, helping to moderate home prices. Median home prices slumped 6.2% year-on-year in the Central Coast in February. The Central Coast experienced the second largest drop among the four major regions of California, while the median price in the Bay Area is the worst, down 19.2%.

Home price decreases were broad-based in the Central Coast with double-digit declines in Monterey (-12.4%), Santa Cruz (-13.0%) and Santa Barbara (-18.1%). Home prices in San Luis Obispo dipped a more modest 4.3% as home prices in that county continue to outperform the other three counties in the region.

Home Prices Declined in All Metro Areas

Central Coast home prices are projected to drop 8.0% this year – the biggest decline since 2011 – and fall another 2.5% next year. Notably higHotel Room Demand Growth To Slow her mortgage rates and sharply slower job growth will push home prices lower.

Hotel Room Demand Growth To Slow

Tourism Economics expects daily hotel room demand in the region to slow to 5.1% year-on-year in 2023, down from 7.5% last year and an unsustainable 32.4% surge in 2021.

The Central Coast region is relatively more reliant on tourism to power economic growth. Consumer services employment, which is the sum of retail trade and leisure and hospitality, was 25.5% of total employment in 2022 in the Central Coast compared to 20.5% in the nation and 20.1% in California. A deeper U.S. downturn than expected this year could result in fewer visitors to the region and result in slower job, consumer spending and income growth for the Central Coast than currently projected.


Employment Outlook

Central Valley job growth was 0.2% in February month-on-month, on par with January and tied with the Southern California region for the smallest monthly gain. Jobs grew in just five major sectors driven by construction (+3.4%), education & healthcare (+0.7%), leisure & hospitality (+0.4%) and government (+0.3%). The biggest decreases were in information (-2.7%) and professional & business services (-1.2%).

Recent Performance and Outlook

Central Valley job growth from a year ago slowed to 2.7% from 3.1% in January. There were above average gains in seven sectors over the past year with the largest increases in education & healthcare (+6.9%), other services (+5.7%), leisure & hospitality (+5.5%) and manufacturing (+3.6%).

Employment is projected to slow to just 0.3% this year, the weakest growth of the four major regions of California. Job growth is then expected to accelerate to 0.8% in 2024, just shy of the average growth rate of 1.0% from 2008 to 2022.

The unemployment rate in the Central Valley has moved higher since reaching a record low of 4.7% in July of 2022. Despite an upturn, the jobless rate of 5.3% in January was still well-below the long run average of 9.2% from 1990 through January 2023. Traditionally, the region has had higher unemployment rates than other regions in California because of its heavy reliance on net in-migration and the more volatile agricultural and energy sectors to power growth.

The jobless rate in the Central Valley is forecast to average 6.1% in 2023 and then climb to 6.5% next year on slower job gains. This would be the highest unemployment rate since 2017 but still historically low.

Housing Outlook

Central Valley existing home sales sank 28.6% in February from a year earlier, a sharp improvement from the 43.3% plunge in January. The Central Valley housing market is still outperforming the other three regions of the state. Even so, sales declines have been broad-based across the region, ranging from -25.1% in Fresno to -34.4% in Sacramento.

Home Sales Plunged In All Central Valley MSAs

The Central Valley's Unsold Inventory Index rose to 2.9 months in February – on par with the statewide average – but up sharply from 1.9 months a year ago. Meanwhile, the median days on market spiked to 27 in February, a nearly four-fold jump from February 2022.

Median home prices in the Central Valley have dropped 3.4% from a year ago. The largest decreases were in Sacramento (-7.8%), Modesto (-5.0%) and Fresno (-4.9%). Home prices dropped a relatively more modest 2.8% in Stockton, while prices inched up 1.4% from a year ago in Bakersfield.

Home Prices Fell Modestly In Most Metros

Central Valley home prices are forecast to fall 6.5% this year – the first drop since 2011. Home price growth is then projected to slump another 3.2% in 2024.

Excessive Rain Hits Agriculture

This year's rainy season has generated a record snowpack on the southern Sierra Nevada range on the east side of the San Joaquin Valley. And water officials — already struggling with floods from a succession of winter storms that have saturated central California over the past few weeks — are confronting the prospect of even more flooding when all that snow eventually melts.

In Tulare County, as of this writing, at least 50,000 acres of ranches and farmland was inundated by floodwaters, according to estimates from the Tulare County Farm Bureau. On the east side of the county, damage was reported to citrus trees, while further west, almond trees were damaged.

A sudden snowmelt from an early season heat wave – a common occurrence in recent years – could release 2.6 million acre-feet of water into a reservoir that holds 1 million acre-feet and is estimated to be already more than 75% full. This would exacerbate flooding in the region, further damage crops, and sideline farm workers, resulting in even higher job loss and slower growth for the Central Valley than currently forecast.

To learn more, check out this week's U.S. Outlook Report.


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