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California Economic Outlook Report- September 2022

Scott Anderson
Chief Economist
Bank of the West
  • California job growth reaccelerated to a 6.0% annualized rate in July, the best monthly performance since February. Gains in construction and professional and business service jobs were particularly strong last month. California also continued to outperform the nation with job growth of 4.4% from a year ago compared to 4.1% for the United States. Even so, California has more catching up to do. Despite outpacing the U.S. for 16 consecutive months, total nonfarm employment in California is still 2.7% below its pre-pandemic peak of February 2020, while the U.S. surpassed its previous peak in July.
  • California job growth is forecast to accelerate to 4.9% this year – the fastest pace in nearly 30 years –following solid job growth of 3.2% in 2021. The acceleration in statewide job creation is underpinned by pent-up demand for travel and entertainment services, solid nominal income growth and elevated household wealth.
  • Although inflation affects everyone, low-income households are hit particularly hard. Data from the U.S. Census Bureau Pulse Survey reveals that 58.8% of California households with income under $50,000 per year were having a somewhat or very difficult time paying ordinary household expenses in July. This compares to just 18.7% of households earning at least $100,000. If consumer inflation picks up or remains elevated, low income California households will have no choice but to sharply reduce their discretionary spending.
  • The rapid improvement in the California’s labor market pushed the state’s unemployment rate down to 3.9% in July, below the pre-pandemic rate of 4.1% and a record low. Despite steady declines in the unemployment rate, California tied for the thirty eighth highest of all states in July. The state’s jobless rate is forecast to average 4.4% this year – down from 7.4% in 2021 – but average 4.6% in 2023 on slower job growth.
  • The sharp slowdown in the California housing market accelerated in July with existing home sales falling 31.1% from a year ago, down from 20.9% in June. Home sales have declined for 13 consecutive months after rising sharply from July 2020 to June 2021. Due to declining sales and poor affordability, California housing starts are projected to moderate to just 1.6% this year and decline 10.4% next year from a robust 11.4% increase in 2021.
  • California home prices have fallen 7.4% from May’s peak amid poor affordability, rising mortgage rates, and slowing housing demand. California’s median home price was up just 2.8% year-on-year in July, the slowest pace since June 2020. Home price growth is forecast at a still-strong 13.7% in 2022, primarily due to rapid gains earlier in the year. Home price growth is forecast to moderate to just 1.9% next year.

CALIFORNIA

Employment Outlook
California’s labor market continued to shine in July with job growth of 4.4% from a year ago, topping the less-robust U.S. pace of 4.1%. This is the sixteenth straight month in which the state’s employment growth has exceeded the nations.

Despite the long stretch of superior job growth, California has thus far recreated just over 97% of the 2.76 million jobs that were lost in the spring of 2020. While sizeable progress has been made to reach the pre-pandemic level of total nonfarm jobs, the state trails the U.S. which exceeded its previous peak of February 2020 in July. From a year ago, the hard-hit leisure & hospitality sector still leading the way with employment growth of 10%. Still California’s leisure and hospitality employment remains nearly 8% below its pre-pandemic peak as workers are reluctant to join and remain employed in the relatively low-paying industry despite significant recent wage hikes.

The other job sectors with above average job gains include other services (+7.1%) and information (5.3%). Other services includes equipment and machinery repair, photofinishing and dry cleaning and laundry services. Job growth in construction and professional & business services was slightly above average at 5.1% while financial services employment lagged all other job sectors with growth of just 0.8%.

Leisure and Hospitality Job Growth Led the Way
California total nonfarm payrolls are projected to climb 4.9% this year – the fastest pace in nearly 30 years – following solid growth of 3.2% last year. But by 2023, California job growth is expected to decelerate to just 1.5% – more than one percentage point below the long-run average from 1940 to 2021 – as elevated inflation and Fed rate hikes limit consumer and business demand. Over the short-term pent-up demand for travel and entertainment and steady consumer spending powered by sturdy nominal wage gains, adequate but declining savings and high levels of household wealth will drive continued job growth in the state.

California’s labor market is now fully recovered from the ravages of the pandemic based on the state’s jobless rate. California’s unemployment rate has dropped sharply since peaking at 16.1% in May 2020 and reached an all-time low of 3.9% in July, just below the pre-recession rate of 4.1% in February 2020. Even so, the state jobless rate is 40 basis points higher than the national average of 3.5% in July.

CA Jobless Rate Hit Pandemic Low in July
The state unemployment rate is projected to average 4.4% in 2022 and rise marginally to 4.6% next year on moderating job growth. While a considerable improvement from 7.4% in 2021, it will remain noticeably above the projected U.S. average of 3.7% in 2022 and 4.2% next year.

Housing Outlook
The slowdown in the California housing market accelerated in July. Single family home sales totaled an annualized 295,460 units down 14.4% from June and 31.1% lower than a year ago when home sales began to slide. California home sales have been lower year-on-year for 13 consecutive months. The level of California homes sales in July was below 300,000 for the first time since May of 2020, and pending home sales data and rising mortgage rates point to continued weakness in the coming months.

California Home Sales Plunged in July
Low housing affordability is expected to remain a significant obstacle for California homebuyers and will exert downward pressure on existing home sales through 2023. The California Association of Realtors Housing Affordability Index was at an extremely low 16% in the second quarter of 2022, down from 23% a year ago and the lowest level since the third quarter of 2007. This means that only 16% of households in California could qualify to purchase a median-priced home in the second quarter of this year.

On a somewhat positive note, reduced demand is improving California’s home inventory shortage. The Unsold Inventory Index climbed to 3.2 months from 1.9 months a year earlier. The index indicates the number of months it would take to sell the supply of existing homes on the market at the current sales pace. Still, the index remains at a moderately low level by historical standards.

There was more data in the report that confirms the ongoing cool down in the previously red-hot state housing market. The median number of days it took to sell a single-family home in California climbed to 14 in July. This is up from 11 days in June and nearly double the June 2021 reading.

California home prices are declining from recent peaks. The statewide median price was $833,910, down 7.4% from the record-high of $900,170 in May and just 2.8% higher than a year ago – the smallest annual growth since June of 2020. The price moderation is primarily attributed to a change in the mix of sales in July, as million-dollar home sales plummeted nearly 25% from June.

Home Price Gains Slowed Sharply in July
The outlook for California homebuilding over the next two years is dour. Growing home inventory, higher mortgage rates and low and diminishing affordability will dent housing demand. As a result, housing starts are projected to rise by just 1.6% this year – the slowest since starts fell 10.3% in 2019 – and plunge by 10.4% next year. California home prices grew at a blistering pace of 19.2% in 2021 – the fastest since 2013 – and are expected to rise a more moderate 13.7% this year and then slow sharply to 1.9% in 2023 – the slowest since 2019 – as higher mortgage rates and rising unemployment limit housing demand.

Inflation Hits Low Income Residents
It’s well documented that high inflation is increasingly weighing on consumers’ willingness and ability to spend. The overall consumer price index was growing a benign 1.9% year-on-year in the first quarter of 2021 before accelerating to 8.6% by the second quarter of 2022 as pent-up demand was unleashed by households, supply chains became jammed, workers demanded higher wages, and war broke out in Europe.

Although upper income households are not left unscathed by the ravages of high inflation, low income households are impacted by a far greater extent. To wit, data from the U.S. Census Bureau Household Pulse Survey for the period ending July 11 reveals that 58.8% of California households earning less than $50,000 per year were having a somewhat or very difficult time paying ordinary household expenses. This compares to 18.7% of households earning at least $100,000 in the state and 17.8% in the US.

If consumer inflation picks up or remains high, low income households will have no choice but to cut back sharply on their discretionary spending as they devote more dollars to essential items like food and gas. This is an important downside risk to our retail sales growth forecasts for California even as we expect a sharp slowdown to 1.4% growth in 2023 down from a sizzling 20.4% increase in 2021.

BAY AREA

Employment Outlook
The Bay Area labor market has outperformed the other three economic regions of the state over the last four months after lagging in the initial stages of the recovery. Total nonfarm job growth accelerated to a 6.6% annualized pace in July and increased 5.3% from a year earlier in July, easily topping second place Southern California which recorded a comparatively more modest increase of 4.2%, and the statewide average of 4.4%.

Employment increased from a year earlier in 10 of 11 sectors, led by double-digit gains in leisure & hospitality (+14.7%) and other services (+10.0%). Collectively, these two sectors were responsible for almost 30% of Bay Area job growth despite representing 12.5% of nonfarm employment. Mining & logging barely grew and financial activities were unchanged in July but those two sectors only account for 5.0% of total jobs and did little to hold back solid overall job growth in the region.

Bay Area Jobs Increased in Most Sectors
Continued solid job gains pushed the Bay Area unemployment rate down to an all-time low of 2.6% in July. Moreover, the Bay Area had the lowest jobless rate of the four economic regions with the Southern California region a distant second. The region’s jobless rate is projected to average 3.3% this year – the lowest since 2019

Recent Performance and Outlook
The Bay Area includes Alameda, Contra Costa, Marin, Napa, San Francisco, San Mateo, Santa Clara, Solano and Sonoma counties. September 2022 California Economic Outlook and then increase slightly to 3.4% next year on decelerating employment growth.

Bay Area job growth is expected to surge to 5.0% this year and then slow sharply to just 1.7% in 2023. The Bay Area has been the juggernaut of job growth recently, but that will be threatened by the recent weakness in the technology sector and global trade which will slow overall job growth next year. Furthermore, high regional home prices and other costs that push workers and companies to relocate to lower cost locales will contribute to weak population growth and weaker job growth next year.

Housing Outlook
Bay Area existing home sales dropped from a year ago for the eleventh month in a row in July and the decline accelerated sharply to 37.2% – the biggest drop since May 2020. The weakness can no longer be attributed to base effects, rather surging mortgage rates, low affordability and weaker demand are pushing home sales lower. Home sales fell year-on-year at double-digit rates in all nine Bay Area counties in July with the largest decreases in Santa Clara (-46.1%), Contra Costa (-36.0%) and Solano (-35.8%) Counties. Home sales fell the least in Napa (-32.7%), Marin (-31.6%) and San Francisco (-26.0%).

Home Sales Plunged in Every Bay Area County
The inventory of existing homes in the Bay Area improved somewhat in July but is comparatively low relative to the other three regions and the state. Indeed, the Unsold Inventory Index was 2.5 months in July, up from 2.0 months in June and 1.5 months a year earlier. As a result, the median home price declined a modest 0.1% – the first price drop since May of 2020.

Bay Area home prices are projected to climb 15.5% this year – down from 17.4% in 2021 – and then slow to 3.7% in 2023 as demand eases and the supply of homes on the market rises. Indeed, Bay Area housing starts growth is projected to decelerate sharply to 4.0% this year as increasing supply and cooling demand from higher interest rates prompt homebuilders to construct fewer homes.

Bay Area Losing Younger Residents
The pandemic and ensuing recession stripped San Francisco of a decade’s worth of population gain in a little over a year. From April 2020 to July 2021, the city lost nearly 7% of its population, going from 873,965 residents to 815,201 — the lowest number since 2010. Among those age 25 to 29 who are female, white and non-Hispanic, the population plunged by 26%. White men of the same age group saw nearly the same drop.

These population shifts make sense. People in their mid-to-late twenties in San Francisco are much less likely to own homes than older adults, making it more challenging to afford the city and easier to relocate to less expensive areas.

While the decline was glaring, there is data that points to a modest population rebound in the city. The most recent estimate from the California Department of Finance, which uses different methods than the census, put the metro’s population at 842,754 at the start of 2022 — still less than early 2020, but not as big of a drop. If the younger population returns to or tops the pre-pandemic level, our forecast for the Bay Area economy’s performance could be too conservative in the long-run.

SOUTHERN CALIFORNIA

Employment Outlook
Nonfarm employment in the Los Angeles MSA accelerated to a 7.7% annualized pace in July. For Southern California has a whole employment increased by a solid 4.2% from a year ago. This is down sharply from 5.4% in June but the second strongest growth among the four major regions of California, lagging only the Bay Area. The largest job gains were in two of the sectors that endured the biggest jobs deficits through July due to the pandemic: leisure & hospitality (+11.3%), and other services (+8.9%). Information services employment – which includes movies and sound recording and broadcasting – grew 5.2% and was the only other job sector to experience above average growth.

Trade, transportation & utilities employment slowed to 3.9% from a year ago – the first month in 2022 with growth of under 4.0% – as activity at the region’s two largest ports fell to 2.7% year-on-year from 7.0% in June. The only sectors that did not add jobs from a year ago were mining & logging (-0.2%) and financial activities (-6.0%). Meanwhile, government employment – which had expanded by at least 3.0% for the last eight months – increased just 1.4%, the slowest pace since August 2021.

So. California Employment Rose in Most Sectors
Total nonfarm employment growth in Southern California is projected to improve markedly to 5.1% this year and slow to only 1.9% in 2023. A somewhat higher exposure to jobs in recreation, entertainment, television and film production and leisure & hospitality will propel the sharp spurt in employment growth this year as service sector businesses ramp up hiring to meet steady demand.

The region’s labor market is healing at a fairly rapid pace with the unemployment rate falling to a post-pandemic low of 4.0% in July, down from 4.3% in June. That is just above the statewide average of 3.9% and the pre-pandemic rate of 3.9%, but nearing the record-low of 3.8% in June 2019. The Southern California jobless rate is projected to average 4.8% this year – the lowest since 2019 – and then edge up to a 5.0% next year on slower job growth as the Fed’s interest rate hikes begin to bite and elevated inflation limits consumer spending gains.

Housing Outlook
The already-reeling Southern California housing market weakened further in July with existing home sales plunging 35.9% from a year ago, the thirteenth straight year-on-year drop.

The sharp decline in home sales in the region in July pushed the year-on-year gain in the median home price down to 6.7% from 8.5% in June. Prior to June, home prices had risen at double-digit rates for 22 consecutive months.

Home price growth was fairly uniform across most counties in the region over the last year with the exception of Los Angeles, which experienced a fairly weak gain of 4.5%, down from 8.1% in June. Home price growth in the remaining four counties ranged from 9.6% in Riverside County to 12.9% in Orange County with home prices in San Bernardino and Ventura rising around 11.5%.

Home Prices Rose in All So. California Metros
Southern California’s home prices are forecast to rise 15.4% in 2022 – down from 19.3% last year – and then moderate sharply to 2.1% next year with home demand sagging on higher mortgage rates, low affordability and a rising jobless rate.

Regional Trade Boom is Fading
Inbound container traffic in Southern California surged as the US emerged from the initial stages of the pandemic and consumer goods demand and spending exploded. Inbound containers grew at eye-popping double-digit rates year-on-year for 11 consecutive months with a peak growth rate of 97.5% in March 2021. As a result, goods price inflation and transportation and shipping costs jumped around the same time.

Total Inbound Container Growth Has Stalled
Today however, Southern California’s trade boom is clearly over. Inbound container growth has been nearly flat all year and will likely deteriorate in the months ahead. Expect fewer trade and transportation jobs at the ports next year.

CENTRAL COAST

Employment Outlook
After rising by an average of close to 6.0% in the first six months of the year, employment gains in the Central Coast slowed sharply to 3.0% from a year ago in July. Despite 16 straight months of year-on-year job increases, total nonfarm employment in the region is still 2.1% below its February 2020 peak. The Central Coast has an above-average exposure to tourism and employment in the region’s leisure & hospitality and other services sectors is 7.0% and 6.7% below pre-pandemic levels respectively. Employment growth in the region is largely being powered by leisure & hospitality (+6.3%), other services (+5.6%) and education & healthcare (+4.9%). In total, these three sectors are about 34% of total nonfarm employment in the region and accounted for almost the same amount of job growth over the past year.

Job gains in government were slightly below average (+2.7%) and growth slowed sharply from 5.6% in June. Professional & business services, mining & logging, financial activities and trade, transportation & utilities all grew less than 1.0% and limited overall employment growth

Employment Increased in All Sectors
Total nonfarm employment growth in the region is projected to accelerate to a strong 4.2% this year and then drop to 1.2% in 2023. Demand for travel is expected to remain solid for the rest of the year, supporting the region’s all-important tourism industry.

Above average job growth pushed the unemployment rate down to 4.3% in July, a slight drop from 4.4% in June. The steady labor market recovery has pushed the Central Coast’s unemployment rate just below the pre-pandemic level of 4.5% for the last two months although it remains slightly above the record-low of 4.1% in March 2022.

The Central Coast unemployment rate is forecast to average 4.5% this year – a solid improvement from 6.7% in 2021 – and then rise to 4.8% next year as travel and consumer spending slows on higher interest rates and elevated inflation.

Housing Outlook
Central Coast existing home sales plunged 37.3% year-on-year in July – the steepest drop among the four regions. While declines from a year ago were broad-based across the Central Coast, home sales in Santa Barbara plummeted 50.3%. Decreases were large but comparatively more modest in Santa Cruz (-36.8%), San Luis Obispo (-31.5%) and Monterey (-29.3%). Weaker demand is largely to blame, but a lack of existing homes listed for sale – the Unsold Inventory Index was 3.2 months in July, on par with the statewide average – is still an issue.

The lean inventory is reflected in the solid 9.3% annual growth in the median home price in the Central Coast in July despite the sharp decline in home sales. Home prices grew at double-digit rates in San Luis Obispo (+12.6%) and Monterey (+11.5%), while prices rose at a relatively slower rates in Santa Barbara (+7.7) and Santa Cruz (+4.2%).

Home Prices Climbed in All Metros
Central Coast home prices are forecast to rise 16.1% this year – down slightly from 19.5% in 2021 – and then decline 0.5% in 2023, the first drop since 2011. Homebuilders will respond to the weaker demand with housing starts dipping 1.5% this year and plunging 18.5% in 2023.

Hotel Room Demand Has Rebounded
The region’s dependence on tourism to support its economy meant the region was devastated by the pandemic and the subsequent closure of service businesses in 2020.

Fortuitously, there might be some relief on the horizon for Central California. Tourism Economics is forecasting daily hotel room demand to close in on the 2019 level this year and then surpass it in 2023 and 2024. If so, hospitality employment could increase more than anticipated and lift overall job growth above our projection in 2023 and support additional consumer spending.

CENTRAL VALLEY

Employment Outlook
Total nonfarm job growth slowed to just 3.5% in July from a year ago, the smallest gain of all four regions and the slowest pace since growth rebounded in April 2021. Job gains were pervasive across most sectors with the strongest upturns in other services (+7.7%), leisure & hospitality (+5.7%) and construction (+4.5%). Growth was just 0.1% in manufacturing and employment fell 1.3% in financial services.

Jobs Declined in Just One Sector in July
Central Valley employment is projected to advance 4.2% this year, tied with the Central Coast for the slowest rate of growth. Job growth is then forecast to moderate to 1.3% in 2023.

The unemployment rate in the Central Valley has declined for 15 consecutive months and reached a record low of 4.7% in July. Despite the continual improvement, the jobless rate in the Central Valley was the highest of the four major regions in California, Historically, the region has had higher unemployment rates than other regions of the state because of its heavy reliance on the agricultural and energy sectors for growth.

The unemployment rate in the Central Valley is projected to average 5.5% in 2022 – tied for the lowest since 2019 – and then rise to 5.9% in 2023 on moderating job growth. Despite the increase, the unemployment rate next year would be well below the long-run average of 9.8% from 2008 to 2021.

Housing Outlook
Central Valley existing home sales slumped 27.3% in July from a year ago. This is the fourth year-on-year decline in a row after home sales rose slightly in February and March. The drop in home sales in the Central Valley was the smallest of the four major economic regions in the state, partly because homes are relatively more affordable here.

Home sales decreased in all five counties with the biggest declines in Stockton (-39.0%) and Modesto (-34.1%). Decreases were more modest but still large in Sacramento (-30.2%), Bakersfield (-23.8%) and Fresno (-21.2%).

Home Sales Fell Hard In All Central Valley MSAs
Higher mortgage rates are curbing housing demand but improving existing housing inventory. Indeed, the Central Valley’s Unsold Inventory Index improved to 3.1 months in July from 1.9 months in July 2021. Moreover, the median number of days on the market rose to 12 from seven one year ago, possibly marking the beginning of a more balanced housing market.

Home price growth in the region moderated to 6.2% year-on-year in July from 10.0% in June and 12.4% in May. Home prices climbed by double-digit rates of 10.0% in Fresno and Bakersfield and increased more modestly in Stockton, Sacramento and Modesto.

Home Prices Rose in All Central Valley MSAs
Central Valley home prices are forecast to climb 15.5% this year, the third year in a row of double-digit home price gains. Home prices are expected to decline 1.0% in 2023 as home demand weakens sharply on higher mortgage rates and slowing job growth.

Cost of Drought Comes Into Focus
The 2022 California drought is harsh by historical comparisons. After an encouraging start to the rainy season, the lack of precipitation in the first two months of this year left the state with such a deficit that even some snow and rain in March and April left water tables, the snowpack and reservoirs in bad shape. Moreover, the water situation for Sacramento Valley agriculture is as bad as it ever has been, as revealed in numerous ominous announcements of large cutbacks in projected irrigation availability.

A University of California Davis study projects the 2022 drought is likely to cause a loss of about 14,300 jobs and an economic loss of about $1.315 billion in the Sacramento Valley, which is part of the Central Valley. This includes reduced direct farm and ranch output in the Sacramento Valley by about $950 million, a decline of more than 20%.

A loss of jobs on that scale in the Sacramento Valley adds to the downside risks for Central Valley employment and retail sales in the outlook, especially if the drought persists or worsens in the fall.

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

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