Years from now, when the bards of economic lore regale audiences with tales of the Great Pandemic of 2019-22, few stories will be more captivating than the ones based on the U.S. construction sector.
The data has all of the dramatic elements of the day: rampant inflation, acute labor shortages, large-scale supply chain disruptions, seismic cultural shifts, lots of exposure to interest rate risk, an unprecedented level of pent-up demand.
And to think we get to live through all of this in real time.
For plastics materials suppliers and processors in this sector, I expect strong demand to continue for the remainder of 2022. However, the pace of growth will decelerate as the year progresses.
Jerome Powell has signaled that the Fed will be increasingly aggressive in its efforts to quell the rate of inflation. There is no way of predicting what the Fed will do, but no sector provides a better illustration of the complicated cause-and-effect relationship of inflation than the construction sector. Here is what I see in the current data as we embark on a new phase of Fed tightening.
Despite all of the turbulence reflected in some other sectors, total U.S. construction spending increased by a robust 12 percent in the first quarter when compared with the same period in 2021. Total spending for residential projects jumped almost 19 percent, while spending in the nonresidential segment increased a very respectable 6 percent.
I have graphed the historical 12-month rates of change for the data. The chart shows there was a brief dip in residential spending in 2019 with the onset of COVID-19, but spending levels started to recover in the second half of 2020. By 2021, the pace of growth hit another gear. Overall, the rate of change coming out of the moderate cyclical dip in 2019 has been much stronger than I expected, given the historical patterns.
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If you look at the longer-term demographic data, it was apparent that the residential construction sector was underperforming since the housing bubble burst in 2008. In an attempt to explain this subpar performance, there were stories of millennials living in their parents' basements and waiting to start their own households until they were older.
This did not square entirely with the data on household formation, which was showing steady expansion during most of this period. And during all of this time, interest rates were at historically low levels. So the reason for underinvestment for such a long period in new housing is still not entirely clear. But none of that really matters now because the pandemic changed everything.
Higher interest rates are needed to put the brakes on the demand pressure in this market segment and overall inflation in the economy. But how much higher and how fast they must be raised are definitely open questions. In my opinion, activity levels in the residential housing sector for the next year or two will be the most vital indicators for understanding the U.S. economy.
For the processors and suppliers that are affected by the trends in the nonresidential sector, the historical pattern is a significantly different one. But there are still some trends worthy of mention.
The rate of growth in the overall nonresidential data did not fall into negative territory in 2019. These types of projects are longer term in scope, and the short duration of the downturn in 2019 combined with massive amounts of federal relief kept overall spending levels positive that year.
By 2020, the combination of supply chain disruptions, labor shortages and shifting cultural behavior patterns took its toll. Total spending for nonresidential projects actually declined by 3 percent — a sharp contrast from the unprecedented 23 percent spike in residential data.