July 30, 2003

By David F. Seiders
NAHB Chief Economist

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The recession is officially over but the recovery remains a mystery to most Americans …
On July 17, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER) declared that the economic recession that began in March 2001 hit bottom in November 2001. That means we’re now 20 months into the current economic recovery, a fact that seems to have eluded the general public. Indeed, recent polls show that the vast majority of Americans think the economy still is in recession, and a substantial setback in consumer confidence for July (Conference Board series) accentuates that point!

There's a disconnect here because the NBER panel of economists focuses heavily on economic output (real GDP) while the general public focuses heavily on the job market. In fact, real GDP has risen substantially since November 2001 while payroll employment has fallen by almost a million jobs and the unemployment rate has moved up from 5.6% to 6.4% (by June) in the process. Thus, the 20 months of GDP growth resulted entirely from growth in labor productivity (output per hour) as American businesses cut back on hiring in an aggressive attempt to control costs and boost profit margins. It’s no wonder that job market assessment in the July consumer confidence survey fell to the weakest reading in nearly a decade.

The weak economic recovery should soon morph into bona-fide expansion …
The worse-than-jobless economic recovery has disappointed not only the American public but also the Bush Administration, which undoubtedly has vivid memories of the 1991-1992 jobless recovery that effectively ushered the elder Bush out of office. But the stars now are aligned to produce growth in economic output that will be strong enough to generate solid improvements in the job market well before next year’s elections. And we’re now at the cusp of transition from weak recovery to bona-fide expansion that should lift both the U.S. and global economies out of the doldrums (note the close connection between astrology and economic forecasting).

The economy was primed for a second-half upshift by a number of favorable developments in stock, bond, currency and energy markets after the conclusion of major hostilities in Iraq, and most of those preconditions still are in place (the recent upshift in long-term rates is discussed below). Furthermore, a double-barreled monetary/fiscal policy push is now being applied in the wake of the Fed’s cut in short-term rates on June 25 (to 1%), and implementation of the heavily front-loaded $350 billion tax cut bill on July 1. Federal spending on defense and homeland security also is ramping up, helping to offset weakness in spending by state and local governments. [return to top]

Tentative signs of the second-half upshift are dribbling in …
Despite the recent erosion of consumer confidence, a number of economic indicators suggest that economic momentum now is improving to some degree — a conclusion reinforced by systematic improvements in the Conference Board’s index of leading economic indicators during the second quarter. The housing sector continues to be a pillar of strength (more on that below) and there’s gathering evidence of a turnaround in the beleaguered manufacturing sector — pointing toward pickups in business spending on both capital equipment and inventories. There’s even evidence of some evolving improvement in the labor market in recent weeks, signaled by declines in initial claims for unemployment insurance as well as in the level of insured unemployment.

The second-half rebound still is practically all forecast, of course, but NAHB is reasonably confident that economic growth will shift up to about 4% (more than double the first-half pace) and that the labor market will show systematic improvement as a result. Economic momentum should remain quite good in 2004, aided and abetted by favorable monetary and fiscal policies, and the U.S. growth engine should be able to drag other parts of the world economy (including Europe) to a higher plane as well. [return to top]

Long-term interest rates have jumped dramatically, complicating the picture at the wrong time ...
The 10-year Treasury yield hit a cyclical low of 3.1% on June 13 but now stands at 4.3% — a major upshift for sure. How could this have happened in a lackluster economy with virtual price stability and an openly friendly central bank?

The answer comes down to massive swings in psychology in the bond markets, swings that were provoked largely by shifting messages from the Federal Reserve. The Fed fretted about potentially destructive deflation in the U.S. at the May 6 FOMC meeting, the first time our central bank had expressed such a concern during its long and distinguished history. And in the wake of that meeting, Chairman Greenspan and other Fed spokespersons kept stressing the tenuous nature of the post-war economic rebound, the threat of deflation (using Japan as example) and the possible need for unconventional monetary policy weapons to pull long-term rates down. These story lines made market participants expect further cuts in the federal funds rate, maintenance of very low short-term rates for a long time and a substantial flattening of the yield structure. This psychology kicked off aggressive buying of Treasury bonds that drove their yields down to the lows of mid-June.

But a funny thing happened on the way to the June 25 FOMC meeting. Messages from the Fed started to show more confidence in the second-half economic rebound, less concern about prospective deflation and less interest in unconventional policy weapons. The Fed went ahead with a quarter-point cut in the funds rate at the June 25 meeting and continued to talk about a (minor) threat of deflation, but the bond markets were left cold and long-term rates surged. Then Chairman Greenspan delivered the Fed’s semiannual Monetary Policy Report to the Congress in mid-July.

The Chairman made an explicit pledge to keep short-term rates low “for as long as it takes to achieve a return to satisfactory economic performance.” But FOMC economic projections contained in the Fed’s report showed that monetary policymakers expect that goal to be achieved before terribly long, and the Chairman downplayed the need for unconventional policies to haul long rates down.

The other shoe dropped on the bond market just as Chairman Greenspan was dealing with the Congress. The White House budget office released revised estimates and projections for the Federal budget deficit, showing much more red ink than previous projections for fiscal 2003 and 2004. Greenspan picked up on this development, warning of the upward pressure that persistently large deficits eventually would put on long-term rates. These comments, along with the shift in Fed messages about monetary policy, put immediate upward pressure on long rates. [return to top]

Despite the heavy drama, the jump in long-term rates should not short-circuit the expansion …
Long-term rates have jumped in recent weeks but they still are quite low. Furthermore, a number of forces should put a lid on any further increases and might even shepherd rates back down to some degree. After all, the inflation picture is incredibly benign, there’s a lot of slack in resource (labor and capital) markets, and the steepening of the yield structure will cause credit demands to gravitate to shorter-term instruments. It’s also noteworthy that spreads between yields on Treasury bonds, on the one hand, and both corporate bond and mortgage-backed securities yields, on the other hand, have been narrowing as the Treasuries have risen, holding down the cost of long-term credit to the private sector.

And then there’s the Fed. While the central bank may have whipsawed the bond markets with its shifting messages, the Fed is not going to allow misbehaving long rates to short-circuit the smart economic expansion that the FOMC has projected for the second half of this year and 2004. We currently expect the Fed to simply hold the funds rate at 1% for another 10 months, but the Chairman has stressed that monetary policy could be even more stimulative, if necessary, to achieve those projections. [return to top]

Home buying and home building remain strong, refinancings contract and rental vacancies rise …
Home sales, house prices, single-family housing starts and single-family permits turned in strong performances in June, capping an excellent first half. There was some slippage in multifamily starts and permits, reflecting ongoing shifts of households from rent to own and associated increases in rental vacancy rates (up to 9.6% in the second quarter), but even this sector held surprisingly firm through mid-year.

Available indicators for July show ongoing strength in demand for single-family homes despite a substantial increase in long-term home mortgage rates from the lows of mid-June (about 80 basis points to date). NAHB’s Housing Market Index actually posted a modest gain in July, reflecting increases in builders’ assessments of buyer traffic as well as current and expected home sales. And the Mortgage Bankers Association's weekly survey of lenders shows that applications for mortgages to buy homes were hanging around record levels through the week of July 25.

It’s clear that the impacts of sharply rising Treasury bond rates (about 120 basis points to date) on the demand for single-family homes are being blunted by two factors: 

  1. A narrowing spread between the 10-year Treasury rate and the long-term home mortgage rate (an expected development in a rising rate environment)
  2. Heavier usage of adjustable-rate mortgages by home buyers (reflecting the higher and steeper yield structure)

The ARM share already is above 20%, up from about 13% in mid-June when the yield structure bottomed out, and history shows that there’s still a lot of reserve in the ARM “shock absorber.”

The jump in long-term mortgage rates naturally has taken a heavy toll on refinancings, which hit a record pace in June. The MBA’s refinance index already is down to less than half the recent peak and further slippage is in store. That’s not good news for homeowners or for the economic outlook, but the implications are hardly devastating. Indeed, Chairman Greenspan recently reminded us that homeowner access to accumulated housing equity comes mainly through turnover of the housing stock, and sales of existing homes figure to remain quite strong as the economic expansion progresses. [return to top]

Want more economic information? Find it in our publications.
Find more in-depth information in our three economics publications, Home Builders Forecast, Housing Market Statistics and Housing Economics. All are availaible by subscription. 

  • Home Builders Forecast includes analysis of single-family and multifamily residential activities, residential remodeling and the full range of nonresidential construction as well as the macroeconomic factors such as GDP, employment and interest rates that drive construction. If your business depends on reliable estimates of housing starts, construction spending and remodeling activity, Home Builders Forecast is designed to meet your needs.
  • Housing Market Statistics contains an overview of important developments and trends that serves as an executive summary of the current industry situation. It also contains annotated charts depicting movements in key indicators and tables providing monthly, quarterly and annual data for more than 250 variables.
  • Housing Economics is our monthly rigorous overview of the economy, data for more than 100 local markets and in-depth analyses of the niches and nuances of home building markets. Available online or in print, it is written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

To learn more or to order any of these three NAHB economic publications, visit the Economics Publications Information section of the NAHB Web site or call 800-223-2665. [return to top]

For more information or to contact us directly, please visit www.NAHB.org l ©2003, National Association of Home Builders