September 24, 2003

By David F. Seiders
NAHB Chief Economist

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Economic growth is accelerating but there are dark sides to the picture …
Incoming data (including housing data) confirm the acceleration in growth of economic output that we have been forecasting for the second half of 2003. Indeed, we’ve recently upgraded our estimate of third quarter Gross Domestic Product (GDP) growth to 5.0% and jacked up the next three quarters as well (to an average of 4.1%).

The heavily front-loaded tax package that went into effect on July 1 clearly is stimulating consumer and business spending, heavy federal spending on defense and security is in train, and the Federal Reserve is supporting the economy with a highly stimulative monetary policy stance.

The problem is, growth in economic output has been generated by growth in labor productivity (output per hour) during the 22 months of economic recovery that we have under our belts, while payroll employment has been shrinking during this entire period. Furthermore, the productivity surge has been reducing labor cost per unit of output, putting downward pressure on prices in an environment where individual companies can exert little, if any, pricing power. If you’re worried about Japanese-style deflation in the U.S. (as is the Fed), this edge of the productivity sword is quite troublesome.

The economic recovery will not qualify as a bona fide expansion until job growth turns positive (and accelerates) and the threat of deflation is behind us. The key is growth in spending and economic output that is strong enough to virtually force the business community to increase hiring to meet the demand. NAHB’s forecast assumes that the hiring process will begin in earnest during the fourth quarter and move ahead nicely in 2004-2005. But it’s fair to say that productivity growth is a mysterious process that sometimes has unforeseen consequences.

The Fed holds the line on rates and frets about jobs and disinflation …
As we expected, the Federal Reserve held its federal funds rate target at 1% at the September 16 FOMC meeting, and the decision was unanimous. The FOMC noted that spending in the economy had been “firming” since the previous (August 12) meeting, that the labor market had been “weakening,” and that business pricing policy as well as increases in core consumer prices had remained “muted.” This, of course, is the conundrum discussed above.

The public statement issued by the FOMC retained the three-part risk assessment that was introduced at the May 6 FOMC meeting. The FOMC now gives separate risk statements regarding real economic growth and inflation prospects, and then gives an overall assessment that presumably tells us something about monetary policy “ leanings” for the future.

In this case, the FOMC said that the upside and downside risks to sustainable economic growth were “roughly equal” but that the probability of an unwelcome fall in inflation from its already low level “exceeds that of a rise in inflation.” Indeed, the FOMC said that the risk of inflation becoming undesirably low (i.e., threatening outright deflation) “remains the predominant concern for the foreseeable future.”

The weight of the disinflation/deflation concern led the FOMC to conclude that “policy accommodation can be maintained for a considerable period.” NAHB’s forecast shows a stable federal funds rate until mid-2004, followed by gradual increases toward monetary neutrality over the following two years. The financial markets seem to share this general assessment, as the futures market for federal funds shows only minor probabilities for a policy change prior to mid-2004. [return to top]

The bond market now believes the Fed is on the right track …
It’s clear that the Fed got the bond market overly excited in May and early June when messages from the central bank seemed to suggest aggressive near-term monetary easing as well as imminent use of unconventional policy tools to drive long-term rates down. But then the Fed backed away from the unconventional policy concepts and disappointed the markets with a meager quarter-point cut in the federal funds rate at the June 25 FOMC meeting. This sequence of events drove long-term rates down to historic lows in mid-June (5.2% for the fixed-rate mortgage) and then provoked a sharp rebound that sent those rates upward into early September (the mortgage rate approached 6.5%).

Bond and mortgage market conditions have settled down quite a bit since early September, largely because of reduced uncertainty regarding Fed plans and intentions. In the process, the 10-year Treasury yield has gravitated toward 4.2% while the fixed-rate mortgage has moved down to 6% — about equal to the averages for the third quarter. While long-term rates may gravitate higher as economic growth strengthens, Fed stability and a very low inflation environment should contain long rates for at least several more quarters. [return to top]

The housing sector is constructing a strong third quarter and forward momentum is substantial ...
Housing starts recently were revised upward for both June and July and, despite a 3.8% decline, starts for August hit a robust seasonally adjusted annual rate of 1.82 million units. Furthermore, issuance of building permits soared to a 1.89 million rate, including an all-time high for the single-family sector (1.48 million) and a robust 411,000 pace for multifamily. As a result, the number of housing units authorized by permit but not yet started (so-called “backlogged starts”) rose to 179,000 at the end of August, boding well for starts activity in September.

Available survey data for September also are positive. NAHB’s Housing Market Index (based on surveys of single-family builders) edged off in September following a powerful rise in August, but the component for builder sales expectations held at an elevated level (78). The weekly survey of mortgage lenders conducted by the Mortgage Bankers Association showed solid readings for home purchase applications for the first three weeks of the month, and the recent decline in mortgage rates has even revived the refinancing market to some degree following a massive plunge from the June records.

It now appears that housing starts will surge to more than 1.8 million units for the third quarter, paced by a single-family market that will approach 1.5 million. This kind of performance is likely to push growth of the housing production component of GDP (residential fixed investment) toward an annual rate of 10%. While this performance will be hard to maintain, the fourth quarter promises to remain strong and we now expect housing starts to reach 1.76 million units in 2003, about 3% above the strong performance of 2002. [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 provides a rigorous monthly overview of the economy, along with monthly 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.

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