Payroll employment growth surges well beyond expectations …
The first 21 months of the current economic recovery (beginning in late 2001) were marked by systematic losses of payroll employment, and only meager job growth had been recorded for the Sept. 2003-Feb. 2004 period. But on April 2, the Labor Department reported a surge of payroll employment for March (308,000) and also revised both January and February upward substantially. The new and revised numbers were a big surprise to the forecasting community as well as to financial markets.

In view of the vagaries of the labor market data, it’s hard to be sure that payroll employment now is truly in gear. But it’s also true that the previously reported payroll job weakness was straining credibility, especially since other (independent) sources of information were suggesting better labor market performance. Thus, it’s a good bet that the job market genuinely turned a corner in the first quarter.

The new job pattern fundamentally alters the economic landscape …
The new payroll job pattern for the first quarter suggests that the final piece of the maddening economic recovery puzzle finally is falling into place. That’s a comforting thing for forecasters that have been scrambling to rationalize persistently strong growth of economic output (GDP) and persistently weak payroll employment. It’s also cause for celebration by a Bush camp that’s been trying to put a good face on a job market situation that, until now, has looked pretty dismal.

If the job market is truly in gear, we’ve now got a full-fledged economic expansion on our hands. That means both employment and personal income growth will be accelerating, providing stronger foundations for economic activity during the second half of this year and in 2005. That’s great news, since the period beyond mid-2004 has been considered vulnerable to an economic setback as the temporary stimulus from last year’s tax-cut bill inevitably fades away.

But it must be realized that full-fledged economic recovery has some sobering consequences for the interest rate structure, some of which have already been felt. For housing, the ultimate outcome will be determined by the tug-of-war between better “real” economic fundamentals and a less favorable interest rate environment. [return to top]

Long-term interest rates bounce upward …
The surprisingly strong payroll employment data released on April 2 caught the markets off guard. The news provoked large purchases of corporate equities and large sales of bonds, and long-term interest rates moved up by about 25 basis points during the day — an adjustment that essentially has held to this point.

In a nutshell, market participants concluded that the economic expansion has real legs after all, that inflation issues may arise sooner than previously anticipated, and that the Fed may start raising short-term interest rates sooner rather than later. That’s a prescription for higher bond and mortgage rates now and in the future. [return to top]

Monetary policy is being reassessed at this time …
At the conclusion of the March 16 Federal Open Market Committee (FOMC) meeting, the Fed said that it “can be patient” in removing the current extraordinary degree of monetary policy “accommodation”— a nominal federal funds rate of 1% and a real rate around zero. This position was premised upon substantial slack in the labor market (as measured at that time) and maintenance of very low inflation.

The new and revised readings on payroll employment presumably will alter the Fed’s assessment of evolving conditions in the labor market as well as the inflation outlook. But there’s still a great deal of slack in the labor market and core inflation still is running very low — despite rising import prices (due to the falling dollar) and rising commodity prices. Furthermore, the Fed is not about to be swayed by a reported jump in payroll employment that could be revised downward and that may not be sustained in coming months. [return to top]

‘Patience’ still could prevail for the balance of 2004 …
“Patience” still is the watchword for the Fed, but sustained improvements in job growth could provoke some monetary tightening before the end of the year. Tightening seems out of the question at the next FOMC meeting on May 4, since that meeting precedes release of labor market data for April. Employment data for April and May will be available by the June 30 FOMC meeting, and June-July data will be available for the August 10 meeting.

If the Fed does not pull the trigger by August 10, stable policy is likely for the balance of 2004 (partly because of the November elections). January 2005 may still be the best bet, and NAHB’s forecast will retain that assumption for now. Higher-than-expected oil and gas prices, along with the resurgence of international terrorism and military operations in Iraq, reinforce that assumption since the Fed must consider those negatives for the U.S. economy in setting monetary policy. [return to top]

The evolving economic and financial market picture is still very good for housing …
The economic recovery process has quickly evolved from a jobless affair into a full-fledged expansion involving strong growth of economic output together with highly respectable job growth. The job growth, in turn, inevitably will generate stronger growth of personal income as the expansion proceeds.

These developments are all positive for housing demand. But the higher long-term interest rates provoked by the sudden brightening of the job market are bound to exert some drag on demand over time (the initial effects actually could be positive). Furthermore, persistently strong job growth could provoke the Fed to start raising short-term rates sooner rather than later and the markets are reassessing monetary policy prospects at this time.

So where does all this leave the housing sector? Frankly, a pickup in growth of employment and household income and associated upward pressures on interest rates have been part and parcel of NAHB’s forecasts for some time. The only real surprise relates to timing — the abrupt improvement in job growth, the knee-jerk reaction in the bond market and the possibility of Fed action this year.

Rising interest rates are never a pleasant surprise, but the cause of the recent jump definitely is a plus for housing. At this point, we’re assuming that the interest rate negatives and the job/income positives roughly balance out, leaving NAHB’s housing forecasts about as they were prior to release of the stunning payroll employment data. Actually, the whole package of developments increases the probability that our upbeat forecasts for housing and the economy will be achieved. [return to top]

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