The Fed holds the line on rates but changes the message …
The Federal Reserve held monetary policy steady at the May 4 meeting of the Federal Open Market Committee (FOMC), keeping the federal funds rate target at 1%. As expected, however, the Fed substantially altered the message conveyed by the FOMC press release, indicating that shifting economic conditions are likely to prompt monetary tightening sooner than previously anticipated.

The key changes in economic conditions since the last FOMC meeting on March 16 involve a surprising pickup in payroll job growth as well as a firming up of measures of core inflation in March. The FOMC statement said that “hiring appears to have picked up” and that “incoming inflation data have moved somewhat higher.”

The FOMC still views the upside and downside risks to sustainable economic growth as “roughly equal” but now also views the risks of rising and falling inflation as balanced. That means the Fed is no longer concerned about the possibility of deflation.

The Fed’s signals about future policy prospects no longer are couched in terms of “patience.” However, the FOMC statement continued to refer to low (if not falling) inflation as well as slack in resource markets (particularly the labor market), and stressed that the current extraordinary degree of policy accommodation “can be removed at a pace that is likely to be measured.” That means the Fed is in no rush to start raising rates and that the rate increases, when they begin, are likely to be gradual.

The financial markets are digesting the new Fed messages reasonably well …
The recent data on both employment growth and core inflation had altered market expectations of future Fed action prior to the May 14 FOMC meeting. Thus, release of the FOMC statement had little net impact on either the interest rate structure or the stock market, following a brief and inevitable period of instability as the markets sorted out the Fed’s messages.

As the dust settled, the 10-year Treasury yield gravitated toward the 4.5% level established before the FOMC meeting, and the long-term home mortgage rate held around 6%. While these rates are 65 to 75 basis points above their recent lows in March, they still are quite low on an historical basis. [return to top]

Market expectations of inflation and Fed behavior in line with NAHB’s interest rate forecasts …
Current levels of long-term rates reflect market expectations of inflation that appear to be within the Fed’s unspoken target range (1.5% to 2.0%), and the FOMC statement actually went out of its way to make that point. Long-term rates also incorporate expectations of future short-term rates, and the Fed controls the short end of the rate structure. The markets are placing high probability on an initial rate hike by the Fed this summer (June 30 or Aug. 10), followed by a “measured” process that will gradually raise the federal funds rate toward a neutral position that neither stimulates nor impedes the economy.

NAHB’s forecast currently assumes that the Fed will raise the funds rate by 25 basis point at the Aug. 10 FOMC meeting and that this short-term rate will be 1.5% by the end of 2004 and 3.0% by the end of 2005.

Long-term rates are bound to rise to some degree as this process unfolds, even though current rate levels already incorporate expectations along those lines. We currently expect the fixed-rate home mortgage to be around 6.3% by the end of this year and 7.0% by late 2005. [return to top]

The shifting economic and financial market tides have not weakened the housing outlook …
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 and the earlier Fed tightening provoked by the sudden brightening of the job market and the pickup of core inflation are bound to exert some drag on housing demand over time (the initial effects actually appear to be positive).

So where does all this leave the housing sector? Frankly, a pickup in growth of employment and household income, along with associated upward pressures on interest rates, has been part and parcel of NAHB’s forecasts for some time. The only real surprise relates to timing, as things have happened faster than expected.

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 employment and inflation reports. Actually, the whole package of developments strengthens the chances that our upbeat forecasts for housing and the economy will be achieved. [return to top]

Home prices also have firm foundations, and price 'bubbles' are rare …
The recent surge in interest rates has energized various media sources and market analysts who have been beating the house price “bubble” drum for years. The higher rates, they theorize, will burst house price bubbles in a lot of places, and analogies are being drawn between the current situation and both the early 1980s and 1990s when price declines were recorded in some areas.

The analogies to those earlier periods actually are quite strained for a number of reasons. First, recent rates of price increase have not approached the outsized increases recorded in many areas prior to the declines of the early 1980s or early 1990s. Second, the recent episode has not involved acceleration of house prices and unsold inventories at the same time, a combination that suggests unhealthy speculation. Third, the earlier price reversals occurred during periods of serious economic dislocation when job losses were mounting and various markets were experiencing serious out-migration as a result. We’re now almost 2-1/2 years past the bottom of the national economic recession of 2001, employment growth is picking up nicely for the nation and employment levels have bottomed out in virtually all markets.

When confronted with such compelling counterarguments, some bubble theorists point to high vacancies and rent concessions in rental housing and contend that shifts from ownership to rental tenure will upset the excellent supply-demand balance in the single-family market and lead to price declines. But how many home owners will give up their dream homes and their historically low mortgage payments (that are locked in for many years) to grab at temporary rent concessions down the street? [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.

Housing Economics and Housing Market Statistics are also available through BuilderBooks.com for a special combination rate.  

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.