September 22, 2004

By David F. Seiders
NAHB Chief Economist

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The economy regains balance as growth rebounds, job formation rises and core inflation recedes …
The current economic expansion began around the end of 2001. The early stages were quite weak, characterized by tepid economic growth, net job losses and declining inflation. The expansion looked better by late 2003 as growth picked up, the job market responded and inflation stabilized above zero — avoiding outright deflation.

But the economic patterns took several turns for the worse during the first half of 2004 as inflation accelerated too much, economic growth slowed abruptly and the job market faltered. Indeed, a mid-year economic “soft patch” involved slippage of output growth into the red zone (June) and a virtual stall-out of payroll employment growth (June and July).

Recent data suggest that the economy has found its legs, and the near-term outlook has brightened considerably. Economic growth bounced back in July, and growth of real Gross Domestic Product (GDP) apparently rebounded to about 4% in the third quarter. Job formation rose nicely in August to 144,000, and weekly data on claims for unemployment insurance suggest a similar pace in September. On the price front, key measures of core inflation (excluding food and energy) have slowed down from the elevated pace earlier in the year.

The economy now seems to be in a self-sustaining growth mode, despite a drag from high energy prices and fading stimulus from both monetary and fiscal policy. The long-awaited recovery in the manufacturing sector now is supporting economic growth, and falling unemployment rates and rising capacity utilization rates show that slack in labor and capital markets is being sopped up. These patterns should be maintained for some time.

The Fed tightens again and continues to talk about a ‘measured pace’ of future rate hikes …
As widely anticipated, the Fed hiked its target for the federal funds rate by 25 basis points at the conclusion of the Sept. 21 Federal Open Market Committee (FOMC) meeting. This was the third consecutive quarter-point increase since June 30, bringing the funds rate up to 1.75%.

The Fed’s press release painted a picture of the economy that’s brighter than the previous FOMC assessment on Aug. 10. At that time, the Fed talked about slowing economic growth, a stagnating labor market and an elevated pace of inflation. However, the Fed also suggested that the economy appeared “poised to resume a stronger pace of expansion going forward” and that “a portion of the rise in prices seems to reflect transitory factors.”

The Fed’s assessment on Sept. 21 showed that those expectations were on target and the Fed now says that output growth has “regained some traction,” that labor market conditions have “improved modestly” and that inflation and inflation expectations have “eased” in recent months.

That’s all very good news, but it doesn’t mean the Fed will now stand pat on monetary policy. The Fed stressed that policy still is “accommodative” and described the upside and downside risks to both sustainable economic growth and price stability as “roughly equal” for the next few quarters. In that kind of environment, the Fed wants to move policy toward a more neutral position and that definitely means further rate hikes.

Fortunately, the Fed continued to say that “policy accommodation can be removed at a pace that is likely to be measured.” Unfortunately, we don’t know the Fed’s definition of a neutral federal funds rate or the path from here to there. At this point, we’re assuming one more quarter-point hike this year at the Nov. 10 FOMC meeting) and a series of increases during 2005 that will take the funds rate to 4% by year-end. That should be close to neutral as long as inflation stays close to 2% next year. [return to top]

Long-term interest rates have gone down, rather than up, as the Fed has raised short rates …
Long-term rates generally rise to some degree as the Fed tightens monetary policy, particularly when it’s clear that the Fed is embarked on an extended tightening process. This time, however, long rates have moved downward as the shorts have risen. Between June 29 and Sept. 22, the 10-year Treasury yield declined by 65 basis points while the federal funds rate rose by 75 basis points.

The fall in long-term rates has been related to several key factors: first, evidence of the mid-year “soft patch” in real economic growth; second, the slowing in core inflation from the surprising acceleration earlier in the year; and third, lower probabilities of aggressive tightening by the Fed down the line.

The “soft patch” in real growth apparently is moving behind us, and the transitory factors that boosted core inflation earlier in the year apparently have unwound. If those assessments are on target, it’s reasonable to expect long-term rates to begin moving up soon — as the economic expansion proceeds, the job market tightens, unit labor costs move up and the Fed continues to raise short-term rates at a measured pace. NAHB’s forecast shows about a half-point increase in bond and mortgage rates by the end of this year and an additional percentage point rise during 2005. [return to top]

The housing market gets yet another boost from long-term interest rates and the ARM market …
The surprising decline in long-term rates since mid-year has stimulated housing demand once again.

Financing obviously is the life-blood of the single-family housing market. The fall in fixed-rate mortgage yields certainly has buoyed housing demand and housing production in recent times. Furthermore, there’s been a strong shift toward usage of adjustable-rate mortgages (ARMs), particularly in the new-home market, despite historically low levels of long-term mortgage yields.

Indeed, the ARM share of loans made for the purchase of new homes was up to 45% by July (national average) compared with only 15% a year earlier. It seems clear that ARM usage has risen to help maintain affordability as house prices have climbed aggressively. Indeed, the ARM share is particularly high in high-priced metro areas, especially in California.

There’s currently a spread of nearly two percentage points between 30-year fixed-rate mortgages and 1-year (Treasury indexed) adjustable-rate mortgages, and that’s obviously enough to encourage many buyers to take on the interest-rate risk associated with the ARMs. The ARM rate advantage figures to shrink to some degree as the Fed continues to raise short-term rates, although ARM lenders may elect to discount the starting rates in order to maintain volume. That’s a practice we’ve seen several times in the past. [return to top]

The single-family housing market still is running hot although some cooling off is on the horizon …
The single-family housing market has expanded rapidly for several years as home sales and the production of new units both have surged to higher and higher levels and house prices have grown aggressively in the process. Indeed, there’s little doubt that sales and starts will post records in 2004.

There’s some evidence that single-family housing market activity is in the process of topping out. Sales and starts have changed little, on balance, since late 2003. The same pattern is shown by NAHB’s Housing Market Index (based on monthly surveys of single-family builders), and applications for mortgages to buy homes (MBA series) have been rather flat during 2004 as well.

It’s likely that the numbers of homes sold and produced will come off their recent records as the Fed continues to tighten and long-term rates rise from current levels. To be sure, ongoing growth in employment and household income will be providing support to housing demand at the same time, but history suggests that the net impacts of all these factors will be modestly negative. That means 2005 stacks up as the second-best year on record for single-family sales and starts and that house price appreciation is likely to recede to about 5% from recent rates of about 9%. Considering where we’ve been, that’s an excellent outlook. [return to top]

The rest of the housing sector still is a mixed bag …
The multifamily housing market has been a mixed bag for some time, displaying a strong condo component, a stable market for federally subsidized rental housing and a market-rate rental component beset by high vacancy rates and sub-par absorptions. Multifamily starts, in total, have been essentially flat since 1997, hovering around the 340,000 mark, and NAHB’s most recent Multifamily Market Index was reasonably reassuring. We expect some erosion in coming quarters, although multifamily starts for 2005 should not be far off the recent annual averages.

The residential remodeling market still is going great guns, with activity highly concentrated in the owner-occupied housing component, and NAHB’s Remodeling Market Index points toward solid real growth down the line. Record levels of housing equity will continue to provide solid support to this sector and a higher volume of home equity loans will fill in for reduced cash-out refinancings of first mortgages as homeowners tap their accumulated equity to finance remodeling activity.

The manufactured home (HUD-code) market has been the weakest component of the housing sector for years, and it appears that shipment volume finally is bottoming out. NAHB’s forecast shows modest recovery in 2005-2006, contingent on the availability of reasonable financing. [return to top]

Coming Oct. 1: HousingEconomics Online
HousingEconomics Online is the new online publication from the leading economists at NAHB.

Available Oct. 1 at, HousingEconomics Online combines unique scientific research with practical applications providing insights that are original, useful and written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

This interactive Web site at the executive level provides critical data and information quickly, easily and frequently and includes the following features:

  • Home Builders Forecast
  • The Desktop Analyst
  • Dave Seiders’ Report
  • Housing Activity
  • Housing Policy Focus
  • Multifamily Housing Quarterly
  • Housing Market Statistics

For more details, go to HousingEconomics Online at [return to top]

For more information or to contact us directly, please visit l ©2004, National Association of Home Builders