February 9, 2005

By David F. Seiders
NAHB Chief Economist

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Economic growth slowed in the fourth quarter but underlying momentum remains strong …
Growth of real gross domestic product (GDP) slowed to an annual rate of 3.1% in the final quarter of 2004, according to the “advance” estimate released by the Commerce Department on Jan. 28. This pace was well below consensus expectations and NAHB’s estimate (3.8%).

But the composition of the report hardly suggested that the economic expansion faltered in a fundamental way, and some statistical issues uncovered after release of the GDP report point toward a significant upward revision when the “preliminary” report is released on Feb. 25.

The details of the advance fourth-quarter GDP report actually were quite encouraging and reinforce expectations of solid economic growth for 2005. There certainly was no weakness in domestic demand for goods and services, as the measure of final sales to domestic purchasers rose at a robust 4.3% annual rate. This heady performance was led by rapid growth in both consumer spending and business investment in equipment and software.

The job market continues to improve although the degree of remaining slack has come into question …
On Feb. 4, the Labor Department released the employment report for January and unveiled benchmark revisions to both payroll and household employment figures. The historical revision raised the payroll employment level substantially, and the January gain (146,000 jobs) lifted the employment level slightly above the cyclical peak in February 2001 — while converting a small net loss during the first Bush term into a small gain.

The unemployment rate for January (from the household survey) fell by two-tenths to 5.2%, an unexpectedly low reading. Such a move normally suggests a healthier labor market, but the January decline primarily reflected a decline in the labor force participation rate and a large decline in the labor force.

These results fly in the face of consensus expectations of a rising participation rate and a growing labor force that will continue to support above-trend growth in economic output with minimal upward pressures on labor costs and price inflation. We haven’t exactly scurried back to the drawing board, but it’s fair to say that the plot has thickened with respect to current and future slack in the labor market. [return to top]

The inflation situation remains benign but upward pressures lie ahead …
The inflation situation in the U.S. remains remarkable benign as the economy moves into the fourth consecutive year of expansion. Core inflation (excluding prices of food and energy) has been particularly well behaved in the face of strong growth in economic output and declining slack in the labor market.

It’s worth remembering, of course, that our central bank looks ahead and wants to nip serious inflation pressures in the bud. In this regard, the minutes from the Dec. 14 Federal Open Market Committee (FOMC) meeting — released on Jan. 4 ― highlighted a number of upside risks to core inflation:

  1. Some pass-through of high energy prices into the core
  2. A domestic inflationary impulse from depreciation of the dollar on the foreign exchange markets
  3. A recent slowdown in productivity growth and an associated pickup in unit labor costs
  4. Uncertainty about the degree of remaining slack in the labor market

Everything considered, the FOMC concluded that cost and price pressures were likely to become a clearer intermediate-term risk to sustained good economic performance if the Fed did not continue to reduce the degree of monetary policy “accommodation.” That conclusion virtually mandated another quarter-point increase in the federal funds rate target at the conclusion of the December 14 meeting and guaranteed that the Fed would continue to talk about further monetary tightening “at a measured pace.” [return to top]

The Fed marches down the path to monetary neutrality …
As widely expected, the Fed hiked short-term interest rates by another quarter point at the conclusion of the Feb. 2 FOMC meeting, raising the federal funds rate target to 2.5%. The FOMC statement was nearly identical to the statement issued on Dec. 14, and the stability of the statement implied that the central bank plans to stay with the pattern of gradual rate hikes that began at the middle of last year.

The surprising weakness of payroll employment growth in January, along with downward revisions to job growth in both November and December, prompted some speculation that the Fed might delay the monetary tightening process pending better job growth down the line. However, the FOMC has repeatedly stressed that its “obligation to maintain price stability” will be fulfilled, and the reduction in labor market slack shown by the household side of the January employment report argues strongly for further systematic removal of monetary stimulus from the economy. Translation — count on another quarter-point rate hike at the March 22 FOMC meeting. [return to top]

Long-term interest rates remain stubbornly low …
The monetary policy process kicked off at mid-2004 has yet to raise long-term rates. Indeed, long-term Treasury, mortgage and high–grade corporates are now at or below the levels of mid-2004. Furthermore, quality spreads in bond markets narrowed during this period, lending standards at depository institutions remained quite liberal, the dollar declined rather than rose, and the stock market was up substantially. Thus, prominent measures of overall financial market conditions show better conditions since mid-2004 despite the 150 basis point increase in the federal funds rate.

It’s become clear that persistent forces are holding down long-term rates. As a result, we’ve just trimmed our projected pattern of long-term rates across the 2005-2006 forecast period, cutting year-end readings by about 30 basis points. Moderate increases still are expected, partly because we believe that market participants have overly optimistic views on both future inflation and the amount of monetary policy tightening that lies ahead. [return to top]

Housing markets remain quite strong but further growth will be hard to achieve …
Housing market activity turned out to be surprisingly strong in 2004, and the surprise was due to unexpectedly low mortgage interest rates. Fourth-quarter housing activity was influenced by unusual swings in weather conditions but, in general, the data suggest a topping-out pattern for home sales, housing starts and construction put-in-place. In the process, new annual records were set for sales of both single-family homes and condo units as well as for improvements to residential structures.

The strength of the condo/co-op market kept the production of new multifamily housing flat in 2004 despite a record vacancy rate (11.7%) in the rental apartment market (structures with five or more units). This vacancy rate is the “other side” of the record high homeownership rate (69%) posted in 2004. Thankfully, rental vacancy rates started to move down a bit in the second half of the year as job growth helped fill up some empty units.

Looking ahead, we’re projecting modest (3%-4%) declines in home sales and housing starts in 2005, followed by a similar pace of erosion in 2006. At the same time, we’re projecting positive growth in remodeling activity and a modest recovery in the beleaguered manufactured home (HUD-code) market.

Everything considered, our forecast shows slight declines in the residential fixed investment component of GDP, a process that finally takes housing out of the GDP growth-engine category and converts housing to a bit of a drag on economic growth. [return to top]

Investor-driven price appreciation looms over some housing markets …
It’s fair to say that potential price inflation generated by a surge in buying by investors and speculators looms over both single-family and condo markets in some metro areas. Indeed, the minutes from the Dec. 14 FOMC meeting cited “reports that speculative demands were becoming apparent in the markets for single-family homes and condominiums.”

While overstimulated prices pose risks in some markets, dramatic price declines are unlikely unless interest rates spike upward and/or job markets falter badly. If interest rates behave about as we expect, and if job markets continue to strengthen in most areas (as we expect), the most likely prospect is for price flattening in overheated markets and a slowdown in national average house price appreciation. We’re looking for national price gains on the order of 5% this year, off from roughly 10% in 2004. [return to top]

'HousingEconomics Online' provides in-depth analysis of housing market.
"HousingEconomics Online" is NAHB's new online publication from the NAHB Economics Group that provides the latest housing economic data, trends and key events that shape the economy. NAHB’s leading economists analyze and synthesize the housing and economic information to provide in-depth analyses of the niches and nuances of the home building market.

Available at BuilderBooks.com, "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
  • Access to NAHB’s Staff of Economists
  • Seiders' Report
  • NAHB Economic & Housing Forecast 
  • Housing Activity
  • Housing Policy Focus
  • Multifamily Housing Quarterly
  • State and Metro Focus 
  • Housing Market Statistics

For more details, go to www.housingeconomics.com. [return to top]

For more information or to contact us directly, please visit www.NAHB.org l ©2005, National Association of Home Builders