April 20, 2005

By David F. Seiders
NAHB Chief Economist

 
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The economy hits a “soft spot” in March …
The economic expansion in the U.S. gathered strong forward momentum in 2004, as growth of real Gross Domestic Product (GDP) accelerated to a 4.4% pace, and economic activity remained quite good in the early months of 2005. But then a series of economic indicators softened considerably in March, prompting reassessment of the state of the economy in the first half of 2005.

The softening process was suggested, first of all, by surprisingly weak growth in payroll employment for March (a gain of only 110,000). Subsequent weak readings on our trade balance, retail sales, housing starts (see below) and consumer confidence/sentiment confirmed the impression that the demand for U.S. goods and services lost momentum in the latter part of the first quarter.

Furthermore, a good bit of spending in the first quarter reflected inventory accumulation by U.S. businesses, hardly a signal of fundamental strength in economic activity. Serious weakness in the stock market reflected investor perceptions of the sudden economic slowdown in March and early April.

The economic outlook remains positive …
The incoming data have forced a downward revision to NAHB’s estimate of GDP growth for the first quarter (from 4.5% to 4.0%), and the second quarter definitely began with less forward momentum than previously estimated — prompting a downward revision in projected GDP growth from 4.2 to 3.2%. Those growth rates still are pretty good, but the pattern of deceleration certainly raises questions about the sustainability of the economic expansion going forward.

We’re currently characterizing the recent slowing of economic activity as a “soft spot” that bears some resemblance to the temporary slowdown that occurred around the middle of last year. We still believe that the economy is fundamentally sound and that the recent slowdown is related largely to the oil price spike and a run-up in long-term interest rates, factors that already show some improvement. These judgments apparently are shared by the Federal Reserve, at least for now. [return to top]

Core inflation continues to firm up despite the economic soft spot …
The March softness in economic activity apparently was not enough to relieve gathering upward pressures on core inflation (excluding prices of food and energy) in the economy. The core component of the Producer Price Index (PPI) posted a year-over-year increase of 2.6% in March, down a bit from the January-February pace but still on the high side of readings during the past year. Indeed, the core PPI posted an annualized gain of 3.7% in the first quarter, the most rapid advance of the expansion period.

The core component of the Consumer Price Index (CPI) posted a year-over-year gain of 2.3% in March, and the annualized increase for the first quarter stands at 3.3%. The chain-core CPI (incorporating floating weights) showed a 1.9% increase in March (year-over-year), down a bit from the February pace but still on the high side of recent observations.

It’s fair to say that core inflation is becoming more problematic for our central bank, and it seems clear that high prices of petroleum products (including gasoline) are now “leaking” into the core rates in a persistent way. Thus, the challenges for monetary policy are increasing as the economy forges ahead at an uneven pace. [return to top]

The Fed intends to keep tightening at a ‘measured pace’ …
The recent economic “soft spot” ensures that the Fed will not accelerate the pace of upward interest rate adjustments. However, the persistent upward pressures on core inflation ensure that the Fed will continue the pattern of quarter-point rate hikes at the Federal Open Market Committee (FOMC) meetings that began at mid-2004. Statements by various Fed spokespersons show that the central bank is not about to back off, barring evidence of a really serious shortfall in economic activity.

NAHB expects another quarter-point hike in the federal funds rate target (to 3.0%) at the May 3 FOMC meeting, and we’re still expecting a funds rate of 4.0% by year end. The Fed could be even more aggressive than that if core inflation continues to move up. After all, the Fed wants to move toward a funds rate that’s neutral in real terms, and higher inflation keeps raising the nominal rate needed to achieve that objective. [return to top]

Long-term rates fall back as growth prospects are marked down …
In mid-February, Fed Chairman Alan Greenspan characterized persistently low long-term interest rates as a “conundrum,” and the Fed successfully “talked” long rates up by about half a percentage point as of late March. But the long rates have fallen back since then as evidence of the economic soft spot has accumulated, and we’re now only about 15 basis points above the mid-February lows.

Fixed-rate home mortgages now are around 5.8%, and NAHB’s forecast still shows an average of 6.5% in the fourth quarter of the year. That forecast assumes a solid second-half rebound of economic growth, ongoing upward pressures on core inflation and the Fed tightening pattern described above. Only time (and more economic data) will tell. [return to top]

The housing market throws off mixed signals …
Home sales and housing starts were quite good in January and February, but then housing starts plummeted by 17.6% in March ― much more than expected by NAHB and other forecasters. However, the March shortfall apparently does not signal a fundamental downshift in the housing market.

Timing issues associated with shifting weather conditions and rebuilding in the wake of last fall’s severe hurricane season can account for much of the early-year exuberance as well as the March decline in housing starts. Furthermore, issuance of building permits was off by only 4% in March, following historically high readings in both January and February, and the permits pattern is a better reflection of market trends than the typically volatile starts series.

The starts/permits patterns for March generated a sizeable increase in the backlog of unused permits, a development that bodes well for housing starts in April. The recent decline in long-term rates also will help buoy sales and production in the short term. In this regard, NAHB’s Housing Market Index for April held in a positive range, and weekly data on applications for mortgages to buy homes (Mortgage Bankers Association series) were quite solid through mid-month. [return to top]

The outlook depends heavily on the global oil market …
Oil prices recently spiked to record levels, and NAHB’s forecasts of oil prices have been revised up substantially for both 2005 and 2006. We now expect oil to hang around $50 per barrel (WTI crude) across the forecast period, but volatility in this market defies meaningful projections.

Fortunately, the Federal Reserve has the ability to adjust monetary policy in order to counter impacts of oil price fluctuations on the U.S. economy. Unfortunately, oil price spikes can damage the global economy, and the Fed would be hard-pressed to balance off that kind of damage. Furthermore, oil price increases can weaken economic growth and put upward pressures on core inflation at the same time, a disturbing pattern that’s now evident in the U.S.

Given the choice, the Fed presumably would give higher priority to holding down inflation than to supporting real economic growth, and the outcome could be a demoralizing “stagflation” pattern. Greenspan certainly doesn’t want to hand over such a condition to his successor (presumably by early next year), but the Fed doesn’t have the tools to turn everything rosy. Stay tuned. [return to top]

Register for the Spring Construction Forecast Conference.
See what's on the horizon for the housing industry at NAHB's Spring Construction Forecast Conference and it's accompanying Webcast on May 5 in Washington, D.C. Get the latest forecasts on housing starts, project budgets and other economic bellwethers and developments in the housing industry from some of the country's premier economists and finance experts. To register or for more information, click here. [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.

"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. To order, visit "HousingEconomics Online" details page.

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