Strong Productivity Growth Is Underpinning Growth in Economic Output
Incoming data continue to reinforce the pattern of solid underlying momentum in growth of real economic output, despite some lingering negatives from this year’s record-breaking hurricane season and a record trade deficit in October.

We’re still projecting 3.4% growth of real gross domestic product (GDP) in the fourth quarter, a very nice performance. And we expect even stronger growth early next year as the hurricane effects swing from negative to positive. Growth should subside to a sustainable trend pace (about 3.2%) over the balance of our 2006-2007 forecast horizon.

Economic growth has involved impressive growth in labor productivity (output per hour) in recent times. Productivity growth is essential to long-term improvement in living standards for Americans, and strong productivity growth also helps to hold down both inflation and interest rates. Productivity growth also holds down business demands for labor, of course, although the length and strength of the economic expansion has the labor market in a decent gear.
 

 
The National Labor Market Is Back on Track
As expected, the employment report for November revised away some of the hurricane-related weakness in September and October and revealed good forward momentum in November. Nonfarm payroll employment rose by 215,000, above the average for the first eight months of the year, and the unemployment rate held at 5.0% — compared with an expansion low of 4.9% in August.

NAHB’s forecast shows healthy growth in payroll employment through 2006, and we expect the unemployment rate to tick down a bit as GDP growth runs a bit above potential for at least part of the year. Growth of both GDP and employment should settle to trend in 2007, holding the unemployment rate around 5%. [return to top]
 

 
The Inflation Picture Looks Very Good, at Least for Now
Swings in energy prices have whipsawed broad measures of producer and consumer price inflation in recent months, but measures of core inflation (excluding prices of food and energy) have been remarkably stable and well behaved. Indeed, core inflation actually receded in October (latest data available) and remains within the Federal Reserve’s apparent “tolerance range.”

The Fed’s favorite measure of inflation, the core price index for personal consumption expenditures (PCE), registered a year-over-year gain of only 1.8% in October. The market-based version (excluding various implicit prices) showed a benign 1.6% advance, and even this measure has some well-known upward bias. Thus, we’re not far from actual price stability, at least on a “core” basis.

These reassuring performances hardly mean that core inflation will remain a non-issue, and some increase in core inflation seems likely in both 2006 and 2007 as long as energy prices remain at high levels and labor markets tighten further. That possibility obviously is receiving a lot of attention at our central bank. [return to top]
 

 
The Fed Hikes Rates Again But Changes the Message
The Federal Reserve implemented another quarter-point increase in short-term interest rates at the Dec. 13 meeting of the Federal Open Market Committee (FOMC), raising the federal funds rate to 4.25% and the bank prime rate to 7.25%. Both rates are now 3.25 percentage points above their cyclical lows last year.

The adjustment to short rates was in line with market expectations, and the really big news was contained in the public statement issued by the FOMC. The statement no longer characterized monetary policy as “accommodative,” and there was no commitment to an ongoing “measured pace” of monetary tightening. This presumably means that the Fed feels monetary policy is close to “neutral.” We still expect a quarter-point rate increase at the next FOMC meeting (Jan. 31), followed by a lengthy period of policy stability under the incoming chairman, Ben Bernanke.

The bond markets seemed happy with the FOMC message, and long-term bond and mortgage rates are holding in reasonably narrow ranges. We still expect roughly half-point increases in long rates during the coming year, taking the fixed-rate mortgage yield to about 6.75% by late 2006. [return to top]
 

 
House Prices Drive Home Owner Equity to a New Record
Average U.S. home prices increased by 12% in the third quarter (year-over-year basis), according to the House Price Index produced by the Office of Federal Housing Enterprise Oversight (OFHEO). This pace was two percentage points below the second-quarter estimate but continued the string of double-digit increases that began in the third quarter of last year.

Rapid increases in house values have bestowed huge capital gains on America’s home owners, and housing equity continues to climb despite heavy borrowing against accumulated housing equity.

Indeed, the value of the owner-occupied housing stock was $19.1 trillion at the end of the third quarter, and housing equity was a record $10.9 trillion (Federal Reserve data). The performance of house values has greatly strengthened the overall household sector balance sheet and permitted households to run current saving to zero (or negative) and to handle record debt burdens. [return to top]
 

 
The Housing Outlook Continues to Show a Cooling-Down Process Toward a Solid Trend
Although housing market indicators still are throwing off mixed signals, we believe that a cooling process has begun in single-family and condo markets. Indeed, our confidence in the onset of the “cooling” process has been reinforced by reports from Federal Reserve Banks as well as by monthly surveys of single-family home builders (conducted by NAHB) and weekly surveys of home mortgage lenders (conducted by the Mortgage Bankers Association) that extend through November and into December.

The Fed’s most recent “Beige Book,” containing information collected during the first three weeks of November by the 12 Federal Reserve District Banks, said that residential real estate market activity generally remained high, “but many districts reported a slowing or cooling of activity.” The report also noted that residential mortgage lending slowed in several Districts.

NAHB’s single-family housing market index (HMI) fell sharply in early November and preliminary tabulations indicate further erosion into December. Indeed, all the components of the HMI (current sales, buyer traffic and sales expectations) are well off recent highs, and all regions are down significantly as well.

The MBA’s index of applications for mortgages to buy homes was essentially flat during the July-September period and gravitated downward during October and November (four-week moving average basis). The index perked up a bit in the first two weeks of December but remained well below the summer highs. [return to top]
 

 
Affordability Is the Key Issue
Measures of housing affordability definitely are being weighed down by both extraordinarily high house prices and rising mortgage interest rates, and these factors certainly point toward a cooling process in single-family and condo markets.

NAHB’s National Housing Opportunity Index fell to the lowest level in the 13-year history of the series in the third quarter of this year. Furthermore, the Housing Affordability Index produced by the National Association of Realtors® showed broad-based erosion through October. The national Affordability Index has come down substantially from expansion highs, and measures for the Northeast and West regions show particularly large declines. [return to top]
 

 
Eye on the Economy Will Not Be Published on Dec. 28
Eye on the Economy will be taking a short holiday break and will not be published on Dec. 28. Publication will resume on Wednesday, Jan. 11. Have a warm and happy holiday season. [return to top]
 

 
Want to Know Your State and Metro Forecasts for 2006?
Anticipate the trends, make better decisions and improve your bottom line. HousingEconomics.com, the online publication from NAHB Economics Group, is your single source for market analysis, forecasts, housing statistics and more. In-depth analysis and detailed Excel tables and overviews are available for all the state and metro forecasts.  

HousingEconomics.com combines unique scientific research with practical applications providing insights that are original and useful. 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 ― state, metro, non-residential, remodeling, etc.
• Exclusive access to NAHB’s staff of economists
• The Seiders' Report
• Housing Market Statistics — 29 tables including housing starts, home prices, building permits, home sales, value of new construction, etc.
• Housing Activity
• In Depth-Analysis

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

 
Give Your Perspective on the New NAHB Economics Blog
Give your economic perspective on NAHB's new economics blog, “Seiders on Housing,” launched earlier this month. "Seiders on Housing" is an informal Internet-based discussion forum dealing with topical economic issues, housing trends, survey research and other topics affecting the housing sector of the economy.

Log onto the blog at http://nahbblog.blogs.com an get direct access to Seiders' expert opinions, projections and responses. [return to top]