November 1, 2006
By David F. Seiders
NAHB Chief Economist
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Economic Growth Continues to Slow, But Recession Is Unlikely
As expected, growth of real gross domestic product (GDP) slowed further in the third quarter, according to the “advance” estimate released by the Commerce Department on Oct. 27. Third-quarter growth slipped to an annual rate of 1.6%, marking the second consecutive quarter of below-trend economic performance.

The housing production component of GDP (Residential Fixed Investment) was the weakest component of the third-quarter report, contracting at a 17.9% rate and subtracting 1.12 percentage points from the overall GDP growth rate. That weak performance followed an 11.1% contraction and a 0.72-point decline from GDP growth in the second quarter. These results, of course, stand in sharp contrast to the very large positive contributions delivered by RFI during most of the 2003-2005 period.

It’s likely that GDP growth will remain somewhat below trend in the final quarter of this year (we’re projecting 2.7%), and RFI will once again exert a significant drag on economic growth.

However, the worst of the housing contraction now appears to be behind us, and the overall economy should strengthen in 2007 — steering clear of recession and carrying the expansion forward for years to come.

Core Inflation Still Is Elevated, But Should Recede Before Long
Key measures of core consumer price inflation (excluding prices of food and energy) remained on the high side in September. However, much of the upward pressure stemmed from the imputed “owner’ equivalent rent” component, and the evolving economic slowdown is likely to relieve more fundamental inflation pressures before long.

The core component of the Consumer Price Index (CPI) increased at an annualized rate of 2.9% in September and the year-over-year gain also came to 2.9% — the highest rates of the current economic expansion and well above the upper end of the Fed’s apparent “tolerance range” for this measure (2.5%).

However, the technically superior chain-core measure (allowing for substitution within the market basket) stabilized at a year-over-year pace of 2.7%, and the imputed “owners’ equivalent rent” component added half a percentage point to core CPI inflation in September. Thus, a credible estimate of “true” core CPI inflation in September comes to a relatively benign 2.2%, presumably within the Fed’s tolerance range.

The Federal Reserve’s preferred measure of core inflation, the core price index for personal consumption expenditures (PCE), receded a bit to a 2.1% annual rate in September. The year-over-year gain also receded — to a 2.4% pace ― although this reading remained well above the implicit upper bound of the Fed’s tolerance range for this measure (2.0%).

“Owners’ equivalent rent” is a smaller component of the core PCE price index than the core CPI, but removal of that element leaves year-over-year core PCE inflation at a more tolerable 2.15%. [return to top]

The Fed Remains on Hold and the Next Rate Adjustment May Be Downward
As expected, the Federal Reserve kept monetary policy steady at the Oct. 24-25 meeting of the Federal Open Market Committee (FOMC), maintaining the 5.25% federal funds rate target that’s been in place since June 29. This policy position has held the bank prime rate at 8.25% since mid-year, up from a cyclical low of 4% at mid-2004.

The Oct. 25 FOMC statement stressed that economic growth has slowed over the course of the year, and the statement once again singled out a “cooling” of the housing market as a key factor in the slowdown.

The FOMC statement also noted that readings on core inflation have been “elevated” but that inflation pressures seem likely to moderate over time. Thus, the Fed’s inflation expectations, along with the judgment that “going forward, the economy seems likely to expand at a moderate pace,” gave our central bank the leeway to hold policy steady on Oct. 25.

The FOMC statement stressed that any future adjustments to monetary policy will depend on the evolution of the outlook for both inflation and economic growth.

We continue to believe that incoming information will keep the Fed on hold well into 2007 and that the next rate adjustment may very well be downward — as core PCE inflation recedes and the unemployment rate gravitates upward due to the run of below-trend GDP growth. [return to top]

Fed Positioning and Growth/Inflation Patterns Provoke Declines in Long-Term Rates
The recent stability of monetary policy, the pronounced slowdown in economic growth and the credible prospects for slowing of core inflation have combined to provoke a series of bond market rallies that have, on balance, moved long-term interest rates down significantly from their recent highs in July.

Our forecasts for economic growth, core inflation, Fed policy and the foreign exchange value of the dollar argue for reasonable stability of long-term rates over the balance of this year and in 2007.

We are projecting slight increases in the structure of long rates next year, partly because of pressures from abroad, but the projected yield structure should provide a friendly environment for the interest-sensitive sectors of the U.S. economy — particularly housing. [return to top]

The Housing Downswing Still Is Underway, But Housing Demand May Be Stabilizing
Home sales and house price appreciation still appear to be trending downward, despite the government’s report of an increase in new-home sales for September. However, it appears that fundamental stabilization of home buyer demand will occur in short order.

A number of key economic developments are underpinning housing demand. These include the recent declines in mortgage interest rates, the recent declines in energy costs, maintenance of low unemployment and healthy growth in household income.

The dramatic falloff in house price appreciation during the past year, including some dips into the negative range, also are helping to revive housing demand. And home sellers (particularly home builders) have been offering a plethora of non-price sales incentives to bolster home sales and limit sales cancellations.

The adjustments to mortgage rates, house prices and household income have combined to halt the dramatic decline of housing affordability, and the composite Housing Affordability Index by the National Association of Realtors® (NAR) actually perked up in both August and September from a 20-year low. Furthermore, the expectations components of key measures of consumer confidence/sentiment picked up in October and consumers’ assessments of home buying conditions improved as well.

The NAR’s series on “pending” sales of existing homes, NAHB’s single-family Housing Market Index, and the Mortgage Bankers Association’s series on applications for mortgages to buy homes all suggest that the sharp falloff in buyer demand that began in the second half of 2005 now is losing momentum, although the trend still appears to be modestly downward.

NAHB’s forecast anticipates modest further declines in sales of new and existing homes in the fourth quarter of this year, but we expect sales to bottom out in the first quarter of 2007 before embarking on an extended recovery process. [return to top]

Inventory Overhangs Should Delay the Revival of Housing Production and House Price Appreciation
Unsold inventories of new and existing single-family homes moved down a bit in August and September, and the inventory of existing condo units came down a bit in September from its record high. However, inventories still are historically high and the official government numbers exclude the impact of sales cancellations in the market for new single-family homes. Furthermore, there is no measure of the unsold inventory of new condo units, and that overhang presumably is quite heavy.

We expect total housing starts to bottom out in the second quarter of 2007, somewhat beyond the projected trough in home sales, as builders continue to work down their inventory positions.

The forecast depicts a five-quarter fall in housing starts, with a peak-to-trough decline of 25% between the first quarter of this year and mid-2007. This housing correction, if realized, will be roughly half as serious as the downswing that occurred in connection with the 1990-1991 economic recession — in terms of both the depth and duration of the decline.

House price appreciation has contracted dramatically during the past year, and median sales prices for both new and existing homes now are in the negative range on a year-over-year basis.

Some of this contraction reflects compositional shifts as sales of high-priced homes have fallen more than lower-priced homes, and it’s likely that repeat-sales price measures (following the same houses through time) still are in the positive range.

NAHB’s forecast of OFHEO’s quarterly repeat-sales House Price Index shows an orderly deceleration through mid-2007 followed by a few negative quarters on a national basis. [return to top]

Want to Know Your State and Metro Forecasts for 2007?
Anticipate the trends, make better decisions and improve your bottom line., 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. 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 [return to top]

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