December 13, 2006
By David F. Seiders
NAHB Chief Economist
 
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The Economy Is Absorbing the Substantial Housing Correction
The contraction in home sales and housing production has been taking a heavy toll on economic growth since early this year. However, good performances by other sectors have helped the economy absorb the housing downswing and steer clear of recession.

The housing production component of Gross Domestic Product (Residential Fixed Investment) contracted sharply in both the second and third quarters of this year, lopping about a percentage point off overall GDP growth for this period (0.7 in the second quarter and 1.2 in the third).  Available housing data (including construction put-in-place for October) point toward another serious drag on GDP for the final quarter of the year.

Despite the serious drag from housing, the overall economy is performing reasonably well and is not in serious danger of slipping into recession.  GDP growth has been running below trend in recent quarters and another sub-par performance is inevitable for the final quarter of this year (we’re estimating 2%).  However, our projections show improving GDP growth in 2007 as the drag from housing eases off (see below).
 

 
The Job Market Is Also Faring Reasonably Well
The overall job market has been doing reasonably well in the face of the housing contraction.  Employment in residential construction (builders and special trade contractors) has been falling since February, following strong growth during the three previous years, and the falloff in residential construction also has cost jobs in related parts of the economy.

Despite housing-related weakness, overall payroll employment growth has been reasonably well maintained and the nation’s unemployment rate has remained quite low (4.5% in November).  Of course, labor market conditions lag movements in GDP to some degree, pointing to some further slowdown in overall job growth and some increase in the unemployment rate in 2007 (prior to broad-based improvement in 2008). [return to top]
 

 
The Fed Holds Monetary Policy Steady, Citing "Substantial Cooling" of the Housing Market
The Federal Reserve held monetary policy steady at the December 12 meeting of the Federal Open Market Committee (FOMC), maintaining the 5.25% target for the federal funds rate – a target that’s been in place since mid-year.  The FOMC’s decision also keeps the bank prime rate at 8.25%.

The public statement issued at the conclusion of the December 12 FOMC meeting maintained strong focus on inflation risks down the line (a virtually mandatory focus for a responsible central bank).  However, the FOMC’s assessment of real economic growth was somewhat weaker than the assessment offered at the previous FOMC meeting (October 25).  In this regard, housing was once again singled out for special attention; indeed, the FOMC cited a “substantial cooling” of the housing market as a key factor behind the slowing of economic growth this year.  This characterization compares with “cooling” at the October 25 meeting and “gradual cooling” at meetings earlier in the year.  That’s quite a learning curve! [return to top]
 

 
The Bond Market Is Feasting On the Economic Numbers and Fed Messages
The convincing slowdown in GDP growth along with reassuring signals on the inflation front –including Fed suggestions that core inflation pressures “seem likely to moderate over time” – have helped shepherd long-term interest rates to the lowest levels since early in the year.  The 10-year Treasury bond yield has been dancing around 4.5% and the fixed-rate conventional home mortgage rate is hanging around 6.1%.

The messages coming out of the December 12 FOMC meeting, particularly the more serious characterization of the housing downswing and a less-confident judgment about the extent and timing of an expected firming up of economic growth, contributed to the bond market rally.  On the other hand, unexpectedly strong numbers on retail sales for November (released December 13) caused long-term rates to reverse a portion of the recent rally.

NAHB’s forecast shows stable Fed policy well into 2007 and only slight upward pressure on long-term rates in 2007.  These favorable financing conditions are essential to our projection of a near-term bottom for home sales as well as revival of housing production by mid-2007. [return to top]
 

 
Homebuyer Demand Appears to Be Stabilizing at This Time
Stabilization of buyer demand is the essential first step in arresting the dramatic housing downslide that began during the second half of 2005.  Fortunately, broad economic and financial market conditions are supportive of housing demand, and price cuts along with deepening nonprice sales incentives by builders are helping to attract buyers.

A variety of recent data suggest that stabilization of demand for single-family homes is underway.  These include:

  • improvements in measures of housing affordability since July.
  • improvements in consumer assessments of home buying conditions since September.
  • improvements in NAHB’s single-family Housing Market Index (HMI) since September.
  • an upswing in applications for mortgages to buy homes since October.
  • upticks in sales of new and existing homes in October as well as a recent bottoming out of  “pending” sales of existing single-family homes.

NAHB’s single-family HMI measures builders’ assessments of home buyer traffic, current home sales and prospects for sales down the line.  This measure bottomed out in September and then moved up slightly in October and November.  Preliminary tabulations suggest that the December HMI remained around the November reading (that’s good news). [return to top]
 

 
The Inventory Overhang Is Heavier Than it Looks
The standard measures of unsold housing inventory tell a sobering story at this time, but these measures actually provide an inadequate assessment of the true weight of the overhang.  For new single-family housing, the government’s measure of the inventory of unsold homes excludes homes left with builders due to sales cancellations;  indeed, as cancellations surged in 2006, the official inventory numbers fell further and further below the true number of homes for sale by builders.

Inventories (listings) of existing homes have been hanging around record levels recently, and we find that an unusually large proportion of existing homes on the market now are vacant units – a legacy of the surge in buying by investors/speculators during the earlier boom period.  Vacant units in the existing for-sale housing inventory are a much more serious matter than occupied units in that inventory.

We’re also facing a “phantom inventory” of uncertain dimensions, consisting of homes owned by investors who are awaiting stabilization or improvement of market conditions before listing the homes for sale.  Many of these homes were bought from builders during the boom and pose a threat to new production down the line. [return to top]
 

 
Housing Production Still Is Trending Downward
The seriousness of the inventory overhang should keep new housing starts on a downward path through the early part of 2007, even if home sales are moving up by then.  NAHB’s current forecast reflects this starts pattern, based partly on recent signals from home builders.

In early December, we surveyed about 400 single-family builders about their plans for housing starts during the first half of 2007, relative to starts made in the second half of this year.  One-third of respondents said they plan to build about the same number of units and nearly one-fourth said they plan to build more.  However, the rest (44%) said they plan to start fewer units than during the second half of this year, and a relatively large proportion of larger companies fell into this camp.

We also asked whether or not current production plans for the first half of 2007 reflect recent revisions.  Two-fifths of respondents said they recently revised their plans downward and only about 10% said they had revised plans upward (the rest had not made recent revisions). [return to top]
 

 
Housing's Drag On Economic Growth and Payroll Employment Will Ease Before Long

Our projected downtrend in housing starts keeps residential construction put-in-place on a downward path into the second quarter of next year, and the strength of this tide will extend the drag on GDP growth from Residential Fixed Investment through mid-year.  However, the negative growth contributions will be dwindling during the first half of next year, and RFI should begin making positive contributions to GDP growth during the second half of 2007.

Employment by residential builders and specialty trade contractors lags movements in housing starts and moves closely with housing units under construction (or with construction put-in-place).  Thus, employment in residential construction should erode somewhat further in the first half of 2007, although the projected losses are not as serious as during most of 2006.

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

 
Notice: Eye On the Economy Will Not Appear On Dec. 27
This report will not be published on Dec. 27 immediately following the federal holiday on Monday, Dec. 25. We'll pick back up again in the New Year – until then, Happy Holidays!

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For more information or to contact us directly, please visit www.NAHB.org l ©2006, National Association of Home Builders

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