April 11, 2007
By David F. Seiders
NAHB Chief Economist
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Economic Growth Is Subpar and Recession Risks Are Rising
Growth of real gross domestic product (GDP) was 2.5% in the last quarter of 2006, better than the preliminary 2.2% estimate but still a below-trend pace. Indeed, subpar growth was registered during the final three quarters of last year, and available information points toward another tepid performance in the first quarter of this year. We’re currently estimating 2.0%.

The dramatic housing correction has been the major drag on GDP growth since early last year, and another major decline in residential fixed investment will weigh heavily on first-quarter economic growth as well.

The economy now is also faced with an unexpected weakening of business spending on capital equipment and software, a component of the economy that started to contract late last year.

NAHB’s forecast shows somewhat stronger GDP growth in the second half of this year, and we’re counting on better performances from housing and business fixed investment to generate that pattern. However, it’s fair to say that the chances for a second-half rebound seem to be slipping and that the probability of recession later this year has risen — we now put it at 25%.

The Labor Market Still Is Throwing Off Relatively Healthy Signals
Payroll employment growth has been remarkably well maintained in the face of the marked slowdown in GDP growth since early last year, and the unemployment rate actually has continued to gravitate downward.

Employment growth averaged a highly respectable 152,000 per month in the first quarter and the unemployment rate slipped back to a cyclical low of 4.4% in March.

The divergence of output growth and labor market conditions could reflect underestimation of the economy’s strength in the GDP accounts or a slowdown in growth of labor productivity (output per hour).

In this regard it is obvious that productivity in housing production has slipped quite a bit. But the key to the economic riddle of surprisingly robust labor markets may very well be normal lags in labor demand by businesses behind shifts in demand for economic output.

If that’s the answer, it’s only a matter of time before the GDP slowdown results in slower employment growth and a higher unemployment rate. That’s the pattern in NAHB’s forecast for the U.S. economy and the housing sector over the balance of the year. [return to top]

Core Inflation Still is Running on the High Side
Measures of core consumer price inflation (excluding prices of food and energy) have remained above the upper ends of the Federal Reserve’s apparent “tolerance ranges,” despite below-trend economic growth since early last year. The statement issued at the conclusion of the March 20-21 meeting of the Federal Open Market Committee (FOMC) focused heavily on the inflation issue, and Federal Reserve Chairman Ben Bernanke reinforced that message in his March 28 testimony before the congressional Joint Economic Committee.

Ironically, the housing components of the core consumer price measures have been the primary sources of upward inflation pressure — despite the dramatic downswing in home sales, housing production and house price appreciation. That’s because the demand for rental apartments has strengthened as home buying has weakened, pushing up market rents and pushing up the large imputed owners’ equivalent rent (OER) components in the process.

Without this large (and perverse) pressure, both the core Consumer Price Index and the core price index for Personal Consumption Expenditures would have remained within the Fed’s apparent tolerance ranges. [return to top]

An Inflation-Wary Fed Remains on Hold, At Least for Now
Recent Fed statements have continued to stress the risks of inflation to the U.S. economy, a mantra of any responsible central bank.

Indeed, a tight labor market and rising unit labor costs give a legitimate reasons for the Fed to fret, and rising energy costs also weigh on that side — since some “leakage” into the core is inevitable over time. The Fed, however, will hold the line on monetary policy as long as the labor market is tight, even if GDP growth remains well below prevailing estimates of trend.

It’s highly likely that the labor market will weaken (with a lag), and a higher unemployment rate will clear the way for some Fed easing. Furthermore, core inflation is likely to recede as the year progresses, a view expressed by the Fed on many occasions.

In this regard, the Fed expects the OER components to slow as the affordability of home buying improves, as rental demand recedes, and as rent inflation slows.

NAHB’s forecast continues to show a quarter-point cut in the Fed’s target for the federal funds rate at the conclusion of the June 27-28 FOMC meeting.

If core inflation recedes by then and the Fed doesn’t cut the nominal funds rate, the real funds rate will rise and endanger an economic expansion that promises to be weak at that time — a situation that would subject our central bank to heavy criticism from many quarters, including the Congress. [return to top]

Long-Term Treasury and Prime Mortgage Rates Hold in a Narrow Range
The subprime mortgage market debacle prompted a flight to quality in financial markets, a flight that has favored the Treasury securities market.

Following some upward pressure earlier in the year, the 10-year Treasury rate is once again hovering in the lower part of the range that’s prevailed since late last fall. Furthermore, the spread between the rate on prime fixed-rate mortgages and the 10-year Treasury rate has held firm, taking the mortgage rate below 6.2%.

Both the Treasury yield curve and the prime mortgage yield curve (fully indexed) are inverted at this time, and that situation may not hold for long. NAHB’s forecast shows slight increases in long-term Treasury and prime mortgage rates over the balance of the year, a process that will take these rates to the upper ends of recent ranges and help to flatten yield curves in both markets. [return to top]

Subprime Mortgage Mess Weighs on Single-Family and Condo Markets
The subprime mortgage debacle has prompted firmer lending standards not only in the subprime market but also in the so-called Alt-A market — and possibly also in the quantitatively dominant prime market.

NAHB surveyed more than 400 single-family home builders in March in order to get a handle on the early impacts of the subprime meltdown on home sales. One-third of the builders in our survey said that tightening lending standards had taken a toll on their home sales in the early part of 2007. Of those impacted, the median loss was an estimated 10% of sales volume.

Our survey also showed that larger builders, as a group, had been more dependent on subprime mortgage financing than smaller companies in 2006, and relatively high proportions of the larger companies said that tighter mortgage lending standards had taken a toll on their sales volume early this year.

Two-thirds of builders in a supplementary sample of very large companies — in the Builder 200 — said they have finance subsidiaries that offered subprime loans to their buyers last year, and those without finance subs generally referred subprime borrowers to mortgage bankers, mortgage brokers or commercial banks.

Not surprisingly, a large majority of companies in this sample said that tightening mortgage lending standards had taken a significant toll on their sales volume early this year. [return to top]

Housing Forecasts Reduced — A Work in Process
The subprime-related tightening of mortgage lending standards has prompted significant downward revisions to NAHB’s forecasts of home sales for the balance of this year and in 2008. Furthermore, a rising tide of subprime and Alt-A adjustable-rate loans made in 2005-2006 will be adding to an already excessive inventory overhang during the forecast period as monthly payments adjust upward and foreclosures climb.

We’re still forecasting a gradual recovery of housing production — beginning around the middle of this year — although projected housing starts are well below our estimates of the sustainable trend level of production.

In these terms, the major “correction” process that began early last year will extend at least through 2008.

It’s also fair to say that the range of uncertainty around NAHB’s recently revised baseline (most probable) housing forecast is quite wide. Indeed, the key downside risks to the overall economic outlook now reside in the mortgage and housing markets — a point made on March 28 by Fed Chairman Bernanke in testimony before Congress. [return to top]

Attend NAHB Construction Forecast Conference on April 26 — Live or Web
Will housing demand outweigh affordability hurdles, inventory overhangs and the retreat of investors? Where are home prices headed?

Get the answers to these and other questions at the Construction Forecast Conference — Spring 2007 on April 26 in Washington, D.C.

Panels of nationally recognized experts will discuss economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys at the day-long conference.

For more information and to register, click here.

Can't Attend in Person? Webcast of Conference Also Available

The conference is also available via Webcast. For Webcast information, visit www.nahb.org/cfcwebcast. [return to top]

HousingEconomics.com: Want to Know Your State's Forecast for 2008?
Find out in HousingEconomic.com’s State Starts Forecast (sample).

The starts forecast includes downloadable Excel tables of total, single-family and multifamily starts by region and state.

To learn more, visit www.housingeconomics.com. [return to top]

For more information or to contact us directly, please visit www.NAHB.org l ©2007, National Association of Home Builders

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