August 15, 2007
By David F. Seiders
NAHB Chief Economist
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NAHB's Outlook Shows Solid Growth in Output and Employment With Inflation Under Control
Economic growth has rebounded nicely from the first-quarter lull. However, GDP growth is slackening on a trend basis and the government has revised downward the “speed limit” for the U.S. economy. NAHB’s baseline forecast now shows slightly below-trend GDP growth (through 2009), and there’s no recession in that forecast.

The labor market is losing some forward momentum as GDP growth comes off earlier highs.  We expect payroll employment growth to taper down further as GDP growth runs slightly below trend, and the unemployment rate should gravitate upward in the process.  Even so, labor market conditions should remain quite solid at the same time that unit labor costs recede – contributing to a reasonably benign inflation environment.

Core consumer price inflation has been receding in recent months, largely because of deceleration in the large imputed homeowners’ equivalent rent component, and core inflation measures have retreated to the upper ends of the Federal Reserve’s apparent tolerance zones.  We expect further deceleration during the forecast period, completing our admittedly “Goldilocks” macroeconomic outlook (not too hot, not too cold).

...But Turbulent Financial Markets Pose Real Threats to the Economy in the Near Term
Financial market conditions currently pose considerable downside risks to our “Goldilocks” economic outlook.  Financial markets turned turbulent in the latter days of July and the first half of August, kicked off by fresh revelations of credit quality problems in U.S. residential mortgage and mortgage-backed securities markets, and the infection quickly spread to a wide range of markets and to other parts of the globe amidst a worldwide flight toward credit quality.

The drive toward quality froze up various securities markets around the world as risk became difficult (or impossible) to price, particularly on mortgage-backed securities without government backing, causing credit demands to shift toward depository institutions.  Interbank loan rates shot up in the process, prompting the Federal Reserve and some foreign central banks (including the European Central Bank) to inject large amounts of reserves into banking systems in order to maintain established policy rate targets. [return to top]
The Interest Rate Structure Reflects Threats to the Economic Expansion and the Flight to Quality
The recent central bank actions successfully restored order to money markets, at least temporarily, and neither the Fed nor the foreign central banks have reduced their policy rate targets.  The Federal Reserve actually reaffirmed the 5.25% federal funds rate target at the August 7 FOMC meeting, although the FOMC statement recognized the turmoil in financial markets and moved toward a balanced risk assessment.  NAHB’s forecast now shows a quarter-point rate cut at the October 31 FOMC meeting, and an earlier cut is not out of the question.

The stunning flight to quality in financial markets drove Treasury securities rates downward and drove rates on lower-quality debt instruments upward.  The net impacts on home mortgage rates differed considerably across market components:  rates fell slightly in the FHA/VA/Ginnie Mae market, rose modestly in the prime conventional conforming market (served by Fannie Mae and Freddie Mac) and rose considerably in the nonprime (subprime and Alt-A) and jumbo loan markets.  We expect the adjustments to risk spreads to prevail for some time. [return to top]
Home-Buyer Demand Still Is Trailing Downward as Affordability Remains Depressed
Home-buyer demand has continued to trail downward, and the deterioration of mortgage market conditions has added to the downward momentum.  NAHB’s proprietary survey of large home builders shows deterioration of gross and net home sales in July, along with a rise in cancellation rates at the big companies.  Furthermore, NAHB’s broad-based single-family Housing Market Index deteriorated further in August and now stands only slightly above the low recorded during the 1990-1991 economic recession.

National house price appreciation has slowed dramatically from the record highs in 2005, increasing numbers of local markets have been recording absolute declines during the past year, and absolute declines now are being recorded at the national level.  But the price corrections to date pale in comparison to the earlier accumulation of rapid price increases, and measures of housing affordability still are hanging around the lows of the early 1990s.  Although home prices are destined to decline further, prices promise to remain “sticky” on the downside – stretching out the inevitable downward adjustment to sales activity. [return to top]
Housing Vacancies Are Near Record Highs and Homeownership Is Slipping
Second-quarter data on housing vacancies show that the supply overhang remains quite heavy in both the for-sale and for-rent components of the market.  The overhang is particularly heavy in the for-sale market, reflecting large increases in both single-family and multifamily (condo) markets since mid-2005.  This overbuilt condition is a legacy of outsized purchases by investors/speculators during the boom period and subsequent unloading of units onto the market as house price prospects have deteriorated.

The U.S. homeownership rate has been eroding for three years and the rentership rate has shown equivalent gains.  Persistent affordability problems facing prospective home buyers, combined with relatively friendly conditions in the rental market, will put further downward pressure on the homeownership rate – and a rising wave of mortgage foreclosures will contribute to the own-to-rent dynamic. The homeownership rate is sure to rebound on a longer-term basis, however, and new records will be achieved down the line. [return to top]
Home Sales, Housing Starts and Construction Activity Still Have Some Distance to Fall
NAHB’s forecasts for home sales, housing starts and Residential Fixed Investment have been revised downward (again) for 2007-2008, and we’ve run the short-term forecast through 2009.  We’re now expecting home sales to trail downward through all of 2007 and we don’t expect systematic improvements to housing starts and RFI until the second half of 2008.  We’re looking for solid increases in 2009, however, and the housing market will have good growth potential further down the line. [return to top]
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