The housing production component of GDP (Residential Fixed Investment) was a major economic growth engine during the 2003 to 2005 period, and the abrupt downshift in RFI since early last year has weighed heavily on GDP growth ever since. Contractions in industries closely related to housing production, such as mortgage banking, have added to the downward pressure on overall economic growth.

The housing downswing still is underway and several other sectors apparently are losing momentum in the third quarter.

We’re currently expecting GDP growth to recede to a 2.4% annual rate this quarter, and we’ve cut our fourth-quarter forecast to 2.0%. We currently peg the probability of recession within the next 12 months at 33%, up from 20% several months ago.
 

But now the labor market also is weakening, suggesting that the earlier disconnect simply reflected time lags between slowdowns in growth of output and employment.

The employment report for August actually showed a small decline in payroll employment of 4,000 jobs for that month, the first setback in four years, and the employment numbers were revised downward for both June and July.

Indeed, total payroll job growth averaged only 44,000 for the June to August period, down from 147,000 for the first five months of the year. And although the unemployment rate held at a comfortably low 4.6% level in August, this stability masked large declines in both household employment and the civilian labor force — both troublesome signs on their own.

NAHB’s forecast shows a gradually increasing unemployment rate and subpar growth of less than 1% in payroll employment during the balance of this year and the first half of 2008 as GDP growth proceeds at a below-trend pace.

We expect to see better labor market performance during the second half of next year and in 2009 as the drag from housing eases off and GDP growth picks up. [return to top]
 

A special NAHB survey of single-family home builders, conducted in the latter part of August, showed serious negative impacts on home sales as well as renewed upward pressure on sales cancellations. Indeed, the reported impacts of tightening mortgage lending conditions were even more serious than we had found earlier in the year.

The most serious problems were reported by the large companies that start more than 100 units per year and by companies in the West region — presumably reflecting the freeze-up of the jumbo mortgage market in August. [return to top]
 

These experiences have reminded the investment community of credit risks in other parts of the financial markets, kicking off a broad-based flight to quality.

Some credit markets have virtually shut down in the process — the asset-backed commercial paper market is a good example — and quality spreads have opened up in most markets, including the corporate bond market.

Fortunately, the flight to quality also has driven down the entire Treasury yield curve. This has kept rates on things like prime conventional conforming mortgages and high-grade corporate bonds close to levels prevailing before the most recent round of turmoil, despite considerable widening of spreads to comparable maturity Treasuries.

But most other rates have risen in absolute terms — including rates on subprime, Alt-A and jumbo mortgages as well as rates on lower-rated corporates.

These changes definitely are cutting into housing market activity and overall economic growth. [return to top]
 

The Fed almost certainly will cut its target for the federal funds rate at the next FOMC meeting on Sept. 18, and our central bank stands ready to make further adjustments down the line if the economy seems to be slipping toward recession.

NAHB’s current forecast assumes quarter-point rate cuts at the next three FOMC meetings — putting the federal funds rate at 4.5% by year-end.

This will put the real (inflation-adjusted) funds rate at about 2.6%, a modestly stimulative position, and the Fed still would have leeway to deliver more monetary stimulus should the situation demand further action. [return to top]
 

These realities have provoked yet another cut to NAHB’s housing forecast. We now expect total housing starts to be down by 23% in 2007 and an additional 10% in 2008. Residential Fixed Investment now declines by 17% in 2007 and 12% in 2008.

We’re still viewing 2009 as a solid recovery year — with housing starts up by 12% and RFI posting a 6% year-over-year gain — but considerable uncertainties still surround our baseline (most probable) forecasts. A free preview of NAHB's Executive-Level Forecast is available online. [return to top]
 

Can't attend? Watch the conference webcast live.

For more information, or to register for the conference or webcast, visit www.nahb.org/cfc. [return to top]
 

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