Eye on the Economy - 09/26/2007

September 26, 2007

By David F. Seiders
NAHB Chief Economist


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A Slowing Economy Is Showing Up in the Labor Market
Economic growth slowed down in the third quarter, an even weaker performance is likely in the final quarter of the year and the probability that the U.S. economy will slip into recession during the next several quarters has risen during the past month.

We still believe that recession will be averted, however, and we’re looking for decent economic growth in both 2008 and 2009.

The evolving slowdown in GDP growth now is showing up in the U.S. labor market. Payroll employment growth actually contracted slightly in August and the trend of job growth definitely has weakened since the spring of this year.

We expect positive but relatively slow growth in employment during the next few quarters and the unemployment rate should gravitate upward in the near term. Firming GDP growth should improve labor markets beyond mid-2008.

Financial Market Turbulence Forces the Fed’s Hand

Current weakness in the economy primarily reflects the deepening housing market correction. And financial market turbulence touched off by glaring credit quality problems in the subprime mortgage market has engulfed not only residential mortgage markets but also other major parts of U.S. and international financial systems.

The global flight to quality has forced down Treasury rates, constricted credit availability in some markets and widened quality spreads in virtually all private credit markets.

Financial market turbulence in August and early September prompted a series of moves by the Federal Reserve to restore order to money markets and protect the real economy. On Sept. 18, the Fed enacted half-point cuts in both the federal funds rate and the discount rate, citing the recent tightening of credit conditions that “has the potential to intensify the housing correction and to restrain economic growth more generally.”

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Fed Rate Cuts Are No Quick Fix for the Mortgage Market

The Sept. 18 rate cuts by the Fed have had some positive effects in financial markets — primarily by stimulating the stock market and relieving liquidity problems in short-term credit markets.

Although the Federal Open Market Committee (FOMC) statement made no commitment regarding the future course of monetary policy, we expect additional quarter-point cuts at each of the two remaining FOMC meetings in 2007.

Unfortunately, rate cuts by the Fed cannot immediately stabilize mortgage and housing markets, a point recently stressed by Federal Reserve Chairman Ben Bernanke in an address entitled, “Housing, Housing Finance and Monetary Policy.”

The financial markets still are focused heavily on credit quality, and only those components of mortgage markets having explicit or implied government backing are functioning well.

The subprime and Alt-A adjustable-rate mortgage (ARM) markets have shrunken dramatically, the prime jumbo market has not yet thawed out and yield spreads have widened out even in the prime conventional conforming market — loan sizes up to $417,000.

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The Housing Downswing Still Is Underway
Recent NAHB surveys of single-family home builders show serious adverse impacts on gross and net home sales from the abrupt tightening of mortgage lending conditions that occurred in August and extended into September.

Our proprietary survey of large companies showed serious setbacks in new orders and serious increases in sales cancellations in August. Furthermore, our broad-based Housing Market Index fell to a record low in early September as builder confidence continued to contract.

Not surprisingly, single-family housing starts and permit issuance both contracted sharply in August — by 7% and 8%, respectively. Furthermore, sales of existing homes continued to decline, particularly in the condo market, and inventories of unsold homes continued to rise.

In addition, a serious supply-demand imbalance is putting downward pressure on house prices in many parts of the country, according to the S&P/Case-Shiller® measure through July. [return to top]

We’re Still Projecting Upturns in 2008
There’s clearly downward momentum in housing markets at this time. Furthermore, difficult problems in mortgage markets, along with growing evidence of eroding house values in more and more markets, have combined to send many prospective home buyers to the sidelines — with a hefty shove from the media.

And when housing demand revives, there still will be large overhangs of vacant housing units in the markets for both new and existing homes.

These negatives do not mean that housing will continue downward forever. As long as the overall economy continues to expand (with the Fed’s help), throwing off decent growth in employment and household income, ongoing population growth will generate decent growth in the number of households. That’s the key.

In our forecast, this dynamic process is supported by favorable financing conditions in FHA/VA as well as in prime conventional conforming mortgage markets, and we’re assuming that the jumbo mortgage market regains footing before long.

If these conditions come together, and if builders focus heavily on incentives to move inventory, it’s reasonable to expect home sales to stabilize by early next year.

History suggests that housing starts should turn up within a quarter or two of the turn in sales and residential fixed investment should follow closely behind starts — relieving the serious drag on GDP that’s been exerted by contracting housing production since early last year. We currently expect RFI growth to turn positive in the final quarter of 2008. [return to top]

Attend the Fall Construction Forecast Conference Oct. 24

Plan to attend NAHB's Construction Forecast Conference on Oct. 24 at the National Housing Center in Washington, D.C. The conference brings together the nation's premier housing economists and finance experts for an in-depth examination of the economic outlook for the housing industry.

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]

Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2007-2008 Metro Forecast (free preview). Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.

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

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