The major danger zone for the U.S. economy has shifted to the second half of this year, particularly to the fourth quarter, largely reflecting “payback” for the fiscal stimulus that’s supporting consumer spending during the middle two quarters of the year.

A dwindling drag from housing, further improvements in our trade balance and a policy-related firming of business capital spending will be needed to keep the economy afloat as consumer spending weakens late this year.
 

Growing slack in labor markets should hold down unit labor costs and put downward pressure on core inflation during the second half of this year and into 2009, diffusing fears of protracted “stagflation” in the U.S. economy. [return to top]
 

Financial institutions are once again announcing sizeable mark-to-market asset write-downs, volume in private securitization markets is spotty at best, credit quality spreads are widening again in bond and mortgage markets and the stock market has retreated into bearish territory.

These unexpected turnarounds have seriously complicated the near-term economic outlook and presented the Fed with yet another set of challenges — with respect to management of monetary policy as well as the special “liquidity enhancing” innovations put in place since last summer. [return to top]
 

We expect the Fed to talk tough on inflation, but also to maintain the current “accommodative” monetary policy stance — nominal federal funds rate of 2.0% and real funds rate in negative zone — until the second quarter of next year.

Fed funds futures markets are moving toward this view and long-term Treasury rates have receded in the process, following a sizeable mid-June spurt.

Renewed instability in financial markets most likely will encourage the Fed to extend the life of new discount-window mechanisms established earlier this year under the central bank’s emergency lending powers — including the controversial Primary Dealer Credit Facility (PDCF) established in connection with the Fed-engineered “rescue” of Bear Stearns in March.

Assurance of the ongoing presence of the PDCF and other innovative discount window facilities is needed to keep liquidity conditions in U.S. credit markets from deteriorating further. [return to top]
 

NAHB’s surveys of home builders have yet to show stabilization of either net home sales or sentiment regarding the demand side of the market for new single-family homes.

Weak demand and heavy oversupply continue to put substantial downward pressure on house prices, at least on a national-average basis. Median prices of new and existing homes sold continue to trial downward while prominent repeat-sales measures are falling sharply.

The S&P/Case-Shiller 20-city composite home price index fell at a 19% seasonably adjusted annual rate in April and was down by 17% from its mid-2006 peak.

Price-to-income ratios now have fallen back toward normal historical ranges and standard measures of housing affordability have picked up a good bit from their mid-2006 lows. However, tight mortgage lending standards and expectations of further house price declines have kept prospective home buyers on the sidelines. [return to top]
 

We expect the recovery in housing starts to begin in the second quarter of next year, although we also expect both housing starts and residential fixed investment to be down in 2009 on a year-over-year basis.

NAHB’s surveys of builders/developers show that we’re now facing a developing credit crunch in the markets for land acquisition, land development and construction (AD&C) loans.

The availability of new loans has been cut back dramatically and lenders are tightening terms and conditions on many outstanding loans — prodded by financial regulators based in Washington. These financing difficulties compound downside risks to our baseline (most probable) forecasts of housing starts and construction activity. [return to top]
 

The centerpiece of the prospective housing bill is a temporary $8,000 tax credit for first-time home buyers, a provision that could jump-start home sales, help to stabilize house prices and mortgage credit quality and take some pressure off the AD&C loan markets as well.

Other key provisions would limit mortgage foreclosures and strengthen the government-related components of the mortgage finance system in both the short and long term. [return to top]
 

Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.

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