December 17, 2008
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The Economy Is Weakening Badly as 2008 Draws to a Close
We’re now a year into official recession territory and the economic downswing has accelerated in recent months.

The labor market has been weakening systematically during the past year and recent downshifts have been downright alarming. Payroll employment fell by 533,000 in November — the losses were widespread across industries — and the civilian unemployment rate jumped to 6.7% in the process.

Furthermore, weekly data on claims for unemployment compensation continue to climb, virtually ensuring another very weak employment report for December — to be released Jan.  9.

Virtually all components of demand for U.S. economic output have been weakening during the fourth quarter, including consumer spending, housing, business investment and exports.

It now appears that real gross domestic product (GDP) will contract at an annual rate of roughly 6% in the final quarter of the year, the weakest performance since the first quarter of 1982.

The Housing Market Is Contracting Sharply
Recent data show ongoing deterioration of housing demand along with sharp reductions in new housing production.

NAHB’s proprietary survey of 30 large single-family home builders shows further erosion of gross sales in November (seasonally adjusted). A falloff in cancellations left net sales about flat in November, but the downward trend still appears to be in place.

The ratios of cancellations to either gross sales or the backlog of signed sales contracts have not changed much in recent months, but both ratios remain quite high by historical standards.

NAHB’s broad-based single-family Housing Market Index (HMI), begun in January 1985, held at a record low 9 in early December. Furthermore, all three HMI components — present sales, buyer traffic and six-month sales expectations — as well as measures for all four regions of the country, were at or near record lows in December.

Housing starts and issuance of building permits both fell to record lows in November, and large declines were posted in both single-family and multifamily sectors as well as in all four regions of the country.

These downtrends ensure another major subtraction by residential fixed investment from overall GDP growth in the final quarter of 2008. [return to top]

Inflation Fades and Deflation Threatens
The dramatic declines in prices of oil and other key commodities from their peaks earlier this year have put strong downward pressure on top-line measures of inflation at both producer and consumer levels. The Producer Price Index (PPI) for finished goods fell for the fourth consecutive month in November and the Consumer Price Index (CPI) traced the same type of pattern.

Key measures of core inflation (excluding food and direct energy prices) have also lost upward momentum and negative movements have begun to surface. The core PPI showed virtually no change in November, while the November reading for the core CPI was dead flat following a small, and highly unusual, decline in October.

The dramatic changes in the inflation situation are not necessarily good news. Although the Fed has coveted price stability for a long time, the recent patterns of price change (along with inherent upward biases in the inflation measures) raise the real possibility of broad-based deflation in the U.S. economy. That’s not a challenge our central bank wants to face. [return to top]

The Fed Throws ‘All Available Tools’ Into the Fray
The Federal Reserve dropped some bomb shells at the conclusion of the Dec. 15-16 meeting of the Federal Open Market Committee (FOMC).

For one thing, the Fed dropped the federal funds rate target from 1.0% to a range between 0.25% and 0.00% and stated that the FOMC “anticipates that weak economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time”

We take this to mean an average effective funds rate of zero from now through the end of 2009.

The Fed can’t drop the funds rate below zero, so our central bank has effectively run out of ammo on the traditional monetary policy front. However, the Fed committed to “employ all available tools to promote the resumption of sustainable economic growth and to preserve price stability.”

So what are these “available tools?” The FOMC statement said that, going forward, the Fed will support the functioning of financial markets while managing the growth/inflation balance through measures “that sustain the size of the Federal Reserve’s balance sheet at a high level.”

Reliance on the balance sheet often is dubbed “quantitative easing,” as the Fed focuses on purchases of various types of debt and securities to support specific markets and works to facilitate the extension of credit to households and businesses. [return to top]

Fed Emphasizes Support to Mortgage and Housing Markets
The FOMC’s discussion of the use of the Fed’s balance sheet to support credit markets and economic activity put a good deal of emphasis on the needs of the housing sector.

The Dec. 16 statement reiterated the FOMC’s intentions to purchase large quantities of agency debt and mortgage-backed securities over the next few quarters, and added that the Fed stands ready to expand its purchases of both types of instruments “as conditions warrant.”

It’s difficult to predict how well the Fed will be able to support the economy and the housing sector with an essentially dormant federal funds rate and with reliance on unconventional “balance sheet” policies.

It’s true that the cost of funds to the government sponsored enterprises (GSEs) fell in the wake of the Dec. 16 statement and that conventional home mortgage rates retreated in the process. But only time will tell how things will work out in this brave new policy world over the longer term. [return to top]

Strong Fiscal Policy Support Still Is Needed
The major changes in the structure and management of monetary policy announced on Dec. 16 excited the stock market, at least temporarily. But these changes hardly reduce the need for strong fiscal policy support to stop the downward spiral in the housing sector and to limit the depth and duration of the very serious economic recession that’s well underway at this time.

We’re still counting on a very large fiscal stimulus package — around $600 billion — early in the Obama Administration. To be effective, such a package must include strong measures to stimulate home buying and to limit home mortgage foreclosures.

The first priority should be a large and temporary tax credit for all home buyers, along the lines of the provision recommended by the “Fix Housing First” coalition spearheaded by NAHB. [return to top]

Eye on The Economy Will Not Be Published During the Holidays
Eye on the Economy will will not be published during the holidays. Publication will resume on Jan. 14.

Have a happy and warm holiday season and a Happy New Year. [return to top]

Construction Forecast Conference Webcast Available
An on-demand webcast of the 2008 Fall Construction Forecast Conference is available for purchase.

The webcast fee includes access to the webcast archive and electronic copies of the conference handout and presentation materials. Multiple viewers in one office can purchase the webcast for one fee.

The on-demand webcast also gives viewers complete flexibility in their viewing experience — pause, skip forward and backward, or jump directly to your topics of interest.

To purchase and download the webcast, click here. [return to top]

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