Eye on the Economy - 07/27/2005 (Plain Text Version)By David F. Seiders, NAHB Chief Economist View Graphical Version | Subscribe to NAHB Publications | Email our Editor... The U.S. economy definitely is out of the woods …Rampant speculation about a faltering economic expansion has now fallen by the wayside. The U.S. economy has shown impressive resilience to external shocks, including record global oil prices and terrorist outbreaks in London, and the economy is displaying solid fundamentals that should carry us forward for some time to come. Indeed, we figure that the current expansion, which began at the end of 2001, is now moving into its “middle innings” and has a long way to run. We’re now pegging growth of real Gross Domestic Product (GDP) at 3.5% for the second quarter and 3.8% for the third, on par with the solid pace of other recent quarters. GDP growth may slow a bit later this year and in 2006, as slack in resource (labor and capital) markets is gradually reduced, but skillful management of economic policy should help keep growth around a sustainable trend pace for an extended period. At this point, we feel no need to speculate about the timing of the next economic recession. The labor market now is performing well in most places …The growth of aggregate demand and economic output (real GDP) has been strong enough to generate systematic improvement in the national labor market since the fall of 2003, despite historically high rates of productivity growth (output per hour). Even the beleaguered Midwest region is looking somewhat better. Payroll employment increased by 146,000 in June, according to preliminary data released on July 8 by the Labor Department. The average monthly gain for the second quarter (including revisions for earlier months) now stands at 181,000, compared with 190,000 for the first quarter and 172,000 for the past 12 months. NAHB’s forecast shows maintenance of job growth in this range through 2006. The labor market report for June showed an unemployment rate of 5.0%, down from 5.1% in May and 5.6% a year earlier. Growth of household employment was 186,000, the labor force grew by only one thousand, and the labor force participation rate slipped from 66.1% to 66.0%. We expect the unemployment rate to hang around the current level for some time, and an anticipated rise in the labor force participation rate should help maintain enough slack in labor markets to support solid growth in employment and output through 2006 and beyond. [return to top] The ‘core’ inflation picture has improved despite ongoing economic expansion and oil price shocks …Extended periods of above-trend growth in economic output (real GDP) typically generate upward pressures on core inflation (excluding prices of food and energy), at least partly through the labor market (i.e., through rising unit labor costs). Strong growth of labor productivity can hold off these pressures, particularly in the early stages of an economic expansion when productivity surges naturally (labor already hired is used more intensively), but at some point labor costs typically become an inflation force. That’s happening in the U.S. now, and some inflation impulses also are coming from commodity prices and non-oil imports. The inflation issue clearly is on the front burner at the Federal Reserve, and the Federal Open Market Committee (FOMC) has explicitly reserved the right to “fulfill its obligation to maintain price stability” as the Fed moves gradually toward a position of monetary neutrality. In this regard, recent news on producer and consumer price inflation has been rather reassuring. The Producer Price Index (PPI) for finished goods was dead flat in June, and the core component of the PPI showed a year-over-year advance of only 2.2% — the slowest since last November. The Consumer Price Index (CPI) also was flat in June, and the core CPI was up by only 2.0% on a year-over-year basis ― the slowest since last October. The technically superior chain-core CPI showed only a 1.8% gain, the same as in May. The May report on personal income and consumer spending also provided an encouraging read on inflation (June data are not yet available). Indeed, the Fed’s favorite inflation gauge, the core price index for personal consumption expenditures (PCE), held at a year-over-year rate of 1.6% while the market-based core PCE price index held at 1.7% — the same as the average for the previous six months. These readings are within the Federal Reserve’s apparent “comfort zone,” as suggested by economic projections contained in the Fed’s semi-annual Monetary Policy Report to the Congress that was delivered by Fed Chairman Alan Greenspan on July 20-21. However, the upper end of the FOMC’s projected ranges is only 2% for both 2005 and 2006, leaving little room for acceleration from the recent pace. [return to top] Monetary policy marches along …As expected, the Federal Reserve hiked short-term interest rates by 25 basis points at the conclusion of the June 29-30 FOMC meeting. This adjustment took the federal funds rate target to 3.25%, up from 1% when the Fed embarked on the tightening process exactly one year earlier. The bank prime rate has risen from 4.0% to 6.25% in the process. The FOMC statement continued to describe monetary policy as “accommodative” (even after the June 30 rate adjustment) and retained language to the effect that remaining accommodation can be removed “at a measured pace.” Thus, contrary to some speculation in the markets, the FOMC made no suggestion that a pause in the persistent series of upward rate adjustments is imminent and Greenspan’s recent Congressional testimony reinforced that point. We’re expecting another quarter-point hike in the Fed’s target for the federal funds rate at the Aug. 9 FOMC meeting and we’re still projecting a funds rate of 4% by year end. Some further increase is likely in 2006 as the central bank seeks out a position of monetary “neutrality,” with or without Greenspan at the helm. (Greenspan’s term expires in January but President Bush may ask him to stay on pending confirmation of a successor). [return to top] Greenspan expounds on the long-term rate ‘conundrum’ …Greenspan devoted a large part of his July 20-21 monetary policy testimony to the substantial decline in long-term interest rates that’s accompanied the Fed’s progressive increases in short-term rates since mid-2004 ― a pattern he described as “without precedent in our recent experience.” Back in February, Greenspan characterized the behavior of long rates as a “conundrum,” but he now seems much more confident about the fundamental factors at play. He cited four key factors that are restraining long-term rates: low inflation expectations, smaller risk premiums for inflation uncertainty, smaller term premiums for holding long-term securities (because of lessened volatility in the economy), and a global excess of intended saving over intended investment. This is pretty arcane stuff, of course, and the explanations don’t necessarily signal where long rates are going or lay out the implications of stubbornly low long rates for the conduct of monetary policy. The question remains: will the Fed continue to raise short-term rates and risk a yield curve inversion? Greenspan told Congress that an inverted yield curve does not have the same adverse economic implications as in past periods, a statement that raised a lot of eyebrows in financial markets and in the forecasting community. NAHB’s forecast says the Fed will not have to prove that proposition because long-term rates will move up moderately during the second half of 2005 and in 2006 as the Fed systematically moves the federal funds rate to 4% and beyond. Indeed, long-term rates have moved up significantly in recent weeks, aided and abetted by a surprise revaluation of the Chinese currency that provoked questions about the future of Chinese central bank investment in dollar–denominated assets. The 10-year Treasury yield now is hanging around 4.25%, up from 3.90% a month earlier, and we expect this rate to be around 4.5% at year end. [return to top] The housing market charges ahead …The housing market turned in another strong performance in the second quarter, and the third quarter has started out on a high note as well. Total housing starts held firm in June at a 2.004 million pace, and starts averaged more than 2 million units for the second quarter as a whole. The single-family market was particularly strong, as starts averaged 1.67 million for the quarter. Issuance of residential building permits increased by 2.4% in June to a seasonably adjusted annual rate of 2.1 million units. Single-family permit issuance nudged up 1.3% to a rate of 1.649 million units for the month and the pace of multifamily permit issuance was up 6.5%. In the process, the backlog of unused single-family permits rose to an historically high level. Builders obviously are facing very strong demand for homes, and drawn-out regulatory processes in many local jurisdictions have encouraged builders to accumulate an unusually large supply of unused permits to be able to meet anticipated housing demand. Home sales and house prices continued to move ahead in June, showing the strength of demand. Indeed, sales of existing single-family homes and condo/co-op units both hit new records on a national basis and all regions but the Midwest posted record numbers; furthermore, price appreciation accelerated further in both markets, showing year-over-year gains of nearly 15%. In the new-home market, sales were a record 1.374 million units in June and the months’ supply of homes for sale was a low 4.0 ― both symptoms of a demand-driven market. A record 22.3 percent of the for-sale “inventory” consisted of homes that had not even been started, but for which permits had been issued. The median price for homes sold in June was $214,800, down from $227,400 in May. That was probably caused by a change in the regional and segment sales mix. There is no evidence that prices are being reduced to stimulate sales. Surveys of home builders and home mortgage lenders show that strength in the single-family sector extended into July. NAHB’s Housing Market Index was 70 in July, within the elevated range that’s prevailed for the past year, and the index of applications for mortgages to buy homes (Mortgage Bankers Association series) gravitated upward to a new record during the month (four-week moving average basis). [return to top] Housing is headed for a soft landing in 2006 …The recent strength of the single-family market has provoked another upward revision to NAHB’s forecasts for home sales and housing starts in 2005-2006. We’re now projecting 2.004 million total starts for 2005, up by nearly 3% from last year, and the forecast shows a record 1.653 million single-family units. We’re projecting total starts of 1.894 million in 2006, with 1.554 million single-family units — down by 6% from 2005. The anticipated setback is based primarily on our forecast of the interest rate structure as well as expectations for a less aggressive adjustable-rate mortgage (ARM) market and a reduced presence of speculators in the single-family and condo markets. (Read the June 29 issue of Eye on the Economy for a discussion of these two topics). We expect national average home price appreciation to slow to some degree in 2006 as sales volume recedes, but the pace of price gains should not fall below the long-term average (around 5%). Price declines could occur in some local markets in 2006, but widespread declines are just about out of the question as long as our forecasts for the economy and the financial markets turn out to be on target. [return to top] 'HousingEconomics Online' Provides In-Depth Analysis of Housing Market."HousingEconomics Online" is NAHB's new online publication from the NAHB Economics Group that provides the latest housing economic data, trends and key events that shape the economy. NAHB’s leading economists analyze and synthesize the housing and economic information to provide in-depth analyses of the niches and nuances of the home building market. "HousingEconomics Online" combines unique scientific research with practical applications providing insights that are original, useful and written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses. To order, visit the "HousingEconomics Online" details page. This interactive Web site at the executive level provides critical data and information quickly, easily and frequently and includes the following features:
For more details, go to www.housingeconomics.com. [return to top] For more information or to contact us directly, please visit www.NAHB.org | ©2005, National Association of Home Builders |