Eye on the Economy - 07/09/2008 (Plain Text Version)

By David F. Seiders, NAHB Chief Economist

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Danger Zone for U.S. Economy Shifts Toward Year-End

Real gross domestic product (GDP) growth has been running seriously below trend for several quarters and the labor market has been weakening systematically since late last year. That pattern promises to persist over the balance of the year and into 2009, producing a “growth recession,” if not an official economic recession.

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.

Commodity Price Inflation Should Not Generate Persistent ‘Stagflation’

Surging prices for energy and food have driven headline inflation numbers into the stratosphere, and inflation expectations in the private sector have risen significantly. Even so, key measures of “core” consumer price inflation (excluding food and direct energy prices) have been remarkably well contained.

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 Markets Suffer Relapse, Generating More Work for the Fed

Financial market conditions have taken another turn for the worse, following improvements from the abyss reached in March when Bear Stearns essentially went under.

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]

The Fed Will Not Tighten Monetary Policy or Restrict Access to the Discount Window This Year

The Fed held monetary policy steady at the June 24-25 Federal Open Market Committee (FOMC) meeting while paying more lip service to potential inflation pressures.

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]

Home Sales and Prices Continue Downward Despite Revival of Affordability Measures

Home sales have been mixed recently, continuing to erode in the new-home market while stabilizing in the existing-home market. But existing-home sales are simply reflecting rising foreclosures and foreclosure sales, a process that’s actually putting heavier downward pressure on the new-home market.

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]

Credit Tightening in AD&C Markets Adds to Downward Pressure on Housing Production

Housing production still is on a downward path, and improvements in new-home sales and inventory positions must be achieved before any sustained pickup in housing starts can occur.

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]

Housing Stimulus Legislation Badly Needed

The need for federal legislation to spur home buying and hold back the foreclosure wave is increasing day by day. Congress went home for the Independence Day recess without reaching agreement on key aspects of the housing bill, although there’s a good chance that a bill will be sent to President Bush by the August recess.

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]

NAHB's Eye on the Economy Will Not Be Published on July 23

NAHB's Eye on the Economy will not be published on July 23. Publication will resume with the Aug. 6 issue. [return to top]

Want to Know the Housing Forecast for the Top 100 Metros?

Find out in HousingEconomic.com’s 2008 to 2009 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]