• Growth of U.S. economic output (real Gross Domestic Product) slowed substantially in the second quarter and the slowdown has extended into the second half of the year. Housing now is the weakest major sector of the economy (in growth terms) and the drag from the downswing in housing production will hold GDP growth below trend over the balance of 2006 and into 2007.
• The housing sector was a major employment generator during the boom that ran from mid-2003 through early 2006, and the housing downswing now is taking a toll on payroll employment. However, a surging nonresidential construction sector is essentially offsetting that slack and overall job growth is holding up reasonably well —at least on a quarterly average basis. Furthermore, the unemployment rate still is bouncing around the lows for this cycle.
• Core inflation still is running on the high side and business labor costs still are rising at a brisk pace. However, the evolving slowdown in economic growth and job creation should help keep unit labor costs in check, and the recent impressive fallback in energy costs will help stem the “leakage” of higher energy prices into the core. The Federal Reserve and financial market participants apparently concur with this assessment.
• The Fed held monetary policy steady at the September 20 meeting of the Federal Open Market Committee, the second consecutive “no change” decision following 17 straight quarter-point rate hikes. We expect the Fed to hold short-term rates steady over the balance of this year and into 2007, and the next rate adjustment may very well be downward.
• The fixed-income markets have feasted on the evolving economic slowdown, the likelihood of receding core inflation and the prospects for stable (or even easier) monetary policy during the period ahead. As a result, long-term interest rates have fallen substantially since mid-year and should remain close to current levels for some time.
• Recent statements by both the Chairman and Vice Chairman of the Federal Reserve Board reveal strong focus at our central bank on the evolving housing downswing as well as a good bit of uncertainty about how the housing “adjustment” will play out. Major uncertainty surrounds the pattern of prospective house price adjustments as well as associated impacts on the housing wealth effect that’s been supporting consumer spending for several years.
• The Federal Reserve’s balance sheets for the household sector of the economy show a record level of homeowner equity at mid-2006. However, the second-quarter gain was smaller than earlier in the economic expansion, reflecting the slowdown in house price appreciation, and the ratio of mortgage debt to the market value of homes moved up to some degree--trends that are likely to continue for some time.
• Recent housing indicators suggest that the downslide in housing demand may be nearing an end. However, demand remains in a weakened condition and there’s still a heavy supply of for-sale housing on the market, pointing toward further declines in starts of new units in the months ahead.
• NAHB’s housing forecast shows a mid-2007 trough in housing production, an extended period of erosion in “real” house values, a gradually weakening housing wealth effect and only limited negative economic fallout from “payment shock” on “exotic” adjustable-rate mortgages written during the housing boom —messages I recently delivered in the U.S. Sen
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