National Outlook

Highlights

• Third-quarter growth of real GDP has been revised down again, but it's still highly likely that the trough of the Great Recession lies within that quarter. Furthermore, GDP growth is firming up in the fourth quarter, and a sustainable (if moderate) economic expansion should develop during the 2010-2011 period. Housing production has been a major player in the recent economic turnaround and promises to be a key factor in the evolving economic expansion.

• A rebound in consumer spending provided strong support to third-quarter GDP growth, spurred by a surge in auto sales under the federal "cash-for-clunkers" program. At the same time, improvements were being made to household balance sheets, owing largely to better pricing of both corporate equities and homes, and household financial obligations were being worked down as well -- laying groundwork for a sustainable expansion of consumer spending.

• A surge in productivity growth has kept improvements in economic output from transferring to the labor market, although the rate of deterioration in labor market conditions has slowed substantially since the first half of the year. Payroll employment should start growing early in 2010, at least slowly, and the unemployment rate should embark on a long and gradual downward trend at essentially the same time. Employment in residential construction appears to be bottoming out at this time and should post solid growth in both 2010 and 2011.

• The Great Recession and the related slack in labor markets have maintained downward pressure on core inflation in the U.S. economy, despite the weakened dollar and surging energy prices in recent months. Furthermore, long-term inflation expectations in the private sector have remained benign, helping to hold down current inflation rates. We expect key measures of core consumer price inflation to continue to recede during 2010-2011, falling even further below the Federal Reserve's apparent target zone.

• The Fed held monetary policy steady at the December 16 FOMC meeting, maintaining the 0.0 to 0.25% target range for the federal funds rate while continuing to promise "exceptionally low levels" for "an extended period." We still expect the first upward adjustment to the funds rate to occur in the second quarter of 2011, and we do not expect the Fed to actively withdraw reserves from the banking system before then. While special liquidity facilities and securities purchase programs now are being wound down, and some asset holdings are bound to run down naturally, we do not expect outright sales of assets from the Fed's portfolio during the 2010-2011 period.

• Financial market conditions have continued to improve, although the rapid pace of improvement evident earlier this year has tapered off as many markets have regained their footing. Some segments still exhibit serious difficulties, however, including private-label asset-backed securities markets--such as the jumbo RMBS and the CMBS markets. Lending by commercial banks also remains tightly constrained, presenting daunting problems for private businesses lacking access to public debt markets.

• Sales of existing homes (closings) have climbed smartly in recent months, fueled by a large flow of distressed properties on to the market and by the first-time home buyer tax credit that expired at the end of November. But new-home sales (contracts signed) have faded recently, following a rebound from the cyclical low early this year. We expect the recently extended/expanded home buyer tax credit to support both segments of the market through the spring of next year, and we expect economic and financial market fundamentals to put sales on sustainable growth paths following some tax credit-related "payback " around the middle of 2010.

• Single-family housing starts also have slipped from the pace registered in the third quarter of this year, and multifamily starts apparently are heading for a record low in the final quarter of 2009. But we expect single-family starts to regain upward momentum in the first half of next year, due partly to support from the new home buyer tax credit, and we expect the multifamily market to begin a meaningful recovery toward the end of 2010 as the economic recovery gains some steam. Total starts should climb back over the million-unit mark by the latter part of 2011, and other components of the housing sector (including manufactured homes and residential remodeling) should also be back in higher gears by then.

• The housing production component of GDP, residential fixed investment, exerted a heavy drag on the economy from early 2006 through mid-2009. RFI now is off the deck and promises to make solid positive contributions to economic growth in 2010 and 2011. Even that degree of expansion will leave RFI well below its potential trend level, a feature common to overall GDP and to the nation's labor market as well.

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