Looks Like Below-Trend Growth, But Not Recession
Growth of the U.S. economy (real GDP) slowed substantially in the second quarter, and below-trend growth is likely to persist for at least another year. This looks like a mid-cycle correction, however — an economic recession is not on the horizon.

The three-year run of above-trend GDP growth, associated shrinkage of slack in labor markets and record-high energy costs have raised inflation concerns at the Federal Reserve. Thus it was no surprise that the Fed implemented another quarter-point hike in short-term interest rates at the conclusion of the June 29 meeting of the Federal Open Market Committee (FOMC), raising the federal funds rate target to 5.25% and taking the bank prime rate to 8.25% — the highest levels since early 2001.

The quarter-point rate hike actually sparked a sigh of relief in financial markets, since the recent increases in inflation and a series of “hawkish” statements from Fed spokespersons had raised fears of a half-point increase. Moreover, the public statement issued in connection with the FOMC’s announcement of the quarter-point rate increase was not as hawkish on inflation as the markets had feared, and “relief rallies” erupted in both stock and bond markets as the second quarter drew to a close.

The FOMC statement, as expected, stressed that future policy decisions will be data-dependent, and that core inflation readings promise to remain troublesome in coming months. However, the FOMC statement appeared to signal an even-handed assessment of the risks to both sustainable economic growth and price stability, and it’s possible that the Fed is willing to discount perverse inflationary pressures stemming from a technical glitch in the way owners’ equivalent rent is estimated.

NAHB’s forecast assumes that the Fed will not raise short-term rates again this year, and that the Fed will in fact be compelled to drop rates a bit by mid–2007 as the unemployment rate gravitates upward and core inflation stabilizes.

Long-term interest rates should firm up a bit further in this environment, with the 10-year and 30-year Treasury rates edging up slowly to 5.25% and 5.35%, respectively, by late this year. [ return to top ]