Forecast: Fed Actions Address Slowing Economy
GDP revisions for the fourth quarter of 2007 left the overall economic growth rate at a meager 0.6%, but the estimated contraction in residential fixed investment deepened to a 25.2% annual rate and RFI subtracted a whopping 1.25 percentage points from the GDP growth rate. Available data point toward another very weak GDP growth rate in the first quarter of this year, a pattern that skates dangerously close to recessionary conditions. NAHB now views a mild recession as a nearly even bet, but NAHB also believes that aggressive actions by the Fed and the recently enacted economic stimulus package virtually guarantee stronger growth by the second half of the year. It took a while for the Fed to fully appreciate the implications of the housing contraction that began around the end of 2005. But financial market conditions deteriorated badly after that, and the Fed has been reacting to mortgage-related turmoil in financial markets and a weakening economy ever since. The initial Fed reaction, last August, was a massive injection of reserves into the banking system, followed shortly by some changes in discount window policies to help facilitate the functioning of short-term credit markets. In September, the Fed finally dropped both the target funds rate and the discount rate. At its March 18 meeting, the Fed dropped both rates by another 75 basis points, bringing the cumulative cut in the funds rate to three percentage points and the cumulative cut in the discount rate to 3.75 percentage points.

The Fed obviously is open to further easing, and we’re projecting an additional 50 basis point cut at the meeting on April 30. That move, if implemented, will drop the nominal funds rate to 1.75% and place the real (inflation-adjusted) funds rate in the negative zone — exactly where it belongs when housing and the economy are in deep trouble. We expect the Fed to hold the 1.75% funds rate until the spring of 2009, keeping the real rate below zero until then. In addition, the Fed as recently adopted liquidity enhancing innovations like the Term Securities Lending Facility (March 11) and the Primary Dealer Credit Facility (March 16). The PDCF provides collateralized funding to securities dealers at the Fed's discount rate, and the range of collateral includes investment-grade mortgage-backed securities. [ return to top ]