U.S Economy Loses Momentum, Financial Markets Still Volatile
The U.S. economy continues to lose forward momentum, as the 3.3% growth in real gross domestic product (GDP) reported for the second quarter—revised downward today to 2.8%—is likely to be only a temporary bounce. NAHB still expects positive growth in the third quarter, but small negatives in the fourth quarter and in the first quarter of 2009. NAHB currently estimates the probability of official recession within the 2008-2009 period at roughly 60%, although any setback is likely to be mild by historical standards. 

Financial markets have endured rounds of extraordinary volatility for more than a year, now. The initial trigger was the meltdown of the subprime mortgage market, and the problems have expanded and multiplied as other components of the mortgage market have been drawn in. The result has been massive write-downs of portfolios of mortgages and private mortgage-backed securities, decimating capital positions at a number of large, highly-leveraged financial institutions.  

The most recent round of turmoil includes the Sept. 7 federal takeover of Fannie Mae and Freddie Mac, the Sept. 14 bankruptcy of Lehman Brothers and the federally-encouraged purchase of Merrill Lynch by Bank of America, the Sept. 16 Federal Reserve “rescue” of the American International Group and this week's federal takeover of Washington Mutual Bank and its immediate sale to J.P. Morgan Chase. Naturally, speculation abounds about the next major financial institution to fail, and steps that may have to be taken by the government. Meanwhile, the Federal Reserve held short-term interest rates steady at the Sept. 16 meeting of the Federal Open Market Committee (FOMC), keeping the federal funds rate at 2.0% and the discount rate at 2.25%.

The decision disappointed financial markets, in the context of the unprecedented turmoil in capital markets. The FOMC statement highlighted “strains in financial markets” and “tight credit conditions,” but the policy decision came down to a traditional assessment of the downside risks to real economic growth and the upside risks to inflation—risks that the FOMC apparently considers to be in rough balance, at least for now. Evolving weakness in economic growth, slowing inflation, and further tightening of credit conditions should compel the Fed to ease monetary policy a bit further before the end of the year. NAHB does not expect the funds rate to move back above 2.0% before the middle of next year. [ return to top ]