Productivity growth certainly can have short-term negative implications, particularly for those unable to find or hold jobs. But there are positive short-term implications as well — for the incomes of those with jobs, for business firms striving to rebuild profit margins, for holders of corporate equities and for anyone borrowing in the credit markets. Over the long term, productivity growth is absolutely essential to strong noninflationary growth, high employment and rising standards of living for all Americans. Let’s just cheer it on.
Economic momentum is picking up further in the third quarter ...
Some components of the economy (such as defense spending) enjoyed temporary growth surges in the second-quarter GDP report, but that report still suggested some fundamental improvement in economic momentum around mid-year. That reading is consistent with the Federal Reserve’s most recent Beige Book, a regionally based analysis that said the pace of economic activity “increased a notch” during June and the first half of July.
The most reassuring feature of both the GDP report and the Beige Book relates to better signals on the beleaguered manufacturing sector and on the major components of business spending — the glaringly weak sisters of the recovery to date. The Beige Book cited “nascent signs of recovery…in the manufacturing sector,” and the second-quarter GDP report showed a solid pickup in business spending on capital equipment and software, an upturn in spending on nonresidential structures and a sizeable decline in business inventories that bodes well for restocking and production in the second half of the year.
Recent economic data are reassuring ...
Available data for July and early August are supportive of the widely anticipated third-quarter pickup in economic growth — a pickup that should lead to a better job market late in the year. Retail sales were quite good in July (an annualized increase of 18%) and the advance was broad-based, suggesting that the new tax bill already is stimulating consumer spending. Furthermore, the Institute for Supply Management's surveys of purchasing managers suggest that the manufacturing sector posted modest growth in July, the first advance since February, and that the services sector grew nicely in July for the fourth consecutive month.
For housing, NAHB’s survey of single-family builders showed a nice advance in July, and the Mortgage Bankers Association's weekly surveys of mortgage lenders show strength in applications for mortgages to buy homes through the first week of August (moving average basis). And in the labor market, weekly data on initial claims for unemployment insurance continued to trend down through early August, pointing toward stabilization of employment down the line.
The Fed holds monetary policy steady and commits to a period of low short-term rates ...
As we expected, the Federal Reserve kept its target for the federal funds rate at 1% at the Aug. 12 FOMC meeting, and the decision was unanimous. The Fed said that the evidence accumulated since the previous FOMC meeting (June 25) indicates that spending in the economy is “firming” but that labor market indicators are “mixed." With respect to the inflation/deflation issue, the Fed noted that business pricing power and increases in core consumer prices “remain muted.”
Following these market assessments, the FOMC once again presented two risk statements — one for real economic growth and one for inflation/deflation. As it did on June 25, the FOMC viewed the upside and downside risks to the attainment of sustainable growth as “roughly equal,” while saying that the risk of an unwelcome fall in inflation (heading toward deflation) exceeds that of a rise in inflation from its already low level.
The FOMC went on to weigh these two risk assessments, saying, “the risk of inflation becoming undesirably low is likely to be the predominant concern for the foreseeable future.” Then the FOMC delivered the message that Fed Chairman Greenspan had issued in other contexts and that the markets wanted to see from a united committee: “In these circumstances, the Committee believes that policy accommodation can be maintained for a considerable period.” This kind of commitment is unprecedented in Federal Reserve history.
Long-term rates still are a major issue ...
The Fed’s commitment to maintain a 1% federal funds rate for quite some time, along with the rather upbeat assessment of economic growth prospects and an apparent Fed desire to get the inflation rate up, gave an immediate boost to stock prices and also put some upward pressure on long-term Treasury rates. Indeed, the 10-year Treasury yield is now roughly 140 basis points above its historic (and unsustainable) low in mid-June, and the long-term mortgage rate is up more than a percentage point.
NAHB’s forecasts assume that long-term rates (including the 30-year mortgage rate) will remain close to current levels through the balance of the year, and that those rate levels will not prevent the healthy economic expansion or the healthy housing market we are forecasting. These, of course, are major assumptions. We believe that a combination of very low short-term rates and low (but positive) inflation rates will limit further increases in long-term rates. And it should be remembered that businesses and households can shift their borrowing to shorter-term instruments, such as adjustable-rate home mortgages, maintaining credit flows and spending patterns in the process. Home mortgage refinancing already has taken a heavy hit, of course, but home owners seeking low-cost (and tax-advantaged) access to their housing equity can use home equity loans that typically have rates tied to the bank prime rate — an immovable rate for the foreseeable future.
The cost of financing for home builders promises to remain historically low for quite a while ...
Most home builders raise money for land development and construction by borrowing from depository institutions at interest rates that are tied to the bank prime rate (prime plus one percentage point is a typical floating-rate arrangement). These days, the prime rate is set three percentage points above the federal funds rate, which, in turn, is set by the Federal Reserve. The Fed has cut the federal funds rate by 5.5 percentage points since early 2001 and, as a result, the bank prime rate has settled in at a 45-year low of 4%.
The Fed normally begins plotting increases in the funds rate as an economic expansion gains momentum, but this time really is different. The Fed became genuinely concerned about the possibility of destructive price deflation (á la Japan) back in the spring, and the central bank is committed to keeping short-term rates extremely low until it’s perfectly clear that the threat of deflation is behind us and above-trend economic growth has sopped up a lot of the considerable slack in the labor market. That means the bank prime — and the cost of builder financing — should remain quite low for many months to come, and the Fed’s “accommodative” stance ensures that there will be ample liquidity in the banking system to support loan growth.
NAHB Chief Economist David Seiders analyzes the economy from the point of view of the housing market every other week in the free e-newsletter, “Eye on the Economy.” The preceding is a reissue of his Aug. 13 e-newsletter. To subcribe to “Eye on the Economy,” click here.
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