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Eye on the Economy
David F. Seiders, NAHB Chief Economist

The acceleration in growth of economic output that became evident in the second half of 2003 is carrying over to the first quarter of this year. Available indicators suggest that first-quarter growth of real gross domestic product (GDP) is heading toward an annual rate of about 4.5%, even better than the final quarter of 2003.

The deceleration of major inflation indicators also has extended into the early part of 2004. The core consumer price index (CPI) — excluding food and energy — posted a year-over-year advance of only 1.1% in January and the readings for previous months were revised downward. The January inflation rate was about the same as in other recent months (after the revisions) but well below the pace of inflation just a year ago. Furthermore, recent declines in unit labor costs in the nonfarm business sector imply downward pressure on core inflation going forward. Thus, the U.S. economy still could be toying with potential deflation, and clear signs of stable (or higher) inflation may not be evident until mid-year or even later.

The downward pressure on unit labor costs suggests that labor market conditions still are quite weak — with little net hiring and sluggish growth in labor compensation. Indeed, the labor market report for January showed only weak growth in payroll employment, and weekly data on claims for unemployment compensation for the first half of February suggest only halting improvements in the job market.

And although the unemployment rate has been moving down since mid-2003, much of that decline reflects deterioration of the labor force participation rate rather than acceleration of employment. Indeed, Fed Chairman Alan Greenspan recently told the Congress that there’s still a lot of slack in the nation’s labor market despite the declines in the official unemployment rate.

Consumers continue to fret about the job market, sending measures of confidence back down …

Surveys of consumers continue to display deep concern about the condition of the labor market. Measures of consumer confidence (Conference Board series) and consumer sentiment (University of Michigan) both fell back substantially in February, reversing gains posted in January. Furthermore, deterioration was recorded in measures of consumer expectations for the economy as well as in assessments of the current economic situation.

The Conference Board noted that consumers began the year on a relatively high note but their optimism has quickly given way to caution. “At the core of their disenchantment is the labor market. While the current expansion has generated jobs over the past several months, the pace of creation remains too tepid to generate a sustainable turnaround in consumers’ confidence.”

Partisan political wrangling and Administration differences keep the public downbeat about jobs …

There’s no doubt that the U.S. labor market is still not fully in gear. But it’s also likely that the public’s downbeat assessment of the job market is being fed by the constant drumbeat from Democratic presidential hopefuls about the weak performance of the labor market under President Bush. In this regard, the public is being constantly reminded of the “outsourcing” of jobs to foreign countries by an insensitive corporate America. Recent comments by the chairman of the President’s Council of Economic Advisers supporting outsourcing have opened up the Administration to charges of insensitivity as well.

On another front, the President’s failure to endorse upbeat job growth projections recently produced by his own Council of Economic Advisers (CEA) has hardly buoyed public perceptions about the current and prospective condition of the job market or the credibility of the Administration on economic matters.

The Economic Report of the President, released in mid-February, projected a 2.6 million increase in payroll employment for 2004 (year-over-year basis) following losses during the first three years of the Bush Administration. Not only is 2.6 million a robust expectation for payroll employment, it also looks too strong in the context of the growth rate in real GDP projected by the CEA (4.0% on fourth-quarter to fourth-quarter basis). The only way to reconcile CEA’s GDP and job projections for 2004 is to assume a sudden fall in productivity growth, and that puts a real strain on credibility.

When challenged on the reasonableness of the CEA’s employment projections, the President felt compelled to distance himself from the estimates made by the “number crunchers.” No alternative projections were forthcoming, however, leaving the entire issue in limbo.

Fed messages, low inflation, flagging confidence keep downward pressure on long-term rates …

There is a bright side to an economy with low inflation, a weak job market and flagging consumer confidence — the interest rate structure. With respect to short-term rates, Chairman Greenspan recently reassured the Congress and the world that the U.S. central bank will be quite patient as it plots its first increase in the federal funds rate from the 1% target set last June. Furthermore, data received since the chairman’s testimony should reinforce the Fed’s inclination to remain patient.

The Fed will not move before core inflation clearly has stabilized comfortably above 1% and slack in the labor market has been reduced substantially. Indeed, Greenspan recently suggested that “full employment” could mean an unemployment rate as low as 4% (the January rate was 5.6%)! In this context, we continue to believe that the Fed will hold short-term rates steady at least until the Nov. 10 Federal Open Market Committee (FOMC) meeting.

The bond markets have been feasting off both the Fed’s messages and the evolving economic realities. The 10-year Treasury yield currently is hanging around 4%, down significantly since the beginning of the year and below the expectations of most analysts (including yours truly). At the same time, the fixed-rate home mortgage has gravitated down to about 5.6% and one-year adjustables are around 3.5%. These ranges appear to be sustainable, at least for now, providing a great financing environment for housing.

Housing market activity recedes from unsustainable highs but remains quite robust …

Home sales and housing starts soared to unsustainable heights as 2003 drew to a close, propelled by unusually good weather conditions as well as by a surge in buying activity that ensued after mortgage rates bounced off their historic lows (around 5.2%) in mid-2003. These two factors suggest that some housing demand was “borrowed” from early 2004 and that something must be paid back.

Available housing data for early 2004 show that we’re coming off the late-2003 highs but that the levels of market activity still are quite robust — largely because of the recent improvements in interest rates. NAHB’s Housing Market Index, based on monthly surveys of single-family builders, moved down in both January and February but still compared favorably to readings for the first half of last year. As expected, housing starts for January were well off the peak of last December, falling by 8%, but the January pace for single-family and multifamily structures (1.9 million units) still exceeded the average for all of 2003. Sales of existing homes also were off in January (by 5.2%) while maintaining a historically high level, and weekly data on applications for mortgages to buy homes were very well maintained during the first three weeks of February.

Everything considered, the housing sector is off to a very good start in 2004. NAHB’s forecast still shows modest (3%-4%) declines in home sales and housing starts for the year as a whole, and those declines imply some double-digit contractions on a fourth-quarter to fourth-quarter basis. But these forecasts also assume modest but systematic upward pressure on long-term rates as the year goes along. If those pressures fail to materialize, 2004 could equal or even surpass the record performances posted by the single-family housing market last year.

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 Feb. 25 edition. To subcribe to “Eye on the Economy,” click here.

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• Home Builders Forecast includes analysis of single-family and multifamily residential activities, residential remodeling and the full range of nonresidential construction as well as the macroeconomic factors such as GDP, employment and interest rates that drive construction. If your business depends on reliable estimates of housing starts, construction spending and remodeling activity, Home Builders Forecast is designed to meet your needs.
• Housing Market Statistics contains an overview of important developments and trends that serves as an executive summary of the current industry situation. It also contains annotated charts depicting movements in key indicators and tables providing monthly, quarterly and annual data for more than 250 variables.
• Housing Economics provides a rigorous monthly overview of the economy, along with monthly data for more than 100 local markets and in-depth analyses of the niches and nuances of home building markets. Available online or in print, it is written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

To learn more or to order any of these three NAHB economic publications, visit the Economics Publications Information section of the NAHB Web site or call 800-223-2665.

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