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Eye on the Economy

By David F. Seiders NAHB Chief Economist

Economic growth up for third quarter, good momentum going ahead …

Growth of real Gross Domestic Product (GDP) for the third quarter was revised upward by the Commerce Department on Nov. 30, from 3.7% to 3.9%. The upward revision primarily reflected stronger growth in consumer spending and a smaller trade deficit. The construction sector was revised downward, as growth in residential fixed investment was trimmed from 3.1% to 1.7% and spending on nonresidential structures was revised back into the red zone.

The small GDP revision masked a favorable turn in the composition of aggregate spending. Final sales of goods and services were revised upward to a robust 4.9% annual pace while inventory investment was revised lower. This pattern bodes well for the fourth quarter of the year, and NAHB is projecting 3.7% growth for that period.

Core inflation still is within the Fed’s tolerance zone …

The inflation measures in the third-quarter GDP accounts were not revised. The chain-weighted GDP price index was up by 2.2% on a year-over-year basis and the core GDP price index (excluding food and energy) was up by 2%. While not alarming, these measures certainly are running well above the pace of late-2003 and early-2004.

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The best inflation news is provided by the Fed’s favorite price gauge, the core price index for personal consumption expenditures (PCE). This measure was up by only 1.5% in the third-quarter GDP accounts, the same as the second quarter. Furthermore, the core PCE price index was up by the same year-over-year pace in October — according to a report released Wednesday by the Commerce Department.

Another rate hike by the Fed is likely on Dec. 14 …

The Fed’s assessment of economic conditions at the conclusion of the Nov. 10 meeting of the Federal Open Market Committee (FOMC) has proven to be on target. Furthermore, policy is still highly accommodative, with a real federal funds rate that’s barely positive.

These circumstances argue for another quarter-point rate hike at the next FOMC meeting on Dec. 14 as the Fed continues to tighten monetary policy at a “measured” pace. This adjustment will raise the federal funds rate target to 2.25% and take the bank prime rate to 5.25%.

Long-term rates are also on the rise …

Until recently, long-term interest rates remained stubbornly low despite good economic performance, a firming inflation picture and the series of Fed rate hikes that began on June 30. But long rates have backed up during the past month and further increases are in store for the balance of this year and in 2005. NAHB’s forecast shows about a percentage point increase in bond and mortgage rates over the coming year.

The Fed presumably wants long-term rates to rise as the central bank hikes the short end of the yield structure. Indeed, Chairman Alan Greenspan recently talked long rates up (and the dollar down) by suggesting that foreign investors (including foreign central banks) should consider the possibility of over-concentration of their portfolios in dollar-denominated assets such as Treasury securities.

Home sales hold firm and the near-term outlook remains bright …

Sales of both new and existing homes were essentially flat in October, holding at a near-record pace in both markets. It’s now perfectly obvious that home sales will post new annual records in 2004. Indeed, this year’s performance should surpass the previous record (2003) by nearly 10%.

Surveys of both single-family builders and home mortgage lenders show that the single-family market remained fully in gear during November. The NAHB/Wells Fargo Housing Market Index was flat at a historically high level, and the Mortgage Bankers Association’s series on applications for mortgages to buy homes showed essentially the same pattern.

2005 may be tougher for builders to navigate …

Home builders operated in a very favorable economic and financial market environment in 2004. But inventories of unsold homes moved up during the year, buyer resistance to high home prices is growing, and financial market conditions promise to be less favorable in 2005. Builders must focus on the changing environment to make the most of the next year.

Builders should be prepared to deal with some weakening of home buyer demand in 2005. This means, first of all, placing strict controls on inventory accumulation. Second, builders should mine the adjustable-rate mortgage (ARM) market for all it’s worth. ARMs financed nearly half of all new-home purchases in 2004, with particularly heavy usage in high-priced areas, and a similar share is likely in 2005 despite some narrowing of the initial ARM interest rate advantage.

Builders also should be prepared to roll out special sales techniques and incentives that have been successful in past periods. Indeed, a special NAHB survey conducted last November showed heavier usage of realtors/brokers as well as a rising incidence of sales incentives. At that time, 28% of builders were including optional items in homes at no charge, about one-sixth were paying closing costs or financing points, and some companies had begun to “buy down” mortgage interest rates.

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 Dec. 1 edition. To subcribe to “Eye on the Economy,” click here.

‘HousingEconomics Online’ Provides In-Depth Analysis of Housing Market

"HousingEconomics Online" is a new online publication from the NAHB Economics Group that provides the latest housing economic data, trends and key events shaping the economy. NAHB’s leading economists analyze and synthesize the housing and economic information to provide in-depth analysis of the niches and nuances of the home building market.

Available at BuilderBooks.com, "HousingEconomics Online" combines unique scientific research with practical applications providing insights that are original, useful and written in terms that builders, manufacturers and housing finance professionals can understand and apply to their own businesses.

This interactive Web site at the executive level provides critical data and information quickly, easily and frequently and includes the following features:

  • Home Builders Forecast
  • The Desktop Analyst
  • Access to NAHB’s Staff of Economists
  • Seiders' Report
  • NAHB’s Economic & Housing Forecast
  • Housing Activity
  • Housing Policy Focus
  • Multifamily Housing Quarterly
  • State & Metro Focus
  • Housing Market Statistics

For more details, go to www.housingeconomics.com.

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