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Eye on the Economy: The Fed Is Poised to Act Decisively
 U.S. economic output (real Gross Domestic Product) grew at a robust 4.0% annual rate in the second quarter, a nice rebound from the anemic 0.6% pace registered in the first quarter of the year. Even so, second-quarter growth came to only 2.0% on a year-over-year basis — a substantial downshift from the growth registered during the three previous years.
The housing production component of GDP (Residential Fixed Investment) was a major economic growth engine during the 2003 to 2005 period, and the abrupt downshift in RFI since early last year has weighed heavily on GDP growth ever since. Contractions in industries closely related to housing production, such as mortgage banking, have added to the downward pressure on overall economic growth.
The housing downswing still is underway and several other sectors apparently are losing momentum in the third quarter.
We’re currently expecting GDP growth to recede to a 2.4% annual rate this quarter, and we’ve cut our fourth-quarter forecast to 2.0%. We currently peg the probability of recession within the next 12 months at 33%, up from 20% several months ago.
The Job Market Is Throwing Off Troublesome Signals
Until recently, the job market was holding up remarkably well in the face of the pronounced slowdown in GDP growth, and this pattern was particularly striking in the housing sector — implying sizeable downshifts in growth of labor productivity (output per hour).
But now the labor market also is weakening, suggesting that the earlier disconnect simply reflected time lags between slowdowns in growth of output and employment.
The employment report for August actually showed a small decline in payroll employment of 4,000 jobs for that month, the first setback in four years, and the employment numbers were revised downward for both June and July.
Indeed, total payroll job growth averaged only 44,000 for the June to August period, down from 147,000 for the first five months of the year. And although the unemployment rate held at a comfortably low 4.6% level in August, this stability masked large declines in both household employment and the civilian labor force — both troublesome signs on their own.
NAHB’s forecast shows a gradually increasing unemployment rate and subpar growth of less than 1% in payroll employment during the balance of this year and the first half of 2008 as GDP growth proceeds at a below-trend pace.
We expect to see better labor market performance during the second half of next year and in 2009 as the drag from housing eases off and GDP growth picks up.
Financial Market Turmoil Is Taking a Toll on Housing Activity
The progressive meltdown in various components of the home mortgage market since early this year has been delivering serious hits to both gross and net home sales, provoking the serious 2007 downleg in housing starts and Residential Fixed Investment. The problems began in the subprime sector, quickly moved through the Alt-A market and most recently infected the jumbo market — loans above the $417,000 conforming loan limit.
A special NAHB survey of single-family home builders, conducted in the latter part of August, showed serious negative impacts on home sales as well as renewed upward pressure on sales cancellations. Indeed, the reported impacts of tightening mortgage lending conditions were even more serious than we had found earlier in the year.
The most serious problems were reported by the large companies that start more than 100 units per year and by companies in the West — presumably reflecting the freeze-up of the jumbo mortgage market in August.
Mortgage Problems Are Infecting Other Financial Markets
This year’s financial market turmoil is based heavily on deep credit problems in the U.S. subprime mortgage market, and large losses are being taken on mortgage-related securities around the globe.
These experiences have reminded the investment community of credit risks in other parts of the financial markets, kicking off a broad-based flight to quality.
Some credit markets have virtually shut down in the process — the asset-backed commercial paper market is a good example — and quality spreads have opened up in most markets, including the corporate bond market.
Fortunately, the flight to quality also has driven down the entire Treasury yield curve. This has kept rates on prime conventional conforming mortgages and high-grade corporate bonds close to levels prevailing before the most recent round of turmoil, despite considerable widening of spreads to comparable maturity Treasuries.
But most other rates have risen in absolute terms — including rates on subprime, Alt-A and jumbo mortgages as well as rates on lower-rated corporates.
These changes definitely are cutting into housing market activity and overall economic growth.
The Fed Is Poised to Act Decisively
So far, the Federal Reserve has reacted to the financial market upheaval primarily by keeping the federal funds rate on or below target (5.25%), by cutting the penalty rate at the discount window by 50 basis points and by amending the Federal Open Market Committee (FOMC) statement to accentuate downside risks to the real economy while downplaying earlier concerns about upward inflation pressures.
The Fed almost certainly will cut its target for the federal funds rate at the FOMC meeting on Sept. 18, and our central bank stands ready to make further adjustments down the line if the economy seems to be slipping toward recession.
NAHB’s current forecast assumes quarter-point rate cuts at the next three FOMC meetings — putting the federal funds rate at 4.5% by year-end.
This will put the real (inflation-adjusted) funds rate at about 2.6%, a modestly stimulative position, and the Fed still would have leeway to deliver more monetary stimulus should the situation demand further action.
The Housing Forecast Takes Another Hit
The seriousness of the recent turmoil in mortgage markets, and growing evidence of erosion of house values in more and more housing markets, apparently have combined to send many prospective home buyers to the sidelines. And Fed Chairman Ben Bernanke recently pointed out that an easing of monetary policy is no quick fix for the U.S. housing market in today’s financial market environment.
These realities have provoked yet another cut to NAHB’s housing forecast. We now expect total housing starts to be down by 23% in 2007 and an additional 10% in 2008. Residential Fixed Investment now declines by 17% in 2007 and 12% in 2008.
We’re still viewing 2009 as a solid recovery year — with housing starts up by 12% and RFI posting a 6% year-over-year gain — but considerable uncertainties still surround our baseline (most probable) forecasts.
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 Sept. 12 edition. To subscribe to “Eye on the Economy,” click here.
 Attend the Fall Construction Forecast Conference in October
Plan to attend NAHB's Construction Forecast Conference on Oct. 24 at the National Housing Center in Washington, D.C. The conference brings together the nation's premier housing economists and finance experts for an in-depth examination of the economic outlook for the housing industry.
Can't attend? Watch the conference webcast live.
For more information, or to register for the conference or webcast, visit www.nahb.org/cfc.
 Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2007-2008 Metro Forecast (free preview). Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.
To learn more, visit www.HousingEconomics.com.
 NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into next year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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