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Eye on the Economy: The Fed Shifts Gears, Hits Accelerator
 Key data released during the past few weeks reveal a serious slowdown in economic growth as 2007 was drawing to a close, and it’s perfectly obvious that the economy entered 2008 in a seriously weakened condition.
The employment report for December was a real downer, as was the Institute for Supply Management (ISM) report on the manufacturing sector for that month. We’ve also gotten reports of weaker-than-expected retail sales in December, and some regional economic reports have been quite troublesome.
The December report on housing starts and building permits was fundamentally weak — showing that the housing sector exerted a strong drag on economic growth throughout the final quarter of 2007.
NAHB’s recent builder survey measures also are quite weak, and housing production (Residential Fixed Investment) is bound to be a major drag on GDP growth in the first quarter of this year.
The recent proliferation of weak economic news has led some prominent forecasters, including former Federal Reserve Chairman Alan Greenspan, to put better-than-even chances on near-term economic recession. And some analysts are declaring that the U.S. economy already is in recession.
NAHB believes that the economy still is in the black, and we believe that recession will be narrowly averted in 2008 ― our recession probability is 40%.
However, our baseline (most probable) forecasts for housing and the economy are grounded on some key assumptions regarding monetary and fiscal policy as well as prospective housing policy adjustments.
The Credit Crunch Still Weighs Heavily on the Economy
The wide-ranging credit crunch that was triggered by revelations of deep problems in the U.S. subprime mortgage market last year still stacks up as a substantial problem for the U.S. and global economies.
On the positive side, the severe liquidity problems in short-term credit markets have eased since the end of 2007. Libor spreads have narrowed and the Fed’s latest auction of discount window credit — the new Term Auction Facility procedures — shows less demand for liquidity by U.S. commercial banks.
There also have been improvements in commercial paper markets, particularly the beleaguered asset-backed market where rates have come down and the amount of paper outstanding has edged upward.
However, some financial markets are struggling badly. Equity values have been tumbling, particularly in recent days, and quality spreads in corporate bond markets remain at or near the elevated levels of late 2007.
In home mortgage markets, the spread of prime fixed-rate conventional conforming loans salable to Fannie Mae and Freddie Mac over 10-year Treasury yields is holding at an elevated level ― about 200 basis points. And the spread of prime conventional jumbo mortgage rates over the prime conventional conforming yield still is around 100 basis points.
The Fed Shifts Gears and Hits the Accelerator
On Jan. 10, Fed Chairman Ben Bernanke delivered a comprehensive speech on cyclical risks to the economy and pressures in financial markets. He emphasized downside risks to the economy and strains in financial markets that remained quite serious.
With respect to Fed policy, Bernanke said that “additional policy easing may well be necessary,” adding that “we stand ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks.”
Bernanke repeated those messages in testimony before the House Budget Committee on Jan. 17. He also said that “the FOMC (Federal Open Market Committee) must remain exceptionally alert and flexible, prepared to act in a decisive and timely manner and, in particular, to counter any adverse dynamics that might threaten economic or financial stability.”
“Adverse dynamics” certainly emerged on Jan. 21 as foreign stock markets tumbled, racked by fears of recession in the U.S., and futures markets signaled impending damage to U.S. equity markets (U.S. financial markets were closed on Jan. 21). So early in the morning on Jan. 22, the Fed announced 75 basis point cuts to both the federal funds rate and the discount rate — to 3.50% and 4.00%, respectively. These definitely were “emergency” cuts, enacted only eight days before the next regularly scheduled FOMC meeting.
The Jan. 22 FOMC statement cited a weakening economic outlook ― including deepening of the housing contraction ― and deterioration of financial market conditions (other than short-term funding markets), and noted that appreciable downside risks to growth remain ― even after the 75 basis point cuts. The statement also moved earlier inflation concerns well off to the sidelines.
The Fed presumably will enact additional cuts in short-term rates at the Jan. 30 FOMC meeting (we’re currently assuming half-point reductions), and further pressure on the monetary policy accelerator is likely down the line.
We’re looking for a 2.75% funds rate by the March 18 FOMC meeting, translating into a highly stimulative real (inflation-adjusted) rate, and even stronger monetary stimulus will be delivered if conditions warrant.
The Right Policy Structure Will Help Housing Bottom Out in 2008
NAHB’s baseline (most probable) forecast shows stabilization of home sales by mid-2008 and stabilization of housing starts and residential fixed investment by the end of the year.
In view of recent weakening of the U.S. economy and intensification of credit market problems here and abroad, NAHB’s housing forecast places heavy reliance on aggressive monetary and fiscal policies to maintain growth of real GDP, payroll employment and personal income and to reduce prime mortgage rates to historic lows.
The forecast also assumes expansion of the FHA mortgage insurance program along with GSE support to the prime jumbo market before long.
Temporary home-buyer tax credits, if enacted, would be a major offset to downside risks to NAHB’s current baseline forecasts for home sales and housing production in 2008.
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 Jan. 23 edition. To subscribe to “Eye on the Economy,” click here.
Webcast of NAHB Fall Construction Forecast Available Till Feb. 5
The webcast of the NAHB Fall Construction Forecast Conference held in Washington, D.C. on Oct. 24. is available for purchase through Feb. 5.
The conference webcast includes panels of nationally recognized experts discussing economic trends, government policies, developments in the housing industry and the results from NAHB's recent surveys.
Purchasers will receive unlimited access to the webcast archive though Feb. 5, as well as electronic copies of the conference handouts and presentation material. Purchasers can watch at their own pace, rewind, fast forward and review important sections.
To Purchase the Webcast
To purchase the webcast, visit www.nahb.org/cfcwebcast.
For more information, contact Kate Carrigan at NAHB, or call her at 800-369-5242 x8244.
 Want to Know the Housing Forecast for the Top 100 Metros?
Find out in HousingEconomic.com’s 2008 to 2009 Metro Forecast (free preview).
Get the metro forecast with in-depth analysis, overviews and downloadable Excel tables.
To learn more, visit www.HousingEconomics.com.
 Free NAHB Kit Gives Builders Back-to-Basics Tips to Navigate the Slowdown
What was once expected to be a relatively mild housing slump following three years of record new home construction and sales has given way to a significant downturn.
To help members navigate the uncharted waters of this slowdown, NAHB has compiled a comprehensive “Back to Basics” online toolkit — the best of the basics, the tried and true and the truly new. To access the toolkit, click here.
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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