Predictably, the stock market gained ground today while bond prices fell and longer-term interest rates backed up — a classic sell-bonds/buy-stocks reaction to a Republican victory. These immediate market reactions presumably will lose momentum before long, giving way to economic realities and the path of monetary policy set by our staunchly independent central bank.
Economic growth was a bit weaker than expected in the third quarter, but the composition of GDP was reassuring …
Growth of real Gross Domestic Product (GDP) was 3.7% in the third quarter, according to the “advance” estimate released by the Commerce Department on Oct. 29. This rate was higher than the second quarter (3.3%) but lower than both NAHB’s projection (4.1%) and the consensus of economic forecasting panels (such as the Blue Chip).
The weaker-than-expected GDP growth can be pinned largely on stronger-than-expected imports which subtracted 1.1 percentage points from third-quarter GDP growth. While imports represent a leakage of demand from the U.S. economic system (the imported goods and services are produced elsewhere), surprisingly fast growth of imports is hardly a sign of incipient weakness in domestic demand.
In this regard, final sales to domestic purchasers — a broad gauge of the strength of domestic spending on goods and services (excluding inventories) — grew at an annual rate of 4.6% in the third quarter, up from 3.5% in the second quarter and the fastest pace in a year. Within this total, personal consumption expenditures expanded by 4.6% and nonresidential fixed investment grew at an 11.7% pace. Growth of these two components is absolutely essential to a pattern of self-sustaining economic expansion, and we’re apparently still on that path despite adverse impacts of historically high energy costs on discretionary spending by both consumers and businesses.
The housing production piece of GDP is flattening out at a high level and some modest erosion is in the cards …
As expected, growth of residential fixed investment (RFI) slowed to a 3.1% annual rate in the third-quarter GDP accounts, reflecting historically high but relatively flat home sales and housing starts since the spring. Indeed, residential construction put-in-place contracted at an annual rate of 2.9% in September on the heels of a robust growth surge that began early in 2002.
Housing market activity has been very well maintained in recent months and annual records for home sales and single-family starts are virtually a sure thing for this year. But the single-family market apparently has been straining its potential, and it is reasonable to expect some modest slippage in sales, starts and residential fixed investment in the final quarter of this year and in 2005 as well. Upward gravitation of the interest rate structure is a key factor behind the anticipated slippage.
The Fed most likely will hike short-term rates on Nov. 10 but then take a breather …
Evolving patterns of solid growth in economic output, systematically rising payroll employment and modest upward pressure on core inflation (excluding prices of food and energy) have set the stage for another quarter-point hike in the federal funds rate at the Nov. 10 meeting of the Federal Open Market Committee (FOMC). This adjustment will take the funds rate to 2%, up a full percentage point since June 30. The bank prime rate still is being set at three points over the funds rate, so prime will be 5% in a week.
We expect the Fed to take a breather at the Dec. 14 FOMC meeting, holding steady while assessing the economic impacts of its monetary policy process, the oil price situation and the outcome of the November elections. But further increases are in store for 2005, as the Fed proceeds at its self-proclaimed “measured pace” toward a position of monetary neutrality. Our forecast still shows a federal funds rate of 3.75% by the end of next year.
Bond prices still are fighting gravity, but long-term rates are bound to firm up …
The disconnect between short-term and long-term interest rates that has been evident since mid-year may now be in the process of correcting. While bond and mortgage rates still are well below their mid-year levels (while short-term rates are up significantly), settlement of the elections removed uncertainties from the market and presumably strengthened market expectations for GDP growth as well as for core inflation.
Furthermore, the Fed's process of short-term interest rate adjustments inevitably will create tighter credit market conditions across-the-board, since the increases in short rates are achieved by withdrawing reserves from the banking system (it’s not just a series of announcements). Our forecast still shows increases of roughly a percentage point in bond and mortgage rates over the course of the next year.
Homeownership and rental vacancy rates suggest weakening of the rent-to-own dynamic …
Soaring homeownership and rental vacancy rates have been key features in housing markets during recent years, reflecting highly affordable buying conditions that drained households out of rental apartments into first-time homeownership. However, third-quarter estimates show modest declines in both homeownership and rental vacancy rates from their second-quarter records, possibly signaling a weakening of the rent-to-own dynamic. If so, soaring home prices may stack up as a major factor in the evolving transition, since interest rates still were historically low in the third quarter.
Despite the third-quarter decline, it’s clear that the nation’s homeownership rate has not hit some sort of natural limit, since the rates for different regions, income levels and racial/ethnic groups still are quite different. Although the overall rate was 69% in the third quarter, white households sported a 76.1% rate while both blacks and Hispanics were at 49% — leaving a glaring gap that needs to be addressed by public policy down the line. The Bush Administration has placed priority on closing the minority homeownership gap and that focus presumably will be maintained in the second term.
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 Nov. 3 edition. To subcribe to “Eye on the Economy,” click here.
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