The unemployment rate held at 5.4% in December, and the average for 2004 came to 5.5% — down from 6.0% in 2003. The unemployment rate is down less than a percentage point from the cyclical peak of 6.3% in June of 2003, and the labor force participation rate has been stuck at 66% for more than a year — down from 67% just prior to the 2001 recession.
These measures suggest that a good deal of slack remains in the labor market, and that bodes well for future growth in both U.S. economic output and employment.
Core inflation firmed up in 2004 but inflation fundamentals remain reasonably good …
The U.S. economy shook off the deflation threat of 2003 by early last year, and core inflation (excluding prices of food and energy) firmed up significantly as 2004 rolled along. The best measures of core inflation — the chain-core Consumer Price Index and the core market-based price index for Personal Consumption Expenditures — both approached 2% by late in the year (year-over-year basis), about double the pace of late 2003.
The firming of core inflation in 2004 reflected somewhat higher unit labor costs, rising import prices (partly reflecting a falling dollar) and upward pressures on commodity prices. Core inflation is likely to firm up a bit more in 2005, even as overall inflation recedes along with energy prices, although a serious inflation breakout is not in the cards. This kind of performance, along with evidence of anti-inflation resolve at the Fed, should control inflation expectations in financial markets.
The Fed has moved closer to monetary ‘neutrality’ but further rate hikes are in store …
The Federal Reserve held the federal funds rate at 1% during the first half of 2004 in order to help solidify the economic expansion and insure against a deflation problem in the U.S. The Fed began to move off this extraordinarily stimulative monetary policy stance on June 30, and the fifth consecutive quarter-point hike in the funds rate target was implemented at the Dec. 14 Federal Open Market Committee (FOMC) meeting.
Although the real (inflation-adjusted) federal funds rate now is positive, the current monetary policy stance still is stimulating the U.S. economy. The Fed wants to get back to a more “neutral” stance as long as economic growth continues to sop up slack in resource markets (labor and capital) and continues to generate inflationary pressures.
NAHB’s forecast shows a federal funds rate of 3.75% by the end of 2005. We’re expecting quarter-point rate hikes at the February, March, May and June FOMC meetings with a less aggressive process during the second half of the year.
Long-term interest rates still are stubbornly low but some increase is virtually inevitable this year …
Long-term rates held in a narrow range in 2004, closing out the year at about the same levels that prevailed when the year began. Indeed, long rates gravitated downward during the second half despite the series of hikes in short rates kicked off by the Fed on June 30, and the long-term home mortgage rate still is hanging around 5.7%.
Current levels of long-term interest rates will be tough to sustain as 2005 rolls along. We’ve trimmed our rate outlook to some degree, but NAHB’s forecast still shows a systematic increase in long-term rates over the course of 2005, a process that takes the long-term home mortgage rate to 6.50% by late this year.
The factors behind this move include the projected pattern of Fed policy, a falling dollar and further upward pressure on core inflation — partly from the labor market. It’s worth remembering that the Fed’s march toward monetary neutrality is not just a series of rate announcements but involves extraction of liquidity from the financial system and a broad-based tightening of credit conditions.
Housing posted new records in 2004 and only a modest fade is in the cards for this year …
The housing sector turned in a great performance in 2004, thanks largely to the stunning behavior of long-term interest rates as well as to deepening discounts of initial rates on adjustable-rate mortgages by lenders. New records were set for home sales and single-family housing starts as well as for sales of condo units in multifamily housing, and the rental housing market performed reasonably well in the face of record-high vacancy rates.
It will be tough to post further growth in 2005 as the interest rate structure moves upward. NAHB’s forecast for 2005 shows modest slippage in home sales as well as in starts of both single-family and multifamily housing units.
Some increase in manufactured home shipments (HUD-code units) may be in the cards following the free-fall of recent years, and the residential remodeling market should continue to post solid real (inflation-adjusted) growth throughout the forecast period. Even so, residential fixed investment probably will not be able to maintain its position as a strong GDP growth engine — a role enjoyed throughout the 2002-2004 period following unprecedented resilience during the 2001 economic recession.
Homeownership rates are not topping out in the U.S …
The U.S. homeownership rate hit an estimated 69% in 2004, easily a new annual record. Indeed, the homeownership rate climbed by five percentage points during the past 10 years, a truly impressive run after a decade of virtual stagnation.
The dramatic performance of recent years moved the U.S. homeownership rate toward the top of the list of countries around the world, prompting speculation that the U.S. rate has approached some sort of natural limit.
But there’s still plenty of potential for rising homeownership in this country, public policy is focusing upon some glaring differences across income classes as well as racial/ethnic groups, and structural changes in the mortgage market have extended the reach of homeownership to more marginal buyers. Thus, it appears that builders of single-family homes and condo units can look forward to a dominant share of the housing pie for some time to come, and manufactured homes may also regain some market share in the years ahead.
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. 26 edition. To subcribe to “Eye on the Economy,” click here.
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