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Housing to Stay Healthy as It Recedes From Its Peak
Despite some current softening of growth in the U.S. economy, an ongoing effort by the Federal Reserve to push up interest rates and rampant price increases in the nation’s hottest housing markets, economists at the NAHB Construction Forecast Conference in Washington, D.C. last week said that housing activity should remain healthy through next year even as it recedes from peak levels.
Panelists emphasized that the demand for housing should hold up, driven by ongoing growth in U.S. population and household formations, an expanding market for second homes and the need to replace aging units. Further growth in the nation’s job force and rising incomes should help offset the negative impact of higher mortgage interest rates, which are still expected to be at affordable levels by historical standards.
While concern was voiced over the upward trend in investment and speculation in some of the frothiest markets — which tend to be in California, Las Vegas, Southern Florida, Washington, D.C. and the New York to Boston corridor — by and large analysts at the conference indicated that they expected to see a slowdown in the rate of price appreciation in most parts of the country rather than an actual decline.
How aggressively the Fed pushes up interest rates will depend on the inflation picture, and although inflation has now moved to the upward range of what the Fed finds acceptable, prices remain well under control, economists said, and the outlook appears favorable, unless there are further unexpected run-ups in energy prices.
 One of the big unanswered questions raised at the forecast conference is the health of the nation’s job market. “There are deep uncertainties about the issue of slack in the labor market,” said NAHB Chief Economist David Seiders, and that is one of the reasons why the Fed has been moving cautiously as it pushes up interest rates.
The unemployment rate fell to 5.3% in the first quarter, and Seiders predicted it will head down a bit further, to 5.1% in 2006. That could be about as low as it can fall without generating some inflation, he said, but, then again, that level could be as low as 4%.
Jim Glassman, managing director and senior policy strategist with J.P. Morgan Chase, said that there has been a significant undercount in the potential size of the nation’s workforce, which is the chief reason he believes that “we are only in the second inning of recovery.”
Payrolls have returned to where they stood at their peak in February of 2001, he said, but since then “the number of people who have come of working age has increased by 9 million.” Confronted with the bad job market that stubbornly persisted long after the end of the 2001 recession, young potential workers decided to head back to college. “We aren’t seeing the army of people who disappeared” in the 20-25 age range, he said.
 “There is no way these people have the option of not working,” Glassman said. There are about 3 million of them, “and there is a good chance they will be coming into the market.” If this group had stayed in the job market, “unemployment would be more like 7% than 5.2%.”
Glassman also said that a return to the non-inflationary 4% level of unemployment that existed in the late 1990s would mean that there are 2 million more people “who need to get back to work.”
Estimating housing demand in the next decade at 2 million units annually, Glassman said that recent productivity gains bode well for housing in the period ahead because they have bolstered corporate profits, and that in turn will lead to better wage gains. At current annual productivity gains in the 2-1/2%-3% range, he said, America’s standard of living will double in one generation. That’s compared to the 1% productivity gain of the 1970s and 1980s, a rate at which it took three generations for the living standard to double.
Expecting not too much more improvement on the employment front, Chris Varvares, president, Macroeconomics Advisers, puts today’s expansion at the bottom of the seventh inning, with the economy settling in for a soft landing and 3.4% growth in the Gross Domestic Product for the year as a whole.
 Although he expects to see some measurable decline in housing activity next year, Varvares sees no recession on the horizon and pegs sustainable GDP growth at 3.5%.
Varvares cited a number of downside risks to his growth forecast. Crude oil prices could turn upward, but he is forecasting a $10-a-barrel decline by next year. The erosion of fiscal stimulus could help slow growth, although most indicators suggest that there is enough momentum in manufacturing and other parts of the economy to make up for it. Monetary policy could take a toll, but adjusted for inflation, the federal funds rate only turned positive in the first quarter and he doesn’t expect it to move up higher than 2%, which would be historically low. There could be a decline in the stock market, but Varvanes is predicting 8%-10% cumulative gains through the end of next year.
Agreeing with Varvares in his assessment of the first-quarter economic slowdown that has continued into the current quarter, Seiders predicted that “we do come out of it, we do better and we glide out in 2006” with “pretty good” GDP growth in the 3.2%-3.5% range. Growth declined from a rate of 3.8% at the end of last year to 3.1% in the first quarter, and is expected to decline slightly further, to 2.9%-3.0% in the second quarter.
Seiders forecast a 4% federal funds rate at the end of this year, with another one-quarter percentage point increase in 2006, moving up the prime rate from 6% now to 7% at the end of 2005 and 7-1/4% at the end of next year. Varvares pegged the federal funds rate at 3.75% at the end of 2005 and 4.5% at the end of 2006.
Although it now looks possible that mortgage interest rates on a 30-year loan won’t quite reach the 6.4% average projected by NAHB for this year’s fourth quarter, the pressures on those rates “have to be up going ahead,” Seiders said.
A bit more optimistic about the outlook for interest rates, Glassman said that the “market believes we are getting closer to the end of Fed rises.” The Fed, he said, is aiming to set the federal funds rate at two percentage points over core inflation, which should be running in the 1-1/2%-1-3/4% range.
Addressing the conundrum of falling long-term interest rates at a time when the Fed has been moving in the opposite direction, Glassman noted that, “This is the first time since the 1960s when prices have been stable,” and that could bring the yields on 10-year Treasuries “lower than you might have thought in the past.”
Glassman discounted fears of falling housing prices taking a toll on the economy. With the exception of a few boom markets, he said, high housing appreciation largely reflects the real estate market catching up with the lagging homes prices of the 1990s.
“Worry if you want to,” Glassman said. “I think I would take most of the worries with a grain of salt and just get back to business.”
Photos by Morris Semiatin
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