Eye on the Economy
By David F. Seiders, NAHB Chief Economist
The economic ‘soft spot’ is now behind us …
Various data suggested a rather pronounced slowdown in growth of economic activity toward the end of the first quarter, and the “advance” reading on first-quarter growth in real Gross Domestic Product (GDP) seemed to confirm the slowdown pattern.
Revisions to key data for March, along with a series of upbeat readings for April, point toward a significant upward revision to first-quarter GDP growth as well as solid forward momentum in the early stages of the second quarter. Indeed, the much-feared economic “soft spot” now looks like a minor event in the rear view mirror.
Revisions to first-quarter estimates show stronger patterns for employment, residential construction activity and foreign trade as well as less inventory investment (that’s actually good). Reassuring data for April relate largely to the job market, the housing market and retail sales. Everything considered, GDP growth appears headed for about 3.5% for the first half of the year, and that pattern should generate ongoing improvements in the labor market.
The labor market regains solid forward momentum …
Sagging payroll job growth was one symptom of the economic “soft spot” toward the end of the first quarter, and there was considerable apprehension among analysts about another sub-par employment report for April. However, the April report not only revised away some of the apparent weakness in March, it also unveiled a robust picture for April (on a preliminary basis, of course).
The April jobs report raised March payroll employment by 93,000 and then piled on a hefty 274,000 gain for April — an increase that was broad-based by industry. Furthermore, the length of the average workweek rose significantly and the index of aggregate hours worked in the nonfarm business sector surged. In the process, average hourly earnings posted a solid increase and stood 2.7% above a year earlier.
Signals from the household survey also were quite positive in April. The unemployment rate held steady at 5.2% as a solid increase in household employment (598,000) was roughly matched by a solid increase in the labor force (605,000). The labor force participation rate moved up from 65.8% to 66.0% in the process, a healthy signal that may very well be reinforced as the economic expansion moves ahead.
Core consumer price inflation recedes despite high energy costs …
Key measures of core inflation (excluding prices of food and energy) have firmed up considerably since late 2003 as upward pressures have come from rising non-oil import prices, an apparent leakage of oil prices into the core, and gradually rising unit labor costs. Indeed, core inflation percolated upward during the first quarter despite the apparent economic “soft spot” in March.
Recent data on core inflation suggest that prices are by no means running out of control and that earlier inflation concerns may have been overdone. The core Producer Price Index (PPI) was up by 2.6% on a year-over-year basis in April, the same as in March and below the pace of January and February. Of even greater importance, the core Consumer Price Index (CPI) was unchanged in April (month-to-month) and showed a year-over-year advance of only 2.2% — slower than for any month in the first quarter of the year.
Core inflation is now running in a range that presumably is acceptable to Federal Reserve officials. However, policymakers are not about to relax when the economy is in the middle stages of a business expansion and additional price pressures are bound to emerge as the expansion matures.
Economic growth and inflation patterns keep Fed on gradualist policy path …
The reassuring signals regarding growth in real GDP and core consumer price inflation should combine to keep the Fed on a path of “measured” monetary policy adjustments as the central bank continues to remove policy “accommodation” from the U.S. economy.
The Federal Open Market Committee (FOMC) statement of May 3 said that the upside and downside risks to the attainment of sustainable economic growth and price stability should be kept roughly equal “with appropriate monetary policy action.” The recent economic signals suggest that further rate hikes by the Fed definitely are in store. NAHB’s forecast still anticipates another quarter-point rate hike at the June 30 FOMC meeting, a funds rate target of 4% by year-end, and a cyclical high of 4.25% by early 2006.
Long-term interest rates fall back to mid-February lows …
The apparent disconnect between short- and long-term interest rates has persisted despite efforts by the Federal Reserve to “talk up” long-term yields. Thus, the global “conundrum” that Chairman Alan Greenspan described on Capitol Hill in mid-February still is present in the financial markets. Indeed, the 10-year Treasury yield now is back below 4.1%.
Greenspan recently expressed some regret over his earlier use of the word “conundrum,” although he continued to cite international considerations in an attempt to rationalize stubbornly low long-term rates — both in nominal and real terms. In this regard, Greenspan stated, “There is very little doubt that what we are observing is an underlying set of pressures which has been a major factor causing the disinflationary forces worldwide over the last decade, and clearly these forces…are key to understanding why real long-term interest rates are as low as they are.”
It’s obviously hard to understand and forecast long-term interest rates. However, it’s hard to believe that long rates will stay this low if the Fed proceeds along the monetary policy path we’re projecting. Indeed, that outcome would produce a virtually flat yield curve, and that’s often been a major economic complication. NAHB’s forecast currently shows half-point increases in long-term rates by late in the year, compared with full-point increases for the federal funds and 90-day Treasury bill rates.
Housing starts bounce back and forward momentum carries into May …
A sharp decline (nearly 18%) in housing starts was a key part of the economic “soft spot” in March. That decline certainly seemed temporary in view of other available housing data for March, and more-recent indicators suggest that the strong trend in housing market activity still is underway.
The April report on housing starts did not revise away the March weakness but showed a nice rebound (up by 11%) as well as ongoing strength in permit issuance (up by 5.3%). Furthermore, the backlog of unused permits rose to a record level, presaging another strong starts performance in May.
Surveys of home builders and mortgage lenders also point toward strong levels of single-family market activity in May. NAHB’s Housing Market Index moved up to 70 in May, near the upper end of the elevated range that’s prevailed for more than a year. Furthermore, the index of applications for mortgages to buy homes (Mortgage Bankers Association series) moved upward during April and the first half of May (four-week moving average), posting record highs in the process.
The near-term housing outlook has brightened …
Recent housing market indicators, recent signals on overall economic activity and the recent decline in long-term interest rates all point toward ongoing strength in home sales and single-family housing starts, despite persistent tightening of monetary policy by the Fed. We’re now looking for single-family numbers for 2005 that challenge the records of last year.
The condo component of the multifamily sector also seems headed for new records, and NAHB’s first-quarter Multifamily Market Index shows improvements in rental market conditions as well. Our first-quarter Remodeling Market Index also shows great strength, and a record level of homeowner equity (nearly $10 trillion) most likely will support a record volume of remodeling outlays on owner-occupied homes in 2005.
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 May 18 edition. To subcribe to “Eye on the Economy,” click here.
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