Eye on the Economy
By David F. Seiders, NAHB Chief Economist
Economic growth may stumble but the economy will regain balance before long
Incoming data suggest that annualized growth of real gross domestic product (GDP) was heading toward a robust pace of about 4.5% in the third quarter before Hurricane Katrina hit the Gulf Coast on Aug. 29. We estimate that Katrina took nearly a percentage point out of third-quarter GDP growth (dropping it to an estimated 3.6%) and that the one-two punch from Katrina and Rita will hold fourth-quarter growth to 3.2% — still a trend-like performance that displays the resilience of the U.S. economy to serious shocks.
GDP growth should accelerate in the first half of 2006 as rebuilding activities gear up in the wake of this year’s unprecedented hurricane damage. A bit further out, GDP growth should settle down to a sustainable trend pace (around 3.25%), reflecting minimal remaining slack in labor markets and maintenance of solid growth in labor productivity.
Labor market fundamentals remain positive
The employment report for September contained upward revisions to payroll employment for both July and August, bringing the average monthly gain to a robust 244,000. The preliminary estimate of net job losses in September came to only 35,000, much less than the consensus expectations, although data collection problems in the Gulf region definitely created a wide range of uncertainty.
For now, the Labor Department suggests that, in the absence of Katrina, employment growth probably would have followed its recent trend (an average gain of 194,000 for the previous 12 months), meaning that Katrina probably subtracted around 230,000 jobs from the national numbers in September. It’s also worth noting that strikes subtracted 22,000 from the September payroll employment numbers, implying that, ex-Katrina and ex-strikes, payroll employment increased by about 225,000 — in line with the strong July-August performance.
The inflation picture becomes more complicated
The hurricanes have seriously complicated the inflation picture, boosting energy prices and headline inflation in the near term and putting some upward pressure on core inflation down the line as energy prices inevitably seep into the business cost structure.
We’re currently assuming that the spot price of WTI crude oil averages a record $65 per barrel in the fourth quarter and gradually recedes to about $45 per barrel by late 2007. We expect the retail price of gasoline to continue to recede gradually from the post-Katrina peak (above $3.00 per gallon) but remain historically high across the forecast horizon. We also assume that persistently higher prices for natural gas will make their way into the prices for residential gas and electric service as utilities gain regulatory approval to raise their rates.
We expect core inflation to firm up to some degree, particularly in 2006, reflecting tight labor markets and stronger growth of hourly compensation as well as some pass-through of high energy prices. Core consumer price inflation is likely to rise from year-over-year rates of slightly below 2% in the third quarter of this year to about 2.5% by 2007. That pace may be around the upper end of the Federal Reserves “comfort zone.”
The interest rate structure is firming up
The apparent strong forward momentum of the U.S. economy, along with the prospects for higher headline and core inflation, apparently have steeled Federal Reserve resolve to keep the inflation situation under control and have sent long-term rates upward.
In recent weeks, various Fed spokespersons have stressed the evolving inflation threat, and another quarter-point rate hike at the next Federal Open Market Committee (FOMC) meeting on Nov. 1 seems a foregone conclusion. Furthermore, we’re assuming additional rate hikes at the Dec. 13 and Jan. 31 meetings, as Fed Chairman Alan Greenspan’s term runs out. We’re assuming the 4.5% funds rate will be considered “neutral” and that monetary policy will hold steady for some time.
The bond markets apparently share the Fed’s perspectives on economic growth and inflation, and market expectations for monetary policy are essentially the same as ours. As a result, long-term interest rates have backed up considerably from their post-Katrina lows and the long-term home mortgage rate edged over 6.0% in the second week of October. Our forecast shows some additional increase in long-term rates in coming quarters — with the home mortgage rate reaching 6.6% by the fourth quarter of 2006.
The housing market may have peaked
Housing market indicators painted a fundamentally positive picture through the pre-Katrina period (essentially through August). For the post-Katrina period, NAHB’s single-family Housing Market Index fell by two points in September but regained that loss in October, leaving the index somewhat below the cyclical peak in June. The weekly index of applications for mortgages to buy homes (Mortgage Bankers Association series) was essentially flat throughout August, September and early October (four-week moving average basis).
Everything considered, it seems fair to say that single-family housing activity has been toying with a cyclical peak and is poised to show some fade before long. Measures of home-buying affordability have been eroding in the face of ongoing rapid increases in house prices in many areas, and the recent upshift in short- and long-term interest rates figures to take some toll as well. Furthermore, there’s a good chance that those “exotic” forms of adjustable-rate mortgages are losing some luster under the public scrutiny of federal financial regulators and the rating agencies. Finally, there’s some tentative evidence of decline in the investor shares of purchases of single-family homes and condo units, and this component of demand can be quite fragile.
The housing outlook remains quite positive
NAHB’s forecast shows a slight decline in total housing starts in the fourth quarter of this year, partly because of hurricane effects in the Gulf region, and we expect total starts to be down moderately in both 2006 and 2007, despite hurricane-related additions.
Our forecast for 2006-2007 shows a cumulative decline of 9% in single-family starts from the 2005 record. The multifamily sector is essentially flat in this forecast, thanks primarily to a good performance by the rental sector. We expect manufactured home shipments to pick up significantly in coming quarters, reaching 150,000 units in 2006 before settling back toward a pre-Katrina pace. Residential remodeling should post solid growth (in both nominal and real terms) throughout the forecast period, supported by a massive amount of home owner equity and swollen repair/improvement needs in the wake of the hurricanes.
Everything included, the residential fixed investment (RFI) component of GDP should soon move out of the strong “growth engine” category occupied since the 2001 recession, although the real value of RFI should remain within a few percentage points of the record high reached in the third quarter of this year.
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 Oct. 19 edition. To subcribe to “Eye on the Economy,” click here
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