Eye on the Economy
The Economy Has Regained Its Stride Following the Late-2005 Stumble
The “advance” report on GDP for the final quarter of 2005 showed an alarming slowdown in economic growth to an annualized rate of only 1.1%. It now appears that fourth-quarter growth will be revised up to about 1.5%. Still a weak performance, but it’s pretty clear that several major causes of the weakness were temporary — including downshifts in both auto sales and federal spending.
Incoming data for the first quarter of 2006 point toward a major rebound in economic growth. Indeed, it now appears that GDP growth could exceed 5%.
It’s true that some of the early-year strength in spending and production reflects a swing from unusually bad weather in December to outlandishly good weather in January. But, everything considered, the economy appears fundamentally sound and GDP growth should settle into a healthy and more sustainable range before long.
Labor market conditions actually have been improving all along, and the outlook definitely remains positive for job growth and the unemployment rate.
The Fed’s Economic Projections Look a Lot Like NAHB’s
Ben Bernanke became chairman of the Federal Reserve Board on Feb. 1 and he delivered the Fed’s semiannual Monetary Policy Report to the Congress in mid-month. Bernanke’s testimony painted a positive picture of the current condition of the U.S. economy. He also expressed comfort with the Federal Open Market Committee’s (FOMC) economic projections for 2006-2007 that were contained in the Fed’s formal report to Congress — the kind of endorsement seldom (if ever) offered by the former Fed chairman, Alan Greenspan.
The FOMC’s economic “projections” may also be viewed as the intentions or preferences of the Fed’s policy-making committee. In any case, the central tendencies of the projections for real GDP growth, inflation and the unemployment rate are close to NAHB’s current baseline (most probable) forecasts for 2006-2007.
Those forecasts depict trend-like GDP growth in both years (a bit slower in 2007), core PCE (personal consumption expenditures) price inflation around 2%, and an unemployment rate in the 4.75%-5.00% range in the final quarters of both 2006 and 2007.
The New Fed Chairman Paves the Way for More Monetary Tightening
Bernanke has yet to chair a meeting of the FOMC, but his mid-February monetary policy testimony gave a pretty good indication of which way he will be leaning at his first FOMC meeting on March 28. He emphasized upside risks to the outlook for economic growth and stressed the Fed’s paramount responsibility to maintain price stability — factors that tend toward more monetary tightening.
At the same time, Bernanke stressed that further changes in monetary policy will be highly data-dependent — a message that also had been delivered in the FOMC statement of Jan. 31 (Greenspan’s last meeting).
Since economic momentum is likely to be impressive during the first quarter, and since core inflation continues to run close to the upper bound of the Fed’s implicit comfort zone, it’s highly likely that the Fed will enact another quarter-point rate hike on March 28 (raising the federal funds rate to 4.75% and the bank prime rate to 7.75%). There’s a significant probability of yet another rate increase at the May 10 FOMC meeting, although NAHB’s forecast does not yet incorporate that step.
Bernanke Expects a Soft Landing for Housing, But Highlights Downside Risks
In his mid-February congressional testimony, Bernanke noted recent signs of softening in the housing market, including slowing home sales, rising inventories and turndowns in indicators of home builder and home buyer sentiment.
He also stressed that “some cooling of the housing market is to be expected and would not be inconsistent with continued solid growth of overall economic activity.” That assessment is entirely consistent with NAHB’s outlook.
Bernanke went on to highlight downside risks to the outlook for modest softening of the housing market, and he stressed that “the Federal Reserve will continue to monitor this sector closely.”
The chairman noted the “substantial gains in house prices and the high levels of home construction activity over the past several years” and conceded that “prices and construction could decelerate more rapidly than currently seems likely.” He also noted that slower growth in home equity, in turn, could lead households to boost saving and trim consumer spending by more than currently anticipated.
The minutes from the Jan. 31 FOMC meeting also expressed concern about downside risks to the housing market. The minutes noted that home price appreciation reportedly had slowed noticeably in some areas, highlighting the risks to aggregate demand of a pullback in the housing sector.
Some FOMC members felt that the effects of an end to rising house prices were “potentially sizeable,” and that the negative effects could be compounded by rising debt-service costs as variable-rate mortgages are reset at higher rates.
January Rebounds in Housing Starts and Building Permits Do Not Invalidate the Housing Slowdown
The evolving slowdown in housing market activity from the highs reached in the third quarter of last year was interrupted by surprisingly large rebounds in housing starts and permit issuance in January (reported after Bernanke’s monetary policy testimony).
However, the rebounds obviously were associated with a massive swing in weather conditions — from unusually bad conditions in December to the best January weather conditions on record. There’s no doubt that the January surge in starts/permits was “full of hot air” and primarily represented acceleration of building that would have occurred later.
The bulk of evidence on housing continues to depict cooling market conditions from unsustainable highs last year. NAHB’s single-family Housing Market Index fell substantially during the second half of 2005 and held steady in both January and February of this year.
Our surveys of builders also reveal a modest upshift in sales cancellations along with efforts by builders to maintain sales and limit cancellations as demand ebbs. With respect to demand patterns, the index of applications for mortgages to buy homes (Mortgage Bankers Association series) is now down by nearly 17% from the recent high reached around the end of September 2005.
Builders Are Fighting Back as Housing Demand Ebbs
A nationwide survey of nearly 500 single-family home builders, conducted by NAHB in January, identified a range of measures being taken to support sales and limit cancellations. Most builders prefer not to trim asking prices when demand ebbs, but our January survey picked up some price cutting in response to growing buyer resistance to elevated market prices. Nineteen percent of respondents said they had reduced prices to maintain sales volume, and the average cut was 5%.
Some builders have reacted to growing price resistance by adjusting their production mix. Indeed, 32% of respondents to NAHB’s January survey said they were placing more emphasis on lower-priced models and less emphasis on high-priced models in current and planned production.
Furthermore, one-third of builders said they had increased their use of Realtors®/brokers in an effort to maintain sales at current prices — a strategy that can bolster sales but doesn’t deliver cost advantages to buyers.
Builders also have cranked up various non-price sales incentives offered to prospective buyers. In order of importance, the incentives were as follows:
- Include optional items in homes at no cost (41%).
- Pay closing costs (31%).
- Pay up-front financing points (15%).
- “Buy down” mortgage interest rates (8%).
The average value of incentive packages (often including several types) was about 2.5% of the sales price.
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 Feb. 22 edition. To subcribe to “Eye on the Economy,” click here
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Attend the Spring Construction Forecast Conference in April
Plan to attend NAHB's Construction Forecast Conference on April 27 at the National Housing Center in Washington, D.C. The conference brings together the nation's premier housing economists and finance experts for an in-depth examination of the economic outlook for the housing industry.
For more information, visit www.nahb.org/cfc.
Give Us Your Perspective on the NAHB Economics Blog
Give your economic perspective on NAHB's economics blog, “Seiders on Housing,” an informal Internet-based forum dealing with economic issues, housing trends, survey research and other topics affecting the housing sector of the economy.
Log onto the blog at http://nahbblog.blogs.com and get direct access to NAHB Chief Economist David Seiders' expert opinions, projections and responses. Then let Seiders know what you think.