Eye on the Economy: The Housing Outlook Has Darkened
Incoming economic data indicate that economic growth for the second half of this year is likely to be somewhat slower than we have been expecting, reflecting a weaker housing market and mildly disappointing performances by a few other sectors. Despite these downward revisions, we expect overall GDP growth to average about 2.5% in the second half and to move up to a trend-like pace (around 3%) in 2007.
The below-trend run of GDP growth that emerged in the second quarter of this year is taking some toll on labor market conditions, reflected in a slowdown in payroll job growth and a recent uptick in the unemployment rate.
Our revised forecasts for overall economic growth point toward maintenance of modestly below-trend employment growth and a slight further upward adjustment to the unemployment rate over the balance of this year and into 2007.
The Economic Slowdown Will Relieve Upward Pressures on Core Inflation
The above-trend run of growth in GDP and employment that we experienced in recent years has been generating upward pressures on labor costs and core inflation (excluding food and energy). The recent and impending slowdowns in these measures of the “real” economy certainly will diffuse some of the inflation pressures, heading off potentially damaging “overheating” of the U.S. economy and paving the way for additional years of solid economic expansion.
The recent news on core inflation has been reasonably good, considering the upward momentum that’s been developing for some time. The core Producer Price Index for finished goods actually fell in August for the second consecutive month and the year-over-year pace receded to less than 1%.
Of even more importance, the core Consumer Price Index (CPI) registered a 2.9% annual rate in August, the same as in July and below the pace seen in the March-June period. Although the recent rates still exceed the upward bound of the Federal Reserve’s implicit comfort zone for the core CPI, the deceleration bodes well for inflation down the line.
The Fed Stays on Hold and Long-Term Rates Recede
As we expected, the Federal Reserve held short-term interest rates steady at the Sept. 20 meeting of the Federal Open Market Committee (FOMC), maintaining the 5.25 target for the federal funds rate. The FOMC statement highlighted the ongoing “moderation” in economic growth, the ongoing “cooling” of the housing market and the likely moderation of inflation pressures over time.
The way things are going, stable monetary policy is the best bet for the balance of this year and the early part of 2007.
The current monetary policy stance, the prospects for stable policy for some time, the slowdown in economic growth and the reassuring news on core inflation have combined to generate a decent bond market rally. Yields on long-term Treasury securities and home mortgages have come down significantly from their mid-year highs, and we’re projecting a reasonably stable interest rate structure for some time into the future.
The Housing Downswing Still Is Underway
Data received in recent weeks clearly show that the downswing in housing market activity still is underway. Housing starts for August were down by 6% from a downwardly revised reading for July and stood 20% below a year earlier. Building permit issuance was down by 2.3% in August and stood 22% below the previous year. Indeed, single-family permits are now down by 25% on a year-over-year basis.
NAHB’s single-family Housing Market Index declined by three more points in September to a level of 30. This compares to a cyclical high of 72 in June of last year, and the current HMI is the lowest since February 1991 (within the 1990-1991 economic recession).
On a brighter note, the weekly index of applications for mortgages to buy homes (Mortgage Bankers Association series) perked up a bit during the first half of September, however this measure remained about 21% below a year earlier (four-week moving average basis) and doesn’t signal a fundamental turn-around in the housing market.
The Housing Outlook Has Darkened Somewhat, But the Adjustment Is Needed
The downward momentum in key measures of housing market activity has prompted some downward revisions to NAHB’s forecasts of home sales, housing starts and house price appreciation for the balance of this year and in 2007.
We’re now showing year-over-year declines in total housing starts of roughly 12% for both 2006 and 2007, and some decline in national average home prices has become a real possibility.
The evolving housing downswing must be viewed in the context of the unsustainable housing boom of 2004-2005. The single-family and condo markets got grossly overheated in many areas and an extended “cooling” process (to use the Fed’s terminology) became inevitable. The markets are now saddled with heavy inventory overhangs, investors/speculators are in retreat and housing affordability measures still are depressed.
I recently testified in the Senate on “The Housing Bubble and Its Implications for the Economy.” I sketched out a likely pattern of “payback” for the 2004-2005 excesses as well as a healthy sustainable trend that housing would approach by late-2008. Stay tuned.
Housing Continued to Bolster Household Balance Sheets Through Mid-Year
On Sept. 19, the Federal Reserve released its estimates of the household sector balance sheet at the middle of this year. In a nutshell, the estimates show ongoing growth in household assets as well as net worth (assets less liabilities), although at a slower pace than earlier in the economic expansion.
With respect to housing, the Fed’s estimates show a year-over-year gain of 10.5% in the market value of homes owned by households, a 12.6% rise in home mortgage debt and an 8.7% gain in owner’s equity.
The ratio of mortgage debt to the market value of homes moved up to 45.9%, compared with 45.1% at the middle of last year, although neither the change nor the level is alarming at this point.
The “holding gains” on household real estate from mid-2005 to mid-2006 came to nearly $1.7 trillion, although the quarter-to-quarter changes decelerated during this period. A further slowdown is inevitable in coming quarters as house prices continue to slow and possibly even decline to some degree, and the lower production levels now in train will also take some growth out of household real estate holdings.
As a result, the powerful housing wealth effect on consumer spending will be losing some strength over time, although the weakening process should be gradual and spread over an extended period of time.
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 Sept. 20 edition. To subcribe to “Eye on the Economy,” click here.
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Want to Know Your State's Starts Forecast for 2007?
Find out in HousingEconomics.com’s State Starts Forecast (sample). The starts forecast includes downloadable Excel tables of total, single-family and multifamily starts by region and state.
To learn more, visit www.housingeconomics.com.