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Eye on the Economy: Housing Production Should Bottom Out Soon
 Growth of U.S. economic output (real Gross Domestic Product) has slowed to some degree in recent quarters as the housing production component (residential fixed investment) has contracted substantially.
However, the housing contraction has not generated serious spillover effects in other sectors of the economy (including personal consumption expenditures), and strengthening activity in some sectors, including nonresidential construction and foreign trade, has helped offset the negatives from housing.
As a result, the economy has not skated close to recession and the probability of an economic downturn in 2007 is not high.
Economic resilience also is evident in the labor market. The housing downswing certainly caused job losses in residential construction during most of 2006, and further losses are virtually inevitable during the first half of this year. However, overall job growth was well maintained in 2006 and we’re expecting a solid performance in 2007 as well.
The unemployment rate is likely to gravitate upward from recent expansion lows, but remain in a historically low range.
Core Inflation Has Begun to Recede, Right on Schedule
Key measures of core consumer price inflation (excluding prices of food and energy) firmed up during most of 2006, moving well above the upper bounds of the Federal Reserve’s apparent “tolerance zones.”
This inflation pattern naturally raised concerns about economic “overheating” at our central bank and prompted financial market participants to anticipate some tightening of monetary policy in the near term.
As 2006 drew to a close, core inflation rates began to recede, at least on a year-over-year basis. The core Consumer Price Index slowed systematically during the fourth quarter, receding to a pace only slightly above the upper bound of the Fed’s apparent tolerance zone for this measure.
The evolving slowdown in core inflation actually had been projected by the Federal Reserve, and this pattern is an integral part of NAHB’s forecast for 2007. The recent and projected improvements on the inflation front reflect modest slowdowns in growth of real GDP and employment as well as dissipation of some special factors that elevated core inflation last year.
The Interest Rate Structure Remains Historically Low
The Federal Reserve has held its target for the federal funds rate at 5.25% since mid-2006, a level that’s around a “neutral” monetary policy stance in the prevailing inflation environment.
We expect the Fed to maintain this funds rate target until the late-June meeting of the Federal Open Market Committee (FOMC), and we anticipate a quarter-point rate cut at that time — in order to keep the “real” funds rate from rising as core inflation recedes.
Long-term interest rates have firmed up to some degree in recent weeks as incoming data on the economy have been surprisingly strong.
Even so, long rates remain quite low on a historical basis and significantly below the recent highs in mid-2006. Indeed, the long-term home mortgage rate recently has been hanging around 6.25%, half a percentage point below the mid-2006 level.
Despite the recent firming of long-term rates, the Treasury yield curve still is inverted across much of its range — a pattern that may not be sustainable for much longer. NAHB’s forecast shows an essentially flat Treasury yield curve by late this year, at least out to the 10-year mark, as short rates recede and long rates move up modestly.
Housing Demand Apparently Stabilized Late Last Year
A healthy job market, good growth in household income and a favorable interest rate environment certainly provided support to housing demand in the latter part of 2006. Furthermore, widespread price cuts and deepening nonprice sales incentives (documented by NAHB surveys) gave further support as the year drew to a close.
Seasonal adjustment difficulties generally complicate interpretation of housing market data during the winter months, and this time is no exception. Weather conditions were unusually harsh last October and unusually mild in both November and December. Even so, it appears that housing demand stabilized in fundamental terms toward the end of 2006, and some improvement may now be underway.
The October-November averages for sales of both new and existing single-family homes were up a bit from their third-quarter averages, and new home sales increased in December.
Furthermore, NAHB’s single-family Housing Market Index — incorporating survey readings for current and expected home sales as well as for traffic of prospective buyers — continued to edge up in January. The January HMI came to 35, up from a low of 30 last September. The weekly series by the Mortgage Bankers Association on applications for mortgages to buy homes also supports the proposition that housing demand has stabilized, despite well-known seasonal adjustment issues.
NAHB’s proprietary monthly survey of 30 large home builders — accounting for about one-fourth of the total for-sale new home market — also provides reassuring signals on the demand side of the single-family market during the final months of 2006. These data, seasonally adjusted, show a flattening of gross sales, a falloff in cancellations and a modest improvement in net sales late last year.
Housing Production Should Bottom Out Before Long
Stabilization of housing demand (net sales) is the essential first step toward completion of the dramatic housing “correction” that has followed the unsustainable housing boom of 2004-2005.
The second step is to work down an excessive inventory overhang in markets for both new and existing housing, and the final step is to bring housing starts and residential construction activity back up to sustainable trend levels.
Since housing inventories can’t be moved around, it’s inevitable that housing starts and residential construction will start moving up in some areas while heavy inventories continue to hold down new production in other areas.
Indeed, NAHB’s forecast anticipates an upturn in national housing starts by the second quarter of this year and a turnaround in residential fixed investment by the third quarter despite the persistence of an unusually large national inventory overhang for some time.
NAHB’s forecast depicts a gradual recovery in national housing production through 2008 as inventories are worked down in more and more markets and housing starts approach our estimate of sustainable trend — about 1.85 million units per year.
During the recovery process, residential fixed investment will swing back to a positive contributor in the GDP growth equation long before housing production is back to trend.
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 Jan. 24 edition. To subscribe to “Eye on the Economy,” click here.
 Want to Know the Housing Starts Through 2015?
Find out in HousingEconomics.com’s Long-Term Forecast.
HousingEconomics.com includes downloadable Excel tables featuring the housing starts forecast, GDP, demographics and more.
To learn more, visit www.housingeconomics.com.
 NAHB Kit Gives Builders Back-to-Basics Tips in Cooling Market
With the current cooling of the nation’s housing market expected to persist into the middle of next year, NAHB has developed a comprehensive online toolkit geared to providing association members with information that will help them prosper in today’s changing business environment.
To access the “Back to Basics” toolkit, you must be an NAHB member and have a login to www.nahb.org. To create a login, go to www.nahb.org/login or click on the log-in button on the main menu bar.
For assistance, call the NAHB Member Service Center at 800-368-5242.
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